The announcement by the Chinese government on the 11th of August 2015 relating to a change in the yuan quotation method and the consecutive depreciation triggered a new phase of panic in the financial markets. The pressure was particularly focused on emerging markets currencies, with fears of a currency war. Emerging markets equities, which are already under pressure, have declined further and taken developed markets with them in the current movement. The low market liquidity this summer has probably amplified this decline.
China and emerging countries
A fall of the Yuan that questions the Chinese growth
China’s central bank made the fixing of the yuan more dependent on markets. Consequently, the yuan has depreciated by 3% since.
This change was made to increase compliance with IMF requirements in order to bring the yuan into the IMF SDR basket of reference and to internationalize its currency. Given the limited impact of currency fluctuations on Chinese growth (a 10% decline in the real effective exchange rate increases growth by only 0.2 to 0.4 points), it is unlikely however that supporting growth is the main objective of this measure. Nevertheless, after the reassuring figures in June, the statistics published in August were disappointing and it is this negative interpretation that dominated.
The fact that the Chinese growth is slowing down is undeniable. As we have already explained, the Chinese economy must transition from a growth driven by extensive investment to a growth driven by consumption. This necessarily results in a slower economy and negative consequences for certain sectors. The key question remains the ability of Chinese authorities to accompany this slowdown. It appears that they still have capacities for action both in budgetary and in monetary terms. The vastly negative market reaction on Monday the 24th of August may also be explained in part by the lack of announcements from the central bank or the government. Announcements in the coming weeks seem very likely.
What about the rest of the world?
The decline in commodity prices, due to these concerns regarding the Chinese growth, amplified the contagion to other emerging countries. Concerning oil, we believe that the current fall is rather due to an abundant supply than to a weak demand. Thisis very good news for the global economy. Obviously, a number of emerging markets are highly sensitive to raw materials and are still under pressure, but in reality when you look at countries like Brazil or Russia, they have already been slowing down for several years.
As for developed countries, the latest statistics remain favorable. The flash PMI indexes in August were good in the Eurozone and in Japan. In the US, the manufacturing sector slightly slowed down but we can also observe an acceleration in the construction activity and the consumption figures have been revised upwards. The weekly jobless claims, one of the best real time indicators for the US economy, remain at a very low level. Let us not forget that the improvement of developed economies is essentially domestic. Overall the growth is expected to remain healthy.
Volatility which should lead the Fed to be cautious
Three weeks before the Fed’s meeting, the current volatility in world markets will certainly have the effect of delaying the first rate increase from September to December. Even if domestic considerations dominate the thinking of the central bank, it always takes into account the overall global context. Given the level of uncertainty and volatility, the FED will probably prefer to wait a bit.
Consequences for the markets
If one can question US equities and emerging market equities, we maintain our positive outlook for the Eurozone equity market. Earnings forecasts for 2015 have been revised upwards in recent months and growth should reach 16%. According to Morgan Stanley, emerging countries account for 30% of the revenue for listed companies in the Eurozone with 6% from China.
In terms of valuation, the correction reduced the PE ratio of equities in the Eurozone to its lowest level since October 2014 (13x). Previously, we had to go back to the summer of 2013 when the Eurozone was just coming out of recession, in order to find a multiple lower than 2013. Regularly, equity markets experience severe anxiety attacks which have so far been buying opportunities. We think that it is the same today.
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