Bleak January trade sets uncertain tone for 2016

January can often feel bleak. But after the worst December in 13 years for major European equities indices, investors could have been forgiven for expecting a brighter start to 2016.

Such optimism has been shattered inside the first week of trading for the year, as concerns over China and international growth prospects have chilled global equity markets. Should the market folklore that January trading sets a pattern for the full year prove true, investors face a very rough 12 months.

Stocks that register a poor year often benefit from a January bounce as investors move in to exploit beaten-down valuations. Not so, at least this far into 2016, where the bears appear to be still scaring bargain-hunters from last year’s biggest fallers, while some of 2015’s best performers are looking overstretched.

“What should have been a perky start to 2016, with new year optimism underpinned by portfolio positioning as investors buy stocks, has been eclipsed,” says Richard Hunter, head of equities at Hargreaves Lansdown.

“The general souring of sentiment has been exacerbated by circuit breakers stopping slides on Chinese markets, which have already had two run-outs this week as well as Federal Reserve minutes questioning the strength of belief in the December hike. It’s all leaving indices without any sign of support.”

Notably, the best performing national stock indices of 2015 — Milan’s FTSE MIB and Frankfurt’s Xetra Dax 30 — have slumped significantly so far this week.

Export-reliant sectors such as carmakers and luxury goods led by the likes of LVMH and Richemont have been hit hard. Sliding commodity prices have intensified the selling of miners and energy companies, one of the big stories from 2015 that shows little sign of changing this year.

While China’s economic slowdown and its great rotation from an investment-driven manufacturing economy to a more consumer-focused service economy continues rattling commodities and the shares of miners and energy companies, Beijing’s crackdown on corruption and ostentatious gift giving also worries continental Europe’s luxury companies.

Analysts are divided on whether conditions will improve later in the year. Some forecast overall gains during 2016 as European companies finally start seeing their profits increase, while others have doubts.

“We’ve already re-rated the Euro Stoxx 600,” says Nick Nelson at UBS. “The price-over-earnings multiples are more or less in line with the long run average so it’s more about what the earnings do.”

This could be the year when Europe’s long-awaited earnings recovery finally arrives, he says. With nominal economic growth likely to be strong in Europe as well as low labour costs and low raw material costs, European companies should see an increase in margins.

“It’s easier to see external risks to the story from China, or even the US, than internal risks,” he says, recommending companies that are focused on the domestic European consumer.

Others point to the opportunities offered by the European Central Bank’s current policy of quantitative easing, which should help cheapen the euro against the dollar as well as boosting the price-to-earnings multiples of European stocks.

Sebastian Raedler at Deutsche Bank prefers “plays on the eurozone recovery that have not yet re-rated”, including “banks, construction materials and staffing agencies”, as well as sectors likely to benefit from a stronger dollar. These, he says, include tech stocks, pharmaceutical companies and airlines.

The outlook for continued economic stimulus from the European Central Bank is also helpful. “Banks would also benefit if the ECB is successful in pushing up inflation expectations,” says Mr Raedler, making them Deutsche’s favourite sector, together with pharma.

“Banks have continued to move in line with German bond yields, which suggest their performance would be supported if German bond yields rise to 1.1 per cent by the end of 2016, in line with our forecasts,” he adds.

But while Rory Bateman, head of UK and European equities at Schroders, also thinks that an earnings recovery will help, he warns that dispersion is likely to increase in European markets as the effects of global economic headwinds make themselves felt.

“Careful stockpicking will be needed as correlations within markets are likely to unwind. It’s worth noting that services and construction make up 75 per cent of German GDP and these areas of the economy are performing well. The same can be said for other large eurozone member countries,” he says.

Alastair Winter, chief economist at Daniel Stewart, has doubts.

“Germany and Italy need someone to sell their exports to, and with China slowing and the eurozone recovery looking tired, where are the big buyers going to come from?” he asks.

“I can see all sorts of reasons why eurozone businesses won’t invest and consumers won’t spend. That will feed through into corporate earnings. The 2015 rally on continental European stock markets is looking stretched, especially in Italy.”