Equity markets have been falling due to concerns over China, falling inflation and the timing of an impending rise in US interest rates. Until this week, trading volumes were seasonally light, with prices moving more on uncertainty, rather than a breakdown in fundamentals or reversal of economic fortunes.
China has been prominent amongst the headlines, with talk of ‘Black Monday’ this week, but we must not forget that the Shanghai Composite rose by 64% in 2014 in sterling terms and was up by a further 60% by mid-May 2015. Even with the latest falls, the index has still gained 44% since the beginning of 2014. What perhaps we are currently witnessing is the bursting of a speculative bubble in the Chinese stock market, unwittingly caused by measures implemented by the authorities to simulate domestic demand and reduce dependency on export-led growth.
The pick-up in the global economy has not yet resulted in inflation and any recent expectations that this was picking up, due to rising economic activity and wage increases have been more than offset by falling commodity prices (oil, industrial metals and agricultural prices). China is managing an economic slowdown and iron ore and other metals have seen sharp falls in import prices. Meanwhile, Saudi Arabia has taken a view that the US oil fracking industry and energy alternatives were a threat to its prominence and has been using its advantage of low-cost producer to monetise its huge underground reserves. While Saudi still makes a profit on sub-forty dollar oil, the marginal players like Canadian tar sands and deep-water explorers are loss-making, leading to widespread cancelation and mothballing of costly capital-expenditure projects, plant and rigs.
On the flip-side, the fall in oil and other input prices should be beneficial for commodity import-dependent countries (e.g. Japan and China and parts of Europe) and energy-reliant industries, manufacturers, logistics, power utilities and chemical companies and not least consumers who will potentially have more money to spend from lower petrol (and food) prices. Those adversely affected include the resource sectors (oil, miners), commodity exporters such as Australia, Latin American and Middle Eastern countries, and the currencies of these countries.
Perhaps the worry that has resonated most with us at James Hambro is the timing of US interest rates. Markets historically have a ‘wobble’, manifested by increased volatility, around the first interest rate rise in a cycle. Because the underlying economies in the western world have shown a sustained, if modest, upward trajectory then monetary policy makers in the US and UK have begun to talk of a ‘normalisation’ in interest rates These comments have been couched in terms such as ‘modest’, and ‘gradual’, indicating that policy will be on the conservative side, to sustain rather than curtail growth and is in recognition that we are now six years on from the financial crisis. Nevertheless, we are aware of the potential for markets to react nervously around interest rate increases.
Clearly, some other market participants have panicked out of positions, indicated by some wild swings of intra-day stock prices and these could provide us with an opportunity, if we deem the valuations and conditions right. Meanwhile, we are prudently looking at all the assets that we hold and challenging both our own internal investment thesis and those of other market commentators.
John Langrish – Chief Investment Officer
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