14 Jan 2016
Headlines, especially negative ones, are the main way in which newspapers and news sources remain in business. Without negative headlines, newspapers largely cease to exist. Trading and acting on headlines is a sure way to destroy your wealth.
Our Chief Investment Officer, Chris Lioutas, looks at what all the recent noise is about.
What’s happened?
The strength of the global economy has been brought into question following the US central bank’s rate rise in December. The new calendar year begun poorly for investment markets largely on the back of deep falls in the Chinese equity market, which was followed up with some weak Chinese economic data.
Whilst the rest of the world is directly largely immune from Chinese equity market falls, the indirect effects (e.g. confidence and sentiment) are putting downward pressure on equity markets globally.
As a result, there have been some fairly negative headlines, with one foreign bank even suggesting that investors sell everything right now. Scaremongering at its best… Especially when considering that fundamentals are unchanged and nothing has changed in the Chinese economy in the last two weeks.
What’s happening in China right now?
The Chinese government had imposed some share trading rules in 2015, aimed at trying to stabilise the Chinese equity market, which were due to expire in the first week of the new year. The impending expiration of these rules caused some Chinese investors to liquidate their holdings in small company shares, which triggered a “circuit breaker” on the exchange. The “circuit breaker” had two levels – one which would suspend trading on the market temporarily following a 5% fall; and one that would close the market for the full day following a 7% fall. These “circuit breaker” levels were set way too low, and were subsequently triggered twice in the first week of 2016.
The Chinese government has since revised their share trading rules, replacing the “circuit breakers” with more specific and direct share trading rules, aimed at curtailing daily price moves and excessive speculation. The sudden turnabout in policy has caused further uncertainty.
Chinese manufacturing data also came in weaker than expected during that time, which didn’t help the markets. The manufacturing sector has been in decline for some time due to rising wages and the lack of demand for manufactured goods both locally and abroad given low global economic growth.
Chinese growth is slowing as expected. The country’s industrial economy is weakening whilst its consumer economy is performing relatively well. The transition is never smooth as a developing economy shifts from an investment-driven economy to a more balanced economy with greater consumption and services.
The Chinese authorities are also attempting to move their currency from fixed to the US dollar to a more freely-floating currency against a broad range of currencies, not just the US dollar. They are managing this process rather than going straight to a free-float which would most likely result in a large depreciation in the currency. Some suspect that the Chinese are devaluing deliberately in order to boost exports. We don’t think this is the primary case, and there is more currency depreciation ahead.
How is this impacting the global economy and global markets?
The Chinese government is attempting to manage a very fine balancing act by maintaining control and power at home whilst appearing to be moving towards a more open economy on the global stage. The appearance of “policy on the run” is not a good look – investors will not invest with that sort of uncertainty, in addition to the dampening of confidence and sentiment that share market falls and uncertain policy changes bring.
The currency depreciation is putting upward pressure on the US dollar, which largely slows the US economy and puts downward pressure on commodity prices. The perception that China is slowing faster than they make out is also a dampener on commodity prices and global aggregate demand, thus putting further downward pressure on inflation globally.
The Chinese economy’s transition will adversely impact economies like Australia which have become accustomed to export-led growth, whilst benefiting other economies that supply services to China and those that are commodity importers.
Outside of China, what else is impacting markets right now?
The world is still grappling with war in the Middle East, mass migration of refugees from the region, the threat of terrorist attacks in Europe and globally, the ability of the Eurozone to remain together and grow their way out of the current malaise, impending US elections and the presidential race, the new development of North Korea apparently testing a hydrogen bomb, and falling oil prices and their impact on oil-export dependent economies and budgets (Russia, Saudi Arabia, Nigeria, Brazil, Venezuela).
Is any action required?
The short answer is no. Headlines sell news, they don’t create wealth, in fact they usually destroy it.
The transition in China’s economy is nothing new. Sharp falls in Chinese equities are not new. The Chinese government has well flagged what they’re attempting to do with their economy. We all knew that the Chinese currency would fall as they moved to more freely floating currency. We all knew Chinese economic growth would slow, just like we all knew the US central bank would raise rates eventually.
The thing about markets is that they will react to news flow whether it’s new or old, whether it’s valid or not.
The key message is not to listen to the noise created by others who have their own agendas.
If you would like to discuss this further with one of our Financial Advisers, please contact us on 02 9324 888 or email info@psk.com.au.
