Bear in a China Shop
Company shares have declined sharply in August, as developments in China sparked concerns for the global economy. China’s clumsy devaluation of the yuan on 11 August 2015 led to fears that the slowdown in the world’s second largest economy might be deeper than expected and raised the threat of a ‘currency-war’, as other countries weaken their currency to ensure their exports remain competitively priced. While movements in stock markets have been severe, we do not believe they will lead to a worldwide recession; the Chinese authorities are likely to continue cutting interest rates and take other steps to stimulate growth. Meanwhile, the economic recovery in the US, UK and Europe appears robust, and we recommend retaining company share allocations.
Throughout the last fortnight, investors have been anxious as large declines in the Chinese stock market have continued, despite Chinese Government action designed to support share prices. The debate over the wisdom and timing of a US interest rate rise has also unnerved investors, and concerns have increased for the growth outlook for export-dependent Asian countries. Many emerging market currencies have reached new lows, and this led to further falls in commodity prices as expectations for global demand were reduced. The UK stock market has a large weighting in oil stocks and, as the oil price approached a 7-year low (see Chart 1 below), the FTSE 100 index declined nearly 10% between 17 and 24 August 2015. While slower growth in China will dampen global economic growth rates, stock markets appear to have over-reacted; this is most probably because the concerns have arisen at a holiday time, when trade volumes are low, which tends to magnify changes in sentiment.
Chart 1: Oil price decline
We believe that the Chinese government will take all necessary steps to stop their economy slowing excessively, otherwise they will put the Communist Party's authority at risk. They have many unused levers to pull to reinvigorate the economy, including additional monetary easing and fiscal stimulus. A new concern, however, is the credibility of the authorities after questions have been raised over their ‘free-market’ approach and their communication with financial markets.
Though near-term market volatility is likely to persist while Chinese economic data reflects slowing economic growth, we believe that our central case of a prolonged cycle of moderate growth in the West is reaffirmed by recent developments – lower oil prices are likely to keep inflation subdued and ensure any interest rate rises are small and gradual. The US and UK remain on a sustained recovery path, which will be reinforced by lower energy costs, and India and Japan are also beneficiaries of cheaper oil. The Eurozone has remained resilient; strong economic surveys for August were overlooked during the market turmoil. Corporate confidence is strong, as reflected in the high level of takeover activity, which has included Warren Buffett's biggest ever acquisition earlier this month. Global markets have since pared some of the earlier losses, as some risk appetite appeared to be returning; an interest rate cut in China and strong US economic data contributed to this.
The multi-year stock bull market which started in 2009 has progressed despite a number of set-backs for global growth expectations. We remain confident in the prospects for developed economies and, subject to individual financial planning circumstances, recommend retaining holdings in company shares, providing these investments are made with a long-term investment horizon; Chart 2 below compares the FTSE 100 index total return with UK retail prices, putting recent market volatility in perspective.
Chart 2: FTSE 100 total returns since 1990
As ever, we will continue to monitor developments and assess the impact of any prolonged market weakness, which we believe is unlikely. It is clear that the changing dynamics of Chinese growth will continue to suppress commodity prices; while this will be a challenge for some emerging countries and corporations, this is reflected in low allocations to China and emerging markets within our recommended portfolios. Meanwhile, our allocations to UK commercial property, private equity and index-linked gilts provide sensible diversification.
To discuss the content of this note or any other matter, please contact Nick Fletcher on 020 3696 6801, or any member of the London Wall Partners investment team on 020 3696 6805.
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