Economic Update - July 2016

Economic Update - Richard Wallis - Head of Research & Investment - Origen


Whilst all the headlines from the first half of this year will undoubtedly focus on the Brexit vote and the UK’s surprise decision to leave the EU, the beginning of 2016 was also notable for its own high levels of volatility.

H1 2016 Index Performance Graph - sourced for Lipper 

An awful start to the year

January was notable for being the worst ever start to a year for many global stockmarkets with high levels of volatility continuing throughout the month. Markets saw sharp falls at the beginning of the month as their direction was driven by sentiment as opposed to fundamentals. The key reasons were concerns over global growth and the state of the Chinese economy, together with the ongoing fall in commodity prices with in particular, the oil price plummeting to multi-year lows. 

China’s authorities had surprised investors by weakening their currency, the renminbi, which sparked wider concerns that they were worried that their economy was undergoing a more protracted slowdown than they had previously expected. Although China’s policies may have been the catalyst for the early declines, a broader driver of the lower risk sentiment was the sharp falls seen in oil prices, which fell almost 30% at one point in January from its starting price at the beginning of 2016. These declines caused a sell off in credit issues linked to the energy sector, which in turn led to losses in financial equities as investors speculated as whether (and which) banks may suffer losses as a result of increases in non-performing loans. 

In the second half of January, risk sentiment improved which led to the recovery of some market losses following supportive rhetoric from the European Central Bank (ECB) at its first policy meeting of the year. Likewise, some Federal Reserve board members adopted a more dovish tone, although overall the Federal Open Market Committee left open the prospect of near-term interest rate rises. Finally, at the end of January, the Bank of Japan made the unexpected decision to follow Europe into cutting interest rates into negative territory in an effort to increase credit creation, spending and, therefore, boost inflation.

Another month of two halves 

February ended up following a similar pattern to January as the first half saw global markets again fall sharply and despite a strong rally in the second half, many indices still ended the month lower. Investors refocused on concerns over slowing global growth and these fears were reinforced by the expectations from the previous month that a US interest rate rise was now unlikely in the short-term. Japan was another focal point for investors as following its move to a negative interest rate at the end of last month, there was a surprisingly adverse impact on its market and whilst the Bank of Japan quickly announced that it had the capacity for further easing measures, the Yen still strengthened owing to its perceived safe haven status. China remained firmly in investors’ sights as the end of February saw the People’s Bank of China deliver further stimulus as it cut reserve requirements for leading banks by 0.5% in a bid to support growth and further measures are expected to be announced in due course. The oil price also stabilised following its recent falls as a number of countries, including the heavyweight producers Saudi Arabia and Russia, agreed to freeze output at January’s levels.

Probably the key news that came out of February was the confirmation that the UK Prime Minister, David Cameron, had reached an agreement on his proposals with the leaders of the Eurozone countries and kick-started the campaign to keep Britain in Europe with the Referendum vote to take place on 23rd June.

The calm before the storm?

As we moved through the middle months of the first half of the year, many equity global indices recovered some of their losses from their difficult start to the year. Investor sentiment rebounded following the announcement of a larger than expected stimulus package by the ECB, including cuts to all its various interest rates, together with an expansion of its Quantitative Easing programme.

Markets also benefited from improving US economic data, which included a surprise upwards revision to Q4 2015 economic growth that helped shrug off the recessionary fears, whilst the continued stability in the oil price was also a positive influence as it recovered to an extent from its lows earlier this year. The US Federal Reserve also adopted a more dovish stance as it changed its expectations to only two rate rises this year as opposed to the original four.

There was also positive news from China where the government claimed that they would continue to support equity markets when required and this also benefited investor sentiment as did data that suggested the economy had stabilised somewhat. In the UK, the budget saw a downgrade to the forecast for economic growth in 2016 from 2.4% to 2%, a move that was given support by the first estimate of GDP growth for the first quarter of 0.4%, down from 0.6% previously. There also continued to be a steady recovery in the oil price as it reached its highest level since late last year when it almost touched $50.


Towards the end of May and the beginning of June, newsflow began to be dominated by the UK’s referendum on its membership of the EU. In the lead-up to the vote on 23rd June, markets had been volatile as the campaigning for both Leave and Remain grew ever more intense. During this time, momentum had been swinging towards a Leave vote, but in the final days before the vote opinion polls suggested a win for the Remain camp and this contributed to a rally in markets in the days leading up to 23rd June. 

Markets were, therefore, completely wrong-footed by the UK’s decision to vote for a Brexit and this resulted in the sharp sell-off on 24th June with the UK unsurprisingly severely hit. However, a response from Mark Carney, the Governor of the Bank of England, in particular helped the FTSE 100 recover its losses by the month-end. The FTSE Mid 250, which is more indicative of the UK economy, remained firmly lower though as it suffered the bulk of the losses. The UK market was not alone though as global markets suffered their biggest single drop in a day on 24th June since 2007, though this was mainly in developed regions with Asia and Global Emerging Markets suffering to a lesser extent.

Following the Brexit vote outcome, as expected Standard & Poor’s lowered the UK’s sovereign credit rating from its prized ‘AAA’ level to 'AA' with the Brexit vote the reason behind this decision. It is now widely anticipated that the US Federal Reserve would delay raising interest rates, potentially until next year, on the back of the uncertain global conditions. The European Central Bank (ECB) also stated that it was prepared to use policy measures should it see any signs of stress in order to try and prevent it having any impact on the nascent recovery in the Eurozone. June also saw the start of the ECB’s corporate bond purchases, which forms part of their overall €80bn monthly programme that also includes government debt and other highly rated fixed interest instruments.

Overall market performance and its impact on clients

There is no doubt that the first six months of this year proved to be a difficult period for markets and investors. The start of 2016 saw most global markets fall sharply with a recovery only really being sustained from the end of February. However, the closer we moved to the EU Referendum, the higher the volatility and though markets in the lead up to the vote seemingly priced in a Remain victory, the surprise win for Leave saw very sharp falls. 

Even with the recovery at the end of June, most equity markets ended the first half of the year lower. The US S&P 500 Index did manage a gain, but there the UK market was split with the internationally-biased FTSE 100 amongst the better performers as it also rose, but there were losses for the more domestic mid-cap index. Having endured a difficult 2015, there was better performance so far this year from Emerging Markets as the broad index posted a small gain, though there were differing regional performances, but these areas should be less affected by Brexit whilst any delay to rising US interest rates is viewed as positive. Europe and Japan have been particularly hard hit this year with their indices amongst the worst performers with some even showing double-digit losses.

However, for UK investors and our clients, the sharp falls in the value of sterling following the Leave victory does mean that the returns from international markets have been boosted with even those indices sharply lower showing much better returns when converted into sterling.

Outside of equities, the strongest returns came from the perceived ‘safe-haven’ government bonds as indicated by the near 10% return from Gilts in the first half of the year. The oil price has also rallied from its lows seen earlier in the year and has posted a gain  of over 26% for the first half of 2016 whilst Gold has also benefited as it produced a return nearing 25%. Property has, however, started to endure a more difficult period as increasing outflows leading up to the Referendum and the subsequent ‘Leave’ vote has led to concerns over liquidity.

Looking forward into the second half of the year, it is highly likely that markets will remain volatile until the path towards the UK leaving the EU becomes clearer and this is unlikely to be an immediate event with the possibility that negotiations will be difficult and protracted. As a result, monetary policy is likely to remain very loose with interest rates probably heading lower from their already record low of 0.5%. Outside of the UK, there are other events that could also impact on markets, including but not limited to the US Presidential Election and the Italian referendum on reforms in October.

As always, we would like to reiterate that any asset-backed investment whether it is equities, fixed interest or property, should be viewed as long-term in nature. When we see volatile conditions and/or periods of falling values, it can be worrying but it is always important not to panic and make a knee-jerk reaction. We continue to believe that a blend of different asset classes, with the allocation being dependent on the level of risk and objectives, will offer the best protection in more difficult periods for markets.

[ Date Posted: 22/07/2016 11:30:14 ]