“Investors should question the stories around market volatility”

29th February 2016

Colin McLean, managing director at SVM Asset Management explains why investors need to take deeper look at what is going on across the banking sector…

The best market signals are not to be found in headlines. It’s easy to believe that the latest economic data from China, or views about European Central Bank intervention, explain investor behaviour on any particular day.

To understand current market volatility investors should focus instead on key signals in the bank sector.

Central banks may not be in control of events. The Bank of England has voiced inflation fears for more than two years, with little supporting evidence.

And, as the effectiveness of monetary policy has waned, central banks have changed tack. Some have turned to actively using currencies, others to fiscal policy. Central banks have implemented many useful policies since the crisis, but it remains a job half done.

Some of the new fears for the market stem from regulatory action. Banks have refinanced using debt instruments that are relatively new and poorly understood.

Liquidity in some has now fallen sharply – particularly in bonds issued by Italian banks.

Although the EU plans to create a uniform and protected banking sector – a full banking union – this is still in its early stages.

Banks in Italy, Spain and Greece continue with significant exposure to guarantees by their own governments. Investors are beginning to recognise that hurdles remain ahead, before fully spreading banking risks.

Banking union is a big project that requires confidence to be sustained in it for several years. Even Germany has risks to defuse.

The bank sector and bond markets are key barometers for the global economy and may offer better signals than commodities or shipping activity.

Investors should also pay attention to global inflation statistics. Disinflation in recent years has been remorseless, and points to the lack of productive new capital investment. This has hit wage growth and the share of wages in national income in many countries.

If this is to change, it’s likely to happen first in the US and Germany. They need to reflate; in the US to boost world demand and the supply of dollars, and in Germany to allow adjustment within the straight-jacket of the euro.

Investors need to think carefully about their sector exposure, particularly if dividend income matters, as deflation would bring dividend cuts. Oil majors and commodity groups are already under strong pressure to reduce pay-outs. Other sectors such as pharmaceuticals and tobacco could prove more resilient.

Investors must look at their share investments in the context of their overall financial planning. Portfolios should be structured to reduce the need to sell after stockmarket set-backs.

Even bear markets have good days, giving opportunities to reposition.

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