Fears and fragility

Market volatility has increased again at the start of the year due to intensified worries over Chinese growth weakness, geopolitical tensions and a further fall of the oil price. Although a lot of bad news is already priced in, we prefer to maintain a cautious positioning.

Well-known fear factors are back on the table again…

After a somewhat calmer holiday season at the end of last year, investors might be forgiven for feeling they are playing a part in a new Groundhog Day movie after the first trading days of the year. In many respects the well-known fear factors from 2015 are back on the table again. Ongoing market fragility is reflected by a renewed spike in market volatility as intensifying worries over growth weakness in China, geopolitical tensions and oil price declines are on the headlines again. Also comparable to last year is that broad-based risk aversion in markets is not triggering massive safe haven flows into global government bond markets, as yields have only dropped modestly and are still trading close to their 3-month average.

Does this mean that nothing will change in 2016 and that we will all start feeling like Bill Murray walking through the village of Punxsutawney, with everything that already happened the day before (read: last year) happening all over again? Obviously we cannot exclude this, but it does seem highly unlikely. Change is the only constant in life and this will not be different for financial markets in 2016.

Still, many things look the same from both a fundamental and behavioural perspective. Global growth is steady with support from DM and risks in EM, China remains a crucial swing factor for both global trade and commodity markets, lack of supply constraints in the oil market continues to add fuel to the fire for commodity sensitive market segments (US HY, EMD, energy/materials sectors) and investor sentiment, and flows and positioning all continue to reflect a cautious tone.

…although the starting position is very different from last year

At the same time, there are some important differences that might well drive markets into patterns that are unlike those seen last year. Much stronger divergence in central bank policy (the Fed hiking, the ECB & BoJ still easing, mixed bag of hikes and cuts in EM space) is one of the most important ones. Furthermore, the degree of healing in DM labour markets is also much further progressed and the peripheral recovery is on a much stronger footing (even the Greek PMI is back above 50 again!). Also, the large repricing of EM assets last year and other oil-sensitive assets create a very different starting position compared to a year or even 6 months ago. As a result, much more misery is already priced in these market segments which dampens the degree to which further contagion into other parts of markets and the global economy could materialize.

While these differences provide some hope on a less volatile market backdrop for the upcoming year, it should also be noted that some new dark forces have emerged which cloud the horizon a bit more. Increasing geopolitical tension in the Middle-East (Saudi-Iran tension, on top of the war against IS and the Turkey-Russia dispute) is one factor, while also political fragility in Europe has increased again with the refugee crisis driving populism higher in many countries and pushing Brexit risk to all-time highs. Furthermore, Spanish and Portuguese politics are increasingly unclear again and the upcoming US elections seem more unpredictable than ever. And finally, the global corporate earnings growth outlook is more challenging than in the last three years.

We prefer to stay modest in our risk taking

With respect to our asset allocation stance this means that we will stay relatively modest in our risk taking. With limited signs of a near-term acceleration in either economic growth or profits and no signs yet of extremely cautious sentiment and positioning (which would be a contrarian signal) we therefore prefer a rather defensive positioning.