Market volatility: Investment committees must keep focused on long term
As the noise of market volatility continues, members of your endowment or foundation investment committee may come to your next meeting with questions like, “What are the root causes of the challenges in our global financial markets?” and “Should we make changes to our portfolio?” It’s important to stress that even several months of volatility or a down market does not translate to an immediate shift in your investment strategy.
The global financial markets have had mixed results through month-end February 2016, with global equities having mostly negative returns, while fixed income markets have been modestly positive. There have been four main themes driving the markets.
China is the world’s second-largest economy, one which had reported gross domestic product (GDP) growth of 6.9 percent in 2015. While still strong and with positive growth, the 6.9 percent figure represents a number that is relatively smaller versus their more recent past. It is important to keep in mind that China is continuing its transition from a production economy to a consumption economy; this process is not going to happen overnight and will likely have many speed bumps along the way. The Chinese government, concerned about this slower growth, has arguably been devaluing its own currency, with the goal of boosting their exports to drive additional growth. The significant drop in the Chinese markets is indicative of investors expressing their lack of confidence that the growth will be there.
The issue with oil is primarily a supply issue; there is simply too much of it. The glut of oil has dramatically lowered prices to the point where prices fell below $30 a barrel during January 2016, the first time it did that in 10 years. Reports of production cuts have helped oil prices move back toward $35 a barrel at February 2016 month-end. Remember, lower oil prices negatively impact inflation, which creates a potential challenge for the Federal Reserve.
For the first time in roughly 10 years, the Fed raised short-term interest rates by 25 basis points in December 2015. At that point, the Fed set their expectations for four more increases in 2016. However, only a month after the Fed announcement, most pundits believed that because of global market volatility, there would likely be fewer rate increases in 2016 than previously predicted. If the Fed raises rates at their next meeting, in March 2016 it is indicative of an improving economy and continued movement toward the target 2 percent inflation. However, without higher inflation, the Fed will likely take longer to raise rates. With strong employment, it has been frustrating for the Fed that inflation hasn’t crept up more. Comparative to other developed economies around the globe, the United States remains the best game in town, on a relative basis.
A ball rolling down a hill gathers momentum. This is what financial markets have felt like recently. With troubles in China, decreasing oil and energy prices, along with Fed uncertainty, there was no shortage of negative investor sentiment, which factored into the negative momentum of markets so far in 2016.
What should investment committees do?
Market downturns can be stressful for any number of reasons. However, simply reacting to these market gyrations may not always provide the best outcome. Instead, having a plan and the discipline to stick with it should provide a better formula for success.