Strawberry Invest took time to look into the macroeconomic factors we feel will shape the financial markets of 2016, and ultimately your investment portfolio.

European and US equity markets entered 2016 with a shock on Monday to discover that Chinese authorities had successfully implemented and used their new market control “circuit breaker”. Following a market fall of 7%, Chinese authorities suspended trading early for the day. Unfortunately, volatility stemming from China has not been unusual over the last 12 months and looks set to continue into the foreseeable future.

However, large swings in the Chinese stock market should not necessarily translate into volatility in international markets.

Chinese markets remain volatile

Much of the market volatility in China is in part a result of investors leveraging, leading to overvalued shares and retail investors vulnerable to a sell-off, rather than fundamental changes in the underlying economy. Unwinding these market inefficiencies will take some time and is not being helped by continued market intervention by the authorities, trading potential short-term market stability for longer term issues. Unfortunately, as financial markets have become more integrated, volatility in what is now the second largest equity market in the world will translate into volatility in other markets, regardless of the fundamentals.

While there are undoubtedly increased risks from the Chinese economy, their stock market is too opaque to use as a guide to the future. China’s economy has slowed down from its previous exceptional growth rate, as it transitions from an export-led, industrial economy to one in which consumers and services drive growth. There are some concerns that this will lead to a “hard landing” and recession if not handled appropriately. However, the economy continues to grow at a sustainable rate.

Commodity and oil price weakness has been another influential theme of 2015. While lower prices have certainly been good for consumers around the world, the stock market has a large stake in commodity assets which are now valued considerably lower. On its current trajectory, the oil price has still further to fall, as few producers are showing a willingness to reduce supply and rebalance the market.

Commodity prices continue to influence markets

However, oil is notoriously susceptible to geopolitical turbulence, which has been highlighted in the last couple of days with tensions between Iran and Saudi Arabia. An escalation of tensions in any oil-producing region could see a quick rise in the price back to higher levels.

In the longer term, there are further concerns for oil producing countries and companies. Acceleration in the development of renewable technologies and alternative fuels has the potential to reduce demand for oil to the point where current reserves may not be required to be extracted. Furthermore, environmental laws may mean a reduction in the usage of oil and other fossil fuels to meet emissions targets. Such a scenario would clearly be problematic to many oil and gas companies, with balance sheets geared to the value of oil they have in the ground.

Monetary policy, both domestically and internationally are additional unknowns this year. The US Federal Reserve has already started down its path of increasing interest rates, and we expect the Bank of England to do the same towards the end of this year or the beginning of 2017.

UK interest rates look to rise

Further weakness in the Euro is expected as there has been added pressure on the ECB to expand its monetary stimulus after disappointing the market before Christmas and with inflation figures remaining stubbornly low. Japan’s monetary easing also has the potential to be expanded, as economic growth and inflation have not been overwhelming. Overall, central banks have guided investors of their intentions, at least of the medium term. Large scale monetary easing will continue to provide a level of support for both bond and equity markets in the foreseeable future.

Finally, the build-up to and vote for the UK to leave the EU will undoubtedly cause some volatility, noting the effects of the Scottish referendum in 2014. The uncertainty surrounding what a vote to leave would mean for the UK economy and companies operating here will cause many investors concern. However, as with the Scottish referendum, this may present some good opportunities for investors to exploit.

We believe that the current trend of higher volatility will continue, however, while volatility is unnerving, it can be a benefit to the long-term investor with a well diversified investment portfolio as well as providing investment ideas for the first timer. Volatility presents opportunities to enter the market at a lower price and for an active investor to exploit inefficiencies that appear during times of market panic. While there are always investment risks, we believe that 2016 will provide a great number of opportunities and periods of market volatility. If you need any further help and are investing for the first time check out our top 10 tips for first time investors.