It was hard to miss headlines last week as markets tumbled in China, and the rest of the world felt the aftershock. On two separate trading days the losses in the Chinese stock market tripped a circuit breaker mechanism designed to shut down all trading for the remainder of the day at certain loss points. For the first time ever. The effects of these losses were felt in developed markets around the world.
The start of 2016 has been a rare occurrence in the marketplace. Never before has China (the world’s second largest economy) started the calendar year with such a drop. As a result, it is certainly one of the worst weeks we’ve seen to start a calendar year for the S&P, Dow and TSX also.
While the mass media might enjoy painting a doom and gloom picture, investors need to keep a level head. Yes, this will be a tough year for investors. But is it time to panic? No.
Rather, investors need to understand what is happening and why. We are in a low rate, low-growth economy in 2016 and going forward. The investor economy is changing. We are in a world of lower investment returns and increased volatility.
So what is happening in China anyway?
China has been a huge growth engine for nearly two decades and its engine is losing steam. As noted by Bruce Cooper, CFA Chief Investment Officer, TD Asset Management Chair, TD Wealth Management Allocation Committee, in Forward Perspectives, Risks from Abroad, “Massive investment in infrastructure projects, real estate development and manufacturing caused the economy to boom, growing at an average rate of 10% in the 1990’s and 2000’s. China was a key engine of global growth during this period and accounted for roughly 25% of global growth since 2000.”
There is a natural expansion and contraction cycle that occurs in all economies over time, and China has come to the end of this particularly large expansion cycle. They are now in their contraction phase. Their ‘old’ economy which has seen growth due to manufacturing and infrastructure will contract as they transition to their ‘new’ consumption and service based economy. An economy can only grow and expand for so long on manufacturing and infrastructure before they need to shift to consumption and service. It’s a natural progression.
The reason we feel it in Canada on the TSX and in other countries is largely because China has been such a big factor to overall global growth. As China slows and continues to have less demand on raw materials and commodities it will also impact the countries that produce these commodities – like Canada.
If this contraction is expected, why such a drop the first week in 2016?
There are a few theories for this, and numerous contributing factors. Some believe, as noted in the Globe and Mail, Global markets see one of the worst recorded starts to a year, the circuit-breaker mechanism itself “may have exacerbated the panic among Chinese investors, who faced being shut out of a suspended market. The losses in Chinese stocks then snowballed into developed markets.”
Many believe the markets are having an initial over-reaction to China. This 4 minute Bloomburg video Plurimi: Markets are Overreacting to China, addresses the current rebalancing of China's economy, the nature of its current growth, the value of the yuan and China's shift from being primarily manufacturing driven to service driven.
Kelvin Tay, regional chief investment officer at UBS Group, AG’s wealth management business in Singapore says, “Investors need to separate the sound from the noise.”
Key messages for investors
“The market action today was consistent with concerns about slow growth,” said Bruce Cooper, chief investment officer of TD Asset management last week. “From our perspective, it’s going to be a fairly challenging year for investors.”
For investors, uncertainty is always a sure thing. Volatility is here to stay.
The longer an investor lives through the different investment cycles, the more they become accustomed to the ups and downs of the market.
Younger investors sometimes don’t have the same comfort or understanding of volatility because it is new to them. They need to learn to understand it, invest within their risk tolerance, and use volatility to their advantage. Time is on their side.
Longer time, experienced investors typically have a better understanding of volatility since they have been through it. As Darren Farwell, director of wealth management at Scotiabank says, in RRSP investment choices for uncertain times, “We’ve lived through 1987, we lived through ’94, the Asian contagion, we lived through the tech boom and the tech bust, we lived through 2008 and 2009.” He notes, “Canada may be facing a low-growth environment in the near term and that means looking long term.”
The challenge for the older investor clearly becomes time. Volatility can be much more challenging when you have less time available before retirement. It is important for the investor nearing retirement to ensure they have some lower risk investment strategies in place, diversification in their portfolio, a cautious approach to asset allocation and some down-side risk management.
We are entering into an era of low rate, low growth, high volatility investing and it looks like it may be here to stay a while.
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Stephanie Farrow, B.A., CFP., Stephanie has over 20 years experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning and Certified Financial Planner designation. Stephanie has been writing a financial planning column for the local business magazine Elgin This Month since 2010. Stephanie and her husband Ken Farrow own Farrow Financial Services Inc. About our Farrow Financial Team.