12th January 2016
Standard Life Investments Alex Wolf and Rowan Dartington Signature’s Guy Stephens each share their views on the outlook for China and its impact on the global markets in 2016…
Alex Wolf emerging markets economist at Standard Life Investments says: “In China, we expect policymakers to continue walking a tightrope – balancing enough fiscal and monetary stimulus to prevent a sharper growth collapse, while slowly proceeding with supply side reforms to remove excess capacity. Slowing Chinese demand, which we believe was worse than official data reflected, was one of the largest causes of the emerging market trade and output contraction experienced last year. As such we see some room for cyclical upside, as policy measures take effect.
“However, our longer-term outlook on China has become increasingly negative. Our own view is that GDP growth is closer to 5% than the 6.9% reported by the Chinese authorities. Although we believe policy makers will avoid a hard landing, it is becoming more likely that Chinese leaders will not enact necessary reforms quickly, especially of state owned enterprises (SOE). SOEs are at the heart of China’s problems, and reforms here would deliver the biggest dividends from a growth and rebalancing perspective, but Beijing has been dragging its feet.
“SOE reform plans delivered over recent months were received with optimism, but we believe they failed to address corporate governance issues or the reduction of excess capacity through corporate restructuring and closures.
“Consolidation has been the preferred path, and the government seemed unwilling to sell or reduce state assets in a meaningful way. The plan will lack effectiveness if the focus on addressing loss-making companies and overcapacity is limited to a small number of centrally-owned SOEs, and not the mass of locally-owned SOEs, where most of the overcapacity and inefficiencies lie.
“If China growth does disappoint this could drive continued volatility in global markets. Sluggish growth is priced into markets but a hard landing which impacts on currency, capital flows, commodities and social stability is not. This could result in more aggressive domestic monetary easing, forcing the renminbi lower against the dollar, with adverse implications for global inflation and a blow to emerging markets dependent on robust Chinese demand for manufactured goods and commodities.”
Rowan Dartington Signature’s Guy Stephens says:
“2016 has already captured the headlines for being the worst start to a New Year ever for many key stock markets. There is uniformly bearish tone to most of the influences that drive investors and this is often when the contrarian investor starts getting interested.
“The market has become very polarised between earnings that appear well supported by macro-economic factors and earnings that look like they are going to go from bad to worse. The valuations in these two areas of the market, not surprisingly, are priced accordingly. Any stock dependent upon the consumer is looking expensive whilst businesses connected to energy looking cheap. However, the expensive areas also feel comfortable and secure whilst the seemingly cheap areas feel dangerous and foolhardy. The fundamentals supporting the former look very attractive with full employment in the US and UK allied to rising consumer wealth caused by falls in energy prices, low inflation and real wage growth. The fundamentals underlying the latter look horrible with a stand-off in OPEC over oil supply exacerbated by regional religious tensions and a commodity pricing outlook which may well result in business failures.
“However, the news that has really upset the market since the New Year has been the return of Chinese stock market volatility which followed the release of some weaker economic data. Global markets appear easily spooked due to the size and importance of the Chinese economy but also by the lack of transparency, and one of the certain ways to get the investors speculating is a vacuum of information. This has been demonstrated continually ever since the Federal Reserve started tapering its Quantitative Easing back in 2013. Investors are still analysing and agonising over when the next interest rate rise will be and whether this will derail economic growth and how bad things could get. Perhaps this is normal human psychological behaviour as we are still feeling the reverberations of the biggest economic crash most investors have ever seen, which is still fresh in the memory. This is doubly disturbing as only a few saw it coming at the time while with hindsight it appeared obvious to most.
“So now, every new risk that appears, whether it be Chinese volatility, US interest rates, oil prices, religious tension or weaker GDP data, causes the market to agonise over whether this new risk will be the straw that breaks the proverbial camel’s back and renewed disaster is just around the corner. It is also not lost on many investors that the markets have doubled and halved twice in the last 15 years.
“History teaches us that most disastrous economic scenarios are unpredictable and the time to spot them is when the skies are blue and the sun is shining, markets are high, volatility is low and all looks set fair. This is at odds with the current environment when most are looking for reasons to support their bearish stance.
“The New Year reverberations around China do not stand up well to scrutiny of the facts. Little has economically changed in China in the last three weeks except for some weaker economic numbers and some poor market behaviour. The question is whether investors had become complacent towards the end of 2015, when the Chinese growth slowdown story was becoming old news? There could of course be a second round of global growth impact that isn’t priced in and only the passage of time and some more economic and corporate results from the West and China will reveal this. The US Q4 reporting season starts this week with the usual Alcoa bellwether whilst Q4 GDP from China is published on January 19th and forecast to be 6.9%.
“Investors should not look at the Chinese stock market and draw parallels with developed stock markets in the West. It is an immature marketplace, dominated by private investors who treat it like a casino, with a lot of short term speculators who trade in and out, often intraday. Worse still, the regulators of the market are similarly inexperienced and are trying to wrestle with the implications of their own doing when they let the beast free in 2015, encouraging leverage and speculation for the general public. Clearly, the authorities did not fully realise the consequences of their actions and it illustrates their misunderstanding of free markets having been constrained in a relative environment of fear and control up to that point.
“Fear and greed are traits of human nature which are arguably, at times, the two biggest influences over short-term market movements with fear easily outweighing greed or actually covering both bases via the fear of losing money and the fear of missing the opportunity to make money! This is why it is so useful to watch the so-called Fear Index, or VIX Index, as it is known which is currently elevated principally because of the behaviour of inexperienced investors and regulators. We all want to buy a bargain but with the investment markets, whenever apparent bargains present themselves via a sudden downward pricing adjustment, investors become scared and stand back as fear takes hold.
“It is true that the current outlook is very opaque and nobody knows about the true global impact as China moves from an investment-led economy to a consumption-led economy. It is unlikely that 15 years of exceptional growth driven by massive infrastructure investment will unwind in a year without painful consequences. Most exposed are the commodity exporting countries and companies.
“We feel it is almost inevitable that some corporate and sovereign defaults will occur and many are living on borrowed time and money, which will run out soon with headline grabbing consequences. The effect of this Chinese volatility and the elevated VIX Index serves to show just how nervous investors are, which presents opportunities for the brave and those with cash wishing to invest for the longer term. It may get worse before it improves with the point of capitulation panic-selling yet to come but with the FTSE-100 alone being almost 17% below its peak of April 2015, investors should be asking themselves at what level would they enter this market if not now.”