Global volatility drivers: Looking beyond China
January 14, 2016
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With securities markets suffering from a so-called January hangover, investors appear to be doing everything in their power to “get out of the way” until visibility improves. Indeed, a lot of discomforting data are coming to light, and volatility is setting in.
In the spirit of helping investors understand some of the developments that are driving this market behavior, here are three charts that help explain some of the turmoil happening right now.
Chart 1. High yield spreads
Here’s a look at the ramp-up in risk premiums in the high yield market over time. Throughout many of the spikes shown, market participants were challenged to interpret the root causes, and the most recent pop in spreads is no different; many analysts and media outlets attributed it largely to concerns about deteriorating business conditions in China. However, we believe this event is more about the enormous global debt and growth challenges, and that China is just one piece of the shrapnel that is flying around.
Data: BofA Merrill Lynch, via Federal Reserve Bank of St. Louis. Daily observations.
Chart 2. In China, policy levers not as potent as they may seem
In this analysis, Royal Bank of Scotland strategist Alberto Gallo shows that China’s enormous cache of reserves (which many economists argue can smother any economic or financial slippage) will be challenged to accommodate the country’s current circumstances. In other words, Chinese officials will have to use this ammunition smartly and efficiently. As shown, Gallo’s estimate for losses related to nonperforming loans is substantial.
Source: RBS Macro Credit Research, NBS, IMF, Bloomberg.
Chart 3. The effects of surging global debt
In a world that is loaded with debt (and challenged to service that debt without the benefit of healthy economic growth), central bank activities have taken center stage. Investors are focusing on central bankers’ efforts to monetize this debt, as well as the overall effectiveness of such monetization. With the U.S. Federal Reserve enacting a tighter monetary regime during the past two years (via its decision to begin tapering its aggressive bond-buying program), harmful second-order effects are exacerbating the situation.
Currency and commodity pressures, for instance, are causing former accumulators of currency reserves and sovereign wealth to reverse course.
As depicted here, liquidity measures by central banks like the European Central Bank and the Bank of Japan have been countered by the aggressive selling of foreign reserves and sovereign wealth, as these entities contend with the Fed’s divergent path.
In the short term, we believe financial markets often overreact to negative news, and securities prices suffer as a result. Despite these near-term downswings, we invite you to join us in keeping a long-term perspective.
All charts shown are for illustrative purposes only.
The views expressed represent the Manager's assessment of the market environment as of January 2016 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds. The high yield secondary market is particularly susceptible to liquidity problems when institutional investors, such as mutual funds and certain other financial institutions, temporarily stop buying bonds for regulatory, financial, or other reasons. In addition, a less liquid secondary market makes it more difficult for the Fund to obtain precise valuations of the high yield securities in its portfolio.
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