Third Quarter 2015
Volatility increased across asset classes in the third quarter of 2015. China’s economy, weak global commodity prices, and anxiety around if, and when, the Federal Reserve will raise interest rates weighed on investors’ minds. This anxious sentiment was matched by weak, global investment returns across equity markets.
Fears around China’s economic health grew. In August, China devalued its currency peg against the U.S. Dollar by approximately 4%, triggering a wave of concerns surrounding China’s economic growth and stoking fears of a currency war. Chinese equity markets dropped further while capital outflows intensified, forcing the Chinese to sell foreign exchange reserves to preserve the yuan’s lower peg against the U.S. Dollar. In August, for example, China sold just under $100 billion of its nearly $4 trillion in foreign exchange reserves due to this pressure. Some worried that this would have a negative impact on the U.S. Dollar and U.S. Treasury prices.
We have mentioned China as a core risk in the investment landscape for the last several quarters. While we continue to see the country’s slowing growth and fragile financial system as areas of potential instability, these risks now seem to be more widely acknowledged and better reflected in asset prices.
Meanwhile, the theme of weak global commodities continued. Oil prices remained low, as did the prices of other commodities such as copper and aluminum. Slower Chinese growth has contributed to lower commodity prices, but oversupply appears to be the dominant reason behind the weakness. We have seen the negative impact of these prices on a number of asset classes including the currencies of commodity-oriented economies such as Canada.
Unsurprisingly, the focus on the Federal Reserve and its decision concerning interest rates was a focal point of the quarter. In September, the Federal Open Market Committee (FOMC) opted to leave rates unchanged, attributing their decision to a lack of visible inflation. However, it was clear from reports of clashing data and disagreement amongst FOMC members that the decision had been contentious.
The intense focus of the market on the Federal Reserve this quarter brought to mind something Warren Buffett once said, “If (Federal Reserve Chair) Janet Yellen came up and whispered in my ear what she was going to do for the next two years, it wouldn’t make any difference to what we do.”
We agree. Markets are chaotic and unpredictable so even if you knew how the Federal Reserve was going to behave, you would not be able to know with certainty how all the other market participants would react to the news. Buffett’s commentary is a good reminder of the absurdity of focusing so heavily on something that does not guarantee investment success (like predicting rates) instead of a practical, long-term strategy.