4 reasons one of the world's biggest asset managers says investors need to brace for more volatility in 2016

Photo by Frank Polich/Getty Images

State Street Global Advisors (SSGA) is one of the world’s biggest asset managers and it is out with a comprehensive look at what the year ahead might hold for markets and investors.

SSGA warns that after the big upswing in volatility stalled in 2015 investors face renewed market ructions in 2016. The key to this outlook they say is that ” geopolitical and structural factors mean that volatility is here to stay.”

They identify 4 key sources of risk for markets and investors and warn that the next year could be a “choppy ride” for investors.

A slowdown in China is at the top of SSGA’s risks. They note that even though, “China continues to be the scapegoat for everything from recent market angst to poor earnings,” risks still remain.

They believe the “risk of a hard landing does pose, perhaps, the most serious risk to the global economy.” Further, they highlight what Credit Suisse calls the “three bubbles of credit, investment and housing” as key risks to the economy.

As China continues to slow, shifting from an investment driven economy to a service driven one, these hefty burdens could intensify instability.

Additionally, on 11 August, the renminbi declined 1.9% versus the dollar following a revision to the quotation method of central parity. If investors fear further declines and capital begins to flow out, a new risk and source of volatility presents itself.

Of course China is not universally bad news SSGA says but, “all eyes will be on China in 2016.”

Investors and markets also face risks because of structural changes in the market which pose challenges to efficient price discovery.

That is, “natural liquidity, which many describe as the ability for buyers and sellers to transact with each other efficiently, is on the decline due to investor consolidation, increases in passive management and regulatory changes.”

Key here is that a combination of less trading by investors and regulatory oversight has, “made it more difficult and less profitable for market makers to warehouse risk” means the market mechanisms to dampen volatility are diminished.

Indeed, SSGA says:

curtailing of this mechanism limits the ability to transfer risk between buyers and sellers and could lead to a mismatch during market sell-offs as investors who wish to reduce or hedge exposures find few takers on the other side.

That in itself can amplify volatility. But SSGA says that the Fed raising rates in 2016 will withdraw a “mechanism that has compressed volatility in recent times.”

Geopolitical events are never far from any investors minds anymore. SSGA highlights the Middle East, instability in Europe, Syrian humanitarian crisis and the recent Paris terrorist attacks have all increased “investor anxiety.”

Looking ahead they say,”innate structural challenges to the euro have not truly gone away.” There is also the UK referendum next year and the chance of “‘Brexit,” where the United Kingdom further distances itself from Europe, may gain attention,” SSGA says.

They also highlight the US could be a source of risk while the “political environment could be a potential culprit as we head into a presidential election year and gridlock in Washington raises the specter of a possible government shutdown.” They even note investors could become concerned of the chance of a US recession.

One of the big risks though seems to be that SSGA suggests the stock market has underpriced the impacts of Fed action. SSGA itself is at the upper end of market expectations assuming the Fed to “move this December, followed by four hikes next year, in March, June, September and December.”

But, they believe that’s important because while,” many suggest this scenario is priced in and the markets will be fine,” they hold another view

They highlight:

The economy has historically been more robust preceding Fed increases than it is today. Concerns roiling other areas, such as emerging markets, could make for an interesting ride.

It looks like 2016 could be a very interesting ride indeed.

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