Looking across the financial horizon, it appears by many measures that 2016 is ending with similar dynamic as 2015: G-7 stock indexes are at or near their highs, the USD Index is on an upswing, the US Federal Reserve lifted rates causing bond yield to firm and Gold prices are stabilizing after a sharp November drop.
As such, the financial media is content to wrap up the year by only focusing on the price action from the last two months and ignoring the two-way market volatility experienced in the previous 10 months.
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Looking into 2017, it’s worth noting that as optimistic as the end of 2015 outlook was, the SP 500 started 2016 under pressure and dropped over 250 points, or 12% by January 20th.
We have identified three potential flashpoints which may trigger a significant correction from the recent post-US election rally during the month of January.
First, the Italian banking sector continues to sag as political manoeuvring has greatly outpaced the progress of any meaningful economic solution. At this point, the focus has been on the bailout of Monte Paschi Bank. Recent “stress tests” have shown that the solvency gap needed to rescue Italy’s oldest lender has grown from €5.5 billion to over €10 billion.
The immediate contagion risk has spread to 10 other EU banks who are holding substantial Monte Paschi debt obligations.
The second potential flash point stems from recent liquidity shocks in the Chinese bond market. Credit conditions have tighten sharply over the last two weeks as over 25 corporate bond issue face a potential default.
This pressure has seen 2-year swap rates spike higher, which has forced the Peoples Bank of China (PBoC) to inject over $60 billion into the short-term money market just to keep the secondary Treasury market from triggering a trading halt…….like it did on December 15th.
Many investors overlook the impact that even temporary credit shocks can have on global equity markets. However, according to some estimates, the global bond market has more than tripled in size over the last 15 years and now exceeds over $ 100 trillion.
By contrast, Dow Jones Research puts the value of the global stock market at just under $65 trillion. In the US alone, bond markets make up over $40 trillion in value, compared to less than $20 trillion for the domestic stock market. In this sense, as G-7 Central bank policies have removed traditional market anchors, a liquidity or solvency shock in a domestic bond market can have a profound impact on global equity markets.
The third potential flash point involves the US earnings season. US companies will begin reporting in the fist week of January with JP Morgan , BoA and Wells Fargo leading the banks starting on January 13th. Forward estimates suggest that the post-election rally has lifted many of the banking names into price valuations which the earnings reports may not be able to support.
It’s not our base case that an external market shock will trigger a protracted sell off in global equity prices and derail the bull market structure during 2017. However, we feel that it’s important for investors to be aware of the potential of such risks and have a strategy in place to protect portfolio holdings during a market correction.
A product which fits this description is the BetsShares BEAR Exchange traded fund (ETF). The BEAR EFT Gives investors a simple and accessible way to obtain ‘short’ exposure to the market.
If you would like to learn more about how the Beta-Share BEAR ETF can protect the long-side of your portfolio, or if you just want to learn how to profit from a downside correction in the ASX 200, get in contact with us and we’ll be happy to introduce you to this dynamic product.
