Our Market View – Volatility Feb 2016

Our Market View – Volatility Feb 2016

Financial markets are once again making newspaper and TV headlines with the FTSE-100 index falling from highs of over 7,000 index points in April last year to levels which nearly touched 5,500 index points earlier this week. This sharp fall reflects greater uncertainties about the global economy which have impacted investor confidence.

Heightened equity market volatility is naturally a worry for all investors. However unlike the last period of sustained stock market falls between 2007 and early 2009 the UK economy is not currently anticipated to move into a recession. Earlier in February the International Monetary Fund confirmed that their expectation is for above 2% economic growth in both this year and 2017, a view reiterated last week by the Bank of England. Looking globally economic growth is anticipated in all other major developed countries around the world too. There are certainly imbalances in the global economy but currently they are much less extreme than back in 2007.

Part of the reason for this has been the experiences Central Banks, governments and private sector companies have all accumulated in the last eight or nine years. Additionally the Governor of the Bank of England believes that UK interest rates are highly unlikely to be increased over the next few months. These low interest rates support consumer spending and job creation.

We anticipate stock markets to start to stabilise globally as investors start to acknowledge some of these positives and realise that future opportunities still outweigh threats. The world’s growing consumer population provides a good medium-term underpinning for global growth and the high international orientation of UK businesses means they are well placed to benefit from this. Comments from many leading corporations in recent weeks support this view.

Finally most investors are likely to have a balance of asset classes represented in their portfolios. For example most bond markets have performed with relative solidity over recent weeks and this significantly dampens any volatility. Such diversification remains highly sensible for most investors.

In conclusion the day to day fluctuations of an uncertain stock market can cause huge concerns. History shows us that bouts of such volatility do occur. History also indicates that the key decision for investors during such times is not to panic but at least to retain the current diversified shape of their portfolios as periods of lowered returns are typically followed by periods of higher ones. Given the global economic backdrop outlined above we believe such a scenario is likely to play out once more.

This article is for information purposes only and should not be taken as advice.

Types of Risk

Inflation Risk

Inflation Risk is the chance that the cash flows from an investment won’t be worth as much in the future because of the changes in purchasing power due to inflation. Inflation causes money to decrease in value at some rate, and does so whether the money is invested or not.

Inflation in the United Kingdom has hit a four year low, in which The Bank of England will now be under less pressure to raise interest rates. Inflation is now subdued we don’t need to think about it. The only real danger of this is that Britain could contract a nasty dose of deflation – in which the Japanese faced. This would include falling prices, stalled demand in expectation of a further price slide and curtailed investment.

Credit Risk

The risk of loss of principal or loss of a financial reward steaming from a borrower’s failure to repay a loan or otherwise meet a contractual obligation they have. Credit risk arises whenever a borrower is expected to use future cash flows to pay current debts they have. Investors are compensated for assuming credit risk by the way of interest payments from the borrower or issuer of a debt obligation.

Credit is closely linked to the potential return of an investment, most notably being that the yields on bonds correlate strong to their perceived credit risk.

An example of this would be to say if higher the perceived risk, the higher the rate of interest that investors will demand for lending their capital. Credit risks are calculated based on the borrowers’ overall ability to repay. The calculation for this includes the borrowers collateral assets, revenue generating ability and taxing authority (such as for government and municipal bonds.)

Currency

A risk arises in currency from a change in price of one currency against another. Whenever investors or companies have assets or business across different countries, they face currency risk if their positions are not hedged.  Any business that operates across different territories that use different currencies will face currency risk. Businesses will be hurt and helped in different ways from exchange rate movement.

Examples of this are:

  • If you’re a British manufacturer and your main market is Europe, you will benefit when the pound weakens. The euro you receive in return for you goods will be worth more pounds therefore your profit increases. And vice versa if the Euro is weaker than the pound you will lose money.

Risk in Stock Markets

The Market risk is the possibility for the investor to experience losses due to the factors that affect the overall performance of the financial market. Market risk, also known as ‘systematic risk’ cannot be eliminated through diversification, thought it can be hedged against it. The major Market Risk is natural disaster as this will cause a decline in the market as a while as an example of market risk. Other sources of market risk are:

  • Recession
  • Political turmoil
  • Changes in interest rates
  • Terrorist attacks