UBS: A volatile start to 2016 - What has happened?

CIO believes that the six month outlook for equities remains positive, supported by solid economic growth in the large developed nations, and rising corporate profits. But the unusually turbulent start to 2016 trading sets the tone for what is likely to be another volatile year. In a low growth environment, markets are still evaluating the ability of global central banks to help stimulate growth now that the US Federal Reserve has begun to hike interest rates. This uncertainty is likely to accentuate volatility in 2016. We will need to remain vigilant for signs of deterioration in the prospects for global markets, with credit spreads, global economic indicators, the path of the Chinese renminbi, and the Middle East in particular focus. But for now, we do not believe the fundamental situation has materially changed enough to warrant a shift in positioning. In our global Tactical Asset Allocation (TAA), we remain overweight in Eurozone equities, Japanese equities, and European high yield credit against high grade bonds.

What is driving current price moves?

China: The 7% slump in onshore Chinese equities appears to have been led by technical factors, as government efforts to prop up the market from the summer of 2015 now lapse. In particular, a rule preventing investors who hold more than 5% of a company's free-float stock from selling is scheduled to expire on Friday, having been in place since the middle of last year. This may have driven some retail investors to reduce exposure ahead of potentially large institutional sales later in the week. A sharpfall in the Chinese currency against the US dollar added to investor anxiety. 

Mixed economic data may have also contributed to negative sentiment. The Caixin manufacturing purchasing managers‘ index (PMI) fell below expectations, signaling the 10th consecutive month of contraction. Still, the data did not mark a significant deterioration, and the official non-manufacturing PMI pointed to the strongest level of activity since August 2014. Othermeasures, such as retail sales, remain robust.

Oil / the Middle East: Markets were further unsettled by Saudi Arabia's decision to sever diplomatic links with Iran following demonstrations over the execution of a Shia cleric. Bahrain, Sudan, and the United Arab Emirates also scaled back diplomatic ties with Iran. Investors were further troubled by the Islamic State’s territorial encroachments in Libya, which are nearing oil installations.

Economic data: The soft tone was reinforced by US economic figures that showed the manufacturing sector slowing to its weakest pace since 2009. That said, the details of the report were more favorable, with production and new orders components both edging up. In the Eurozone, Markit’s manufacturing PMI hit its highest level since April 2014. Every country in the zone registered rising output and job creation in December.

Where do we stand?

We do not believe that the fundamental economic backdrop has materially changed. At a global level, services sectors continue to perform well, while manufacturing remains troubled. China's growth is slowing, but it is transitioning toward a consumer-led economy. Growth in the developed markets is uninspiring but positive. The sharp decline in oil prices is creating dislocations in some credit markets, but ultimately should benefit consumers. Emerging markets remain beset by political concerns and issues with their cost of financing, but the malaise is not translating into crisis.

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