OREANDA-NEWS. January 13, 2016. Stock markets worldwide tumbled to start the New Year on worries over China, energy prices and diverging monetary policies. Concerns over China emerged early in the week with a softer than expected report of manufacturing activity that showed the sector continuing to contract. Chinese stocks quickly began to slide, triggering newly installed circuit breakers, which authorities chose later in the week to eliminate.

As the week progressed it also became clear that the Chinese central bank was allowing the yuan to weaken rather abruptly. Investors began to wonder if that meant the economy was worse than believed. They also began to question the effectiveness of Chinese policy, causing concerns to rise and risk assets to be dumped. For the week, the Shanghai Composite index plunged 11 percent. In the U.S. it was the worst start to a new year ever.

Investors Seek Safety as Volatility Spikes

By week’s end the S&P 500 had shed 6 percent, the NASDAQ composite slid over 7 percent, and the small cap Russell 2000 lost 8 percent. The VIX index of expected volatility spiked almost 50 percent from 18 to 27. Given the worries of growth in China it should not surprise that the worst performer at the sector level was materials, which fell 8 percent. Energy lost 7 percent on continuing oversupply concerns. Financials were also exceptionally weak, pressured by both growth concerns and diminishing expectations of the pace and extent of rising rates. The best performers were utilities and consumer staples. WTI crude oil lost 10 percent to end the week at \\$33.16 a barrel, the lowest price in ten years.

Markets in Europe and developing economies also suffered steep declines, while in dollar terms Japanese stocks held up better as the yen rose sharply versus the dollar in safe haven trading.

The sudden turn toward risk aversion showed up in bonds as well. The Barclays Aggregate index is 0.6 percent higher since the start of the year. The yield on the ten-year Treasury note has fallen sharply from 2.27 percent at year-end to 2.12 to end last week. High yield spreads widened to just below their recent highs of mid-December. The Barclays High Yield index is down 0.3 percent. The two-year note dropped from 1.05 to 0.93 percent. The German ten-year saw a yield decline from 0.63 to 0.51 percent, and in Japan the ten-year yield fell from 0.26 to 0.21 percent.

U.S. Economy Looks to be Fundamentally Sound 

Somewhat overlooked in the focus on China was the exceptionally strong December U.S. jobs report. The economy created 293,000 new jobs, almost 50 percent more than expected. And revisions added 50,000 to the prior two-month total. The report highlighted the relative strength of the U.S. economy, as jobs continue to be created despite weakness in the energy and manufacturing sectors.

Unfortunately, the report on Friday was not enough to prevent stocks from falling even further. It also mattered little that manufacturing Purchasing Managers’ Indices (PMI) showed further expansion in the U.S., Japan, and the Eurozone.

In the week ahead, the focus will remain on China, especially the currency. Its value versus the dollar was stable on Friday, providing some welcome relief. On Monday, the yuan once again strengthened somewhat. The next reading on the Chinese economy will come on Wednesday with the release of trade data for December, and it is expected to be weak. How the Chinese stock market performs moving forward, and what, if any official response follows will be watched carefully. Chinese stocks are decidedly weaker to start this week, with the Shanghai Composite trading down another 5 percent.

China Continues to Weigh on Investors’ Minds

The U.S. economic calendar includes retail sales, industrial production and consumer sentiment. Most importantly, the fourth quarter earnings season gets underway. According to Factset earnings are expected to be down -5.3 percent from last year’s fourth quarter, resulting in a decline of 0.7 percent for the year. Energy and materials are predicted to report the largest declines, while telecom and financials the largest gains. Of particular interest this week are reports from the big banks, including J.P. Morgan Chase, Citigroup and Wells Fargo. Full year 2016 earnings growth is now projected to be 7.4 percent.

It will likely require convincing evidence of both economic and market stability in China for this latest round of growth fears to subside. How much further stocks might fall is impossible to say. Right now the selloff feels akin to the August China episode when the S&P 500 fell 11 percent in just seven trading days. So far this time the drop is not yet as steep. But, valuations are still somewhat stretched, leaving equities vulnerable to more bad news, whether it come in the form of weak economic data, poor earnings or waning sentiment.

Our central view remains that the U.S. economy is fundamentally sound, and that equity markets in the developed world are attractive. As witnessed last week, however, worries over China can overshadow all of that, at least in the short-run.

Important Disclosures:
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The Shanghai Composite Index is a capitalization-weighted index of all stocks on China’s Shanghai Stock Exchange.

The NASDAQ composite index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.

The Russell 2000® Index is a market-capitalization-weighted index made up of the 2,000 smallest US companies in the Russell 3000.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options.

Barclays Capital U.S. Aggregate Bond Index: Is an unmanaged index composed of securities from the Barclays Capital Government/Corporate Bond Index, Mortgage-Backed Securities Index and the Asset-Backed Securities Index. Total return comprises price appreciation/depreciation and income as a percentage of the original investment. Indices are rebalanced monthly by market capitalization.
Barclays Capital High Yield Municipal Bond Index: Is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody's Investors Service with a remaining maturity of at least one year.

The Purchasing Managers’ Index™ (PMI™) is a composite index based on five of the individual indexes with the following weights: New Orders - 0.3, Output - 0.25, Employment - 0.2, Suppliers’ Delivery Times - 0.15, Stock of Items Purchased - 0.1, with the Delivery Times index inverted so that it moves in a comparable direction.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

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