Do investors need to batten down the hatches and prepare for more volatility?

14th December 2015


Investors need to batten down the hatches and prepare for further uncertainty across financial markets in 2016, financial adviser deVere Group has warned.

The caution from Tom Elliott, senior international investment strategist at the firm comes ahead of the US Federal Reserve’s highly anticipated interest rate announcement this week, and after the recent acrimonious OPEC meeting which triggered a collapse in the oil price.

Elliott said: “Investors should expect volatile financial markets in the first half of next year, as stock and bond markets learn how aggressive the Fed is likely to be in its monetary tightening.

“There are, however, a few safe bets. The European Central Bank (ECB) last week revealed itself to be less willing to expand its quantitative easing (QE) program than had been supposed, which somewhat undermines the strong dollar/ weak euro bet that underlies much stock and bond market asset allocation.”

While it is widely expected that the Fed will raise the cost of borrowing this month, the jury is still out in regards to what sort of impact higher rates will have on the US economy.

The hawks at the Fed want tighter monetary policy to prevent wage inflation taking off. They have cited reasonably stable – though hardly robust – economic growth and a shrinking unemployment rate as evidence that the economy needs to have more normal interest rates.

Elliot highlighted that in contrast however the doves, remain mindful of the low labour participation rate which helps keep wage growth low and they are concerned that if rate rise too fast and too soon, the move will hurt an economy that is weaker than headline GDP data suggests.

He added:  “If the hawks are right US and global developed stock markets should be able to see off a few 25 basis point (bp) rate hikes in 2016. Treasuries and other core global bond markets will weaken.

“If the doves prove correct, raising interest rates now may lead to a sell-off on US and global developed stock markets, as it becomes apparent that the Fed has committed a policy error. Treasuries and other core bond markets will recover quickly, as investors sell risk assets and we once again consider the prospect of recession and deflation in the US.

“Higher US borrowing rates will also be bad news for indebted emerging market economies. Not only will interest rates rise, but repayment costs in local currency terms will also go up as the dollar strengthens.

As a result Elliot believes that investors may well see further stock market underperformance from emerging market economies, particularly from those that rely on commodity exports for much of their foreign earnings.

“Meanwhile, the disarray at the recent OPEC summit highlights the likelihood of the ‘lower for longer’ theme that haunts energy and mining prices, and which is a disrupting force in the global economy and financial markets,” Elliot said.

The strategist asserted that in order to prepare for this expected wave of volatility in the first half of 2016, investors will need to ensure that their portfolio is properly diversified across asset classes, sectors and regions.

He said: “This will best position them to be able to take advantage of the inevitable upside that arises from volatility and to sidestep the risks.

“Many are likely to favour eurozone and Japanese equities over those of the US and emerging markets, on the grounds that structural economic reforms in both will deliver long-term domestic demand growth even if the benefits of QE are more questionable.

“In addition, they might also consider building up liquidity to use to buy into financial markets later in 2016, by which time, history suggests, markets may have regained some stability.”

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