Investment View August/September 2015
Global markets have seen significant declines over the month, and particularly over recent days, as the anxiety over the strength of the Chinese economy grows day by day. It is Chinese torture as information seems to seep out painfully slowly. There is frequently no link between the Chinese stock market and the economy but this time it appears that just might be. It feels very similar to August four years ago when the Eurozone was in crisis and the USA’s credit rating was cut. In August 2011 the bump was very hard and very quick. The August 2011 stock markets fall saw a sharp drop in stock prices in stock exchanges across the United States, Middle East, Europe and Asia. This was due to fears of contagion of the European sovereign debt crisis to Spain and Italy, as well as concerns over France's current AAA rating, concerns over the slow economic growth of the United States and its credit rating being downgraded. Severe volatility of indexes continued for the rest of the year but significant gains followed. Particularly once Mario Draghi in the following July resolved to do “whatever it takes” to settle Europe.
The Chinese Government has attempted to intervene to halt the local stock market falling but with limited success. During the month the Government devalued the local currency which wrong footed global markets and caused developed stock markets to slip slowly but surely and now accelerating. Investors know how important a strong Chinese economy is to world growth and any significant slowdown would hinder the global recovery in the short term. At present the economic indicators are reporting a weakening economy in China. Is it temporary, by how much, when is a recovery likely, and what more Government intervention might be on the way – good or bad? As yet these questions remains to be answered and so the short term investor tends to cut and run
The longer term investor needs to be a bit more sanguine. Growth will continue, but it might be less than 7% per annum, but no one is suggesting that growth has evaporated. Schroders suggest that recent GDP growth was built on an equity market bubble and that is unsustainable. So with a weaker equity market performance likely in the second half of the year, a repeat GDP shock seems unlikely. From a variety of data, it seems that across the rest of the economy, a relative slowdown in the second half of the year should see growth in 2015 finish below 7%.
On the more positive side it the Chinese Government has begun opening up the Chinese market to foreign investors - Shanghai-Hong Kong Stock Connect- which will improve transparency and governance. The Government also has scope to cut interest rates, which is not a tool available to any developed economy. The Chinese Government is underway in taking $1Tr of bad debt off local governments, and supporting equity markets- although being generous the jury is out on that decision along with any further devaluation of the Chinese currency. These are significant changes and make the 3-5 year outlook much more encouraging. Undoubtedly, this region has lacked transparency and often for good reason has been viewed with a great deal of scepticism. It does though remain a vital economy for all markets that appears to be significantly stuttering at the moment but it would be unwise to ignore exposure to it. The other reassuring factor is that in the tables of expected returns over 3-5 years produced by many of the fund houses and independent researchers, Emerging Markets continues to offer the greatest returns albeit with the highest volatility. Therefore we must hold our nerve and not be tempted to make any knee jerk reactions despite feeling distinctively uncomfortable.
A consequence of the sharp falls over recent days and weeks is that markets across the globe have become cheaper. This provides fund managers with the opportunity to top up existing positions or indeed find new positions, which they have had under review, but felt the entry price was too rich. As in August 2011, we view this as the silver lining to the large cloud that is over all markets right now.
Despite all the turmoil in China, the UK economy has been progressing satisfactorily with some encouraging data released. For some time now, we have favoured exposure to mid-caps over large caps in both income and capital funds. Royal London’s UK mid cap fund and their UK Income fund feature in many portfolios. The slide “borrowed” from a recent Standard Life presentation shows that the current and forward metrics for mid-caps remain appealing and we will continue with this theme. The metrics will have improved with the recent falls.
Eurozone equities have had a volatile summer but the region’s economy continues to recover and improvements in corporate earnings should deliver further share price advances. Eurozone equities experienced a strong start to 2015 amid the European Central Bank’s announcement of quantitative easing (QE). The market’s performance in recent months has been uneven but we continue to believe there are several drivers for further share price gains. First and foremost, we would point to the ongoing economic recovery in Europe. Reforms and fiscal consolidation undertaken by several countries, notably in the periphery, are starting to show results while ultra-loose monetary policy, including QE, has led to improvements in business confidence. Consumer demand has also been resilient and the fall in oil prices over the past 12 months is helpful for this, especially as the full impact is still to be felt.
Property continues to be a favoured asset class for us. It has shown a resilience over recent weeks that vanished during the financial crisis. It is again doing its job. The chart demonstrates this clearly.
Investors continue to busy themselves with debating whether or not the US economy is strong enough to warrant the first hike in interest rates in nearly 10 years as soon as September or later in December. It is little wonder that bond markets continue to seesaw between pricing in hikes sooner or very much later. The China slowdown is also likely to be a major consideration that will not add to the argument to increase rates sooner.
"Be fearful when others are greedy. Be greedy when others are fearful."