China kicks off 2016 with a New Year’s hangover!

New Year 2016 #2Dear Mr. Market:

Happy New Year and welcome to 2016!  With a new calendar comes hope and optimism! 2015 was a challenging year for the equity markets, it was actually the worst year since 2008 and if you had exposure to the energy sector (as almost everyone does) it was one of the worst on record. Investors were waiting for a new trading year with great anticipation, much like children looking at gifts waiting under the Christmas tree. Well… take a deep breath, the market is getting spanked on the first trading day of the year opening down over 2% thanks in part largely due to China. What does this mean for the rest of 2016?

Don’t allow yourself to feed into the ‘doom and gloom’ that will most certainly dominate headlines for the next few days if not weeks and months! While the sell-off in China is rattling some nerves, there are new factors in place that have to be taken into consideration. Last month Chinese officials put in place a new ‘circuit breaker’ system in an effort to manage the wild swings in their equity markets that helped lead to last summers volatile global environment. The new regulations created a 15-minute halt in trading for the entire Shanghai exchange if there is a 5% sell off. If the slide continued to 7% then the markets would close for the remainder of the trading day. This is exactly what happened today to kick off 2016; a 15-minute pause followed by an early closure of the Chinese stock market (which happens to be one of the largest in the world).

The concern from analysts and traders is that when a market as significant as China’s closes for the day (especially on the first trading day of the year!) it will raise fear with investors leading to a snowball effect. “The circuit breaker system actually creates a downward spiral”, said Hao Hong, managing director at Bank of Communications, “Having this so-called system in place is actually making the selling worse.”

Another factor that is rarely mentioned when discussing the Chinese market/economy is that investors there are highly leveraged as they have borrowed money to invest. Early in the summer investors took loans (margin) from their brokerage firms to buy additional equities, leading markets up significantly. The Shanghai then sold off as investors sold positions to pay back margin balances and attempt to protect the quick profits they generated. To put the numbers in perspective, margin balances peaked around 2.4 trillion Yuan and are now at less than 1.8 trillion, nearly $290 billion. The country has been exploring new rules and regulations to manage this more effectively going forward.

So what does this mean for investors?

The market and investors think and behave very differently based on current events and news. Investors digest headlines that the media inundates them with, jumping online and selling various positions. Behavior like this leads to market weakness and volatility and often results in the ‘snowball effect’ that we mentioned earlier. Historical data shows that the markets look at volatility and sell-offs, like todays, very differently (click here for more information). Consider this…every year since 1980 the S&P 500 has dipped into negative territory. The average intra-year low is -14% but the markets finished +11% over the same time frame.

Today is certainly a rough start for the markets! Don’t get caught up in the hype…look down the road and keep focused on the final destination.

“The journey of a thousand miles begins with a single step.” – Lao Tzu

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