From the market peak in April to the beginning of August, developed world equities traded broadly sideways to slightly downwards, while their Asian and emerging market peers fell relatively consistently in sterling terms.
China’s decision to devalue its currency exacerbated this trend, with the contagion finally spilling over into the developed world, resulting in significant market falls within the space of a week. These moves were most likely accentuated by the lower summer liquidity.
Markets found a footing when China took action and eased its monetary policy, reducing its interest rates and bank reserve requirements. This, combined with more positive Western macro-economic data, helped markets rebound into the month end.
These dramatic moves have come about primarily due to concerns over China’s growth and the policy measures that may be employed. Regardless of what the official numbers say, China’s GDP growth is slowing, which is having a significant impact on demand for commodities and other goods. This is putting pressure on the major exporting nations, particularly in Asia and the emerging markets, which have relied heavily on Chinese growth to drive their own economies.
The developed world had been happy to ignore these issues, as their own economies had improved incrementally, until China devalued its currency. At this point, investors became concerned about the potential for further competitive devaluation by China, which could increase the pressure on already embattled emerging markets.
Cheaper Chinese exports to the indebted nations of the developed world could also increase the deflationary pressures on countries striving to create inflation, having failed to do so despite the huge amount of quantitative easing that has been conducted globally. Furthermore, if a growth crisis were to hit China at a time when global growth is already tepid, the potential for a worldwide recession would be higher.
Rather than a policy to boost its competitiveness, we believe China’s currency devaluation was more a signal that it is looking to move progressively towards a floating exchange rate as it aims for inclusion in the International Monetary Fund’s Special Drawing Rights: a mark of significance on the world stage. As China has proved via its subsequent monetary easing measures, it has a number of conventional levers to pull in order to stimulate its economy. We expect further measures to be announced in the coming months in order to manage the slowdown.
We continue to believe the economies of the developed world are improving gradually, driven particularly by a prosperous services sector, even if growth and inflation are both likely to remain well below previous cycle highs, given the level of indebtedness globally. We do not expect a significant rebound in commodity prices towards their previous highs due to China’s slowing and evolving growth as it attempts to move away from its reliance on investment and export-led growth to a more consumer-driven model.
Furthermore, US shale oil and gas production has markedly changed the outlook for energy, with the Organisation of the Petroleum Exporting Countries and other major oil-producing nations now focused on retaining market share rather than protecting a particular market price. This is a major positive for energy consumers.
China’s devaluation has spread uncertainty across the world during a period which is often seasonally challenging. However, we believe the worst fears of the market are misplaced and equities remain an attractive asset class for investors over the medium to long term.
John Chatfeild-Roberts is head of strategy for the Jupiter Independent Funds Team