The latter half of August has seen Investors’ attention lurch across the Globe to another ‘crisis’ in China. Global equity markets fell anywhere from 4.73% (S&P 500) to 8.84% (MSCI Asia Pacific ex Japan) over the month. In environments such as these, the importance of holding a balanced and well diversified portfolio comes to the fore, as UK Gilts rose by 1.14% with Index Linked Gilts falling by 0.61% and Corporate Bonds by 1.16%, protecting capital to a degree. We would note that the bull market we have enjoyed since March of 2009 has been relatively benign with little volatility. However, there have been some substantial pull backs along the way, which felt uncomfortable but were relatively short lived as the chart from Goldman Sachs shows opposite. Their data suggests that pull backs of more than 5% have taken, on average, 28 days to bottom and then 30 days to recover. Therefore, there may be further discomfort to come before we see a sustained recovery in markets.

Short and almost sweet.

Chart Source: Bloomberg and GSAM from Oct 9, 2007, most recent major drawdown, to Aug 26, 2015. Drawdowns are defined as a period when equities fall. Market and Economic Summary Source: Bloomberg and GSAM. Key Economic Releases Source: Goldman Sachs Global Investment Research and Bloomberg. Please see end disclosures for definitions. Past performance does not guarantee future results, which may vary.

Has anything changed?

In our view, the short answer is no. The decision by the Chinese to devalue their currency was a reasonable step in the transition of their economic model, although the market appears to have taken it as a cue to fret over the pace of the slowdown in the economy. However, the Chinese equity market is much smaller relative to the size of the economy and Chinese consumers are far less exposed. Therefore, we would be surprised if recent events derailed growth completely resulting in a ‘hard landing’. We are of course, cognisant of the very high levels of outstanding debt, the housing bubble and the risks that these pose.

Generally speaking, the developed market economies appear to be doing quite well and whilst equity values are not cheap, they are not overly expensive either. However, markets are highly likely to become more twitchy as the era of Quantitative Easing and ultra-loose monetary policy comes to an end in the US and UK.

United Kingdom

Growth in the UK continues to do well with 0.70% growth for quarter two, compared with 0.40% for the previous three months. This was an improvement of 2.60% over the same period last year. This would all suggest that the Bank of England will be looking to raise interest rates in the early part of next year, although the potentially deflationary effect of the slowdown in China could push this back.

United States

The US economy appears to be firing on all cylinders, posting 3.70% growth in the second quarter, sharply higher that the initial estimate of 2.30%. Consumer confidence also improved in August and the housing market also continued to improve with new home sales increasing 5.40% in July, from June. Despite the positive news on the economy, the market turmoil emanating from China means that the market has pushed back expectations for the first rate rise, yet again. Federal fund futures indicate a 24% chance of a September hike, down from 50% in early August.

Europe

Similarly, the Eurozone economy continues to recover, particularly in Spain, which is now enjoying strong GDP growth. Unemployment is at the lowest level since early 2012 and business confidence is improving. Quantitative Easing in the region, combined with improving corporate earnings, bode well for the equity markets although valuations are not quite as attractive as they once were.

Japan

Japan’s economy posted a disappointing contraction of 1.60% in quarter two, as exports slumped and consumers cut back spending. This is a blow to Prime Minister, Shinzo Abe, and his policy drive to end deflation. Whilst the initial economic and market reaction to ‘Abenomics’ has been positive, wage growth has not been sufficient to bolster private consumption, which is approximately 60% of the economy. The Japanese market is still relatively attractively valued, particularly after recent moves. This, combined with increasing equity allocations in Japanese pension schemes, should provide support, despite the economic data.

Emerging Markets

The Emerging Markets have been hit by an almost perfect storm of the bursting Chinese equity bubble, rapidly falling commodity prices and a strong US Dollar. Sentiment has become extremely negative towards the region and cash has been pulled from Emerging Market funds, both equity and bonds, at an alarming rate. The impending tightening cycle in the US will also place pressure on the Emerging Markets, although certain areas of the region look like very good value, a trait which is hard to find in today’s financial markets.

Simon Brett
Chief Investment Officer
Parmenion Investment Managers