GROWING PAINS?

Investors should be happy to put January behind them. The New Year opened with the worst first week that global markets have seen in more than 20 years and the S&P 500 suffered its worst first week ever. The turmoil of that first week can be traced back to China, which continued to meddle with its currency and stock markets. Around the world, investors worried about the health of the Chinese economy, which has driven so much of the global economy in the past decade.

The Chinese government is working to manage China’s transition from the type of manufacturing economy that is typical of an emerging market to a consumer services economy that is more common among developed countries. That transition brings some growing pains. Investors understand that but they are frustrated that the limitations on the Chinese stock market seem to be prolonging some of the more painful adjustments. Each hiccup renews worries that the Chinese economy will emerge wounded from this transition.

Some investors question whether China actually exerts this much influence on the global economy. Normally, China is a significant influence—as we saw during the summer’s market correction—but its influence is being exaggerated by low oil prices. Investors are worried that soft oil prices are not just an indicator of oversupply, but also of declining demand for petroleum products in China. A decrease in demand for such a crucial commodity might indicate that the Chinese economy is in worse shape than it appears otherwise. This concern impacts investors worldwide, even in the US.

Traditionally, low energy prices are good for the US economy. Corporations benefit from decreased energy and transportation costs, and consumers are able to increase their discretionary spending by using their savings from the pump. Investors need patience when looking to profit from this relationship, a few months can pass before these effects show up on balance sheets and, in the meantime, the energy sector has a negative influence on the stock market.

Over the past year and a half, oil has declined sharply. In fact, it recently fell below $30 per barrel, when it was more than $100 per barrel in June 2014. During that time, the US investors did not see much benefit from the price drop. Rather than seeing cheap oil as a driver of consumer spending, investors worried that it indicated a lack of global demand and that drove them to reduce the risk in their portfolios. This is why the global stock markets and oil prices have been moving in tandem for the last couple of months. When the supply of oil falls to the point that it matches demand, then that should allow investors to break out of this pattern.

In the meantime, investors will also be watching the US Federal Reserve (the Fed) for signs of another interest rate increase. You may recall that the Fed raised interest rates in December after months of speculation amongst investors. Some considered the move long overdue and some believed that it was still premature. The events of January may seem to shed some light on that debate, but there is very little evidence that the Fed’s decision had anything to do with January’s volatility. At its January meeting, the Fed held interest rates steady, as most analysts expected. Investors will be paying careful attention to the Fed’s signals in the coming months. Before the end of the year, we expect that rates will increase slightly, but not as fast as the Fed was predicting in December.