No China crisis yet, but the signs look worrying
As asset allocation committees return in September they are trying to assess the importance of August’s financial market turmoil – with volatility back to levels last seen in the European crisis of 2011-12. Initial talk of a buying opportunity has faded into unease that a more dangerous episode could be developing.
Although the importance of the USA’s interest rate decision should not be under-estimated as a driver of market uncertainty, the deeper issues worrying market strategists are the series of problems facing emerging markets in general and China in particular. Easy times for Chinese policy makers are over. They face a series of conflicting objectives: how to create sufficient employment, how to include the RMB into the IMF’s SDR basket and how to liberalise the financial system. All this is complicated by the backdrop of a major stock market bubble and bust, previous over-investment in many industries, and financial problems such as over indebted local government. Policy makers are struggling as recent decisions on the currency show. No surprise then that questions are being asked about the true growth rate facing the world’s second largest economy. While few believe the official GDP estimate of about 7% a year, measures related to the manufacturing sector would suggest growth has collapsed to zero, while statistics related to consumption and services would be rather higher at say 5-6% a year.
It is important to emphasise though that this is not – yet - a China crisis; instead the global economy is in the throes of a 21st century version of the 1997-98 Asian crisis. A steady downtrend in global commodity prices, linked with the steady uptrend in the US dollar, are putting a range of emerging market economies under pressure. Amongst the biggest, Russia is in recession because of sanctions related to the Ukraine plus the impact of the slide in oil prices, while Brazil is suffering a major recession largely related to a credit cycle unwinding amidst a major corruption scandal.
Against that backdrop, our funds have been well positioned through preferring developed to emerging market assets. Our next task is to assess the extent of the slowdown in corporate earnings growth into 2016, and how much of that bad news is already priced into the markets. Equities need a solid economic recovery, corporate bonds are favoured in the current mixed environment but cash would be king if the emerging market crisis causes too much of a drag on global growth.
Andrew Milligan, Head of Global Strategy, Standard life Investments
First published in Citywire Wealth Manager – 1st October