No sign of China’s goat in 2015 so far

Investors woke up this week to headlines of “Black Monday”—now also associated to the 24th of August 2015—as equity markets continued to fall explosively after a poor week last week.

Over the weekend, market expectations had been high that the People’s Bank of China would offer additional market support, on top of the c $300 bn of support so far, and even lower the RRR (reserve rate ratio) at the important Chinese State Banks who could lend into the markets; indeed there were similar hopes last night too. However there was no intervention, and thus the markets in China fell another 9% and spooked all the other Asian markets.

This emerging loss of confidence in China’s policy makers undermined sentiment in Europe and the USA, where futures markets foretold of a difficult day. Europe was indeed weak as the Euro strengthened, which has this year seen a negative correlation with Equities. When the USA opened, the Dow fell over 1,000 points, and we saw bellwethers fall more than 23%! It was clear during the session that there was intervention to calm markets, however there can be no doubt investors globally are now concerned and unnerved. Why has it happened?

1 Global growth
Although the global economic data has been dull over the summer, there has not been any especially poor results. Commodities seem to telling a negative story on global activity and consequent investment activity but the consumer has seemed resilient, though not growing much in the USA and Europe. We may be suffering a market growth fear shock, as expectations for H2 2015 were high and not reinforced by a very dovish Federal Reserve report last week. However the key dynamic to sentiment has been China, where it seems anecdotally clear that export and industrial production are weak, and that policy responses to the recent market crisis have been stymied by the long running corruption campaigns from Beijing that have stalled decision making.

2 Markets
Fears have been widespread about market liquidity and the impacts of high frequency trading, and in the equity markets, already traditionally quieter over the summer months, we have seen such illiquidity appear in these downshifts. It has, though, all been happening in the futures markets which has thus affected all big stocks and sectors alike. Sector and market correlations have risen so that stock selection has been ineffective, although this should benefit active managers in the right stocks going forward offering growth and sustainable income. Currency markets have been roiled globally through worsening geopolitical news as in Turkey, Russia and Brazil and buffeted by devaluations in Malaysia and others. The equity markets have fallen so quickly that they are known as “oversold” which would suggest they can soon stabilise and reflect on what has just happened. However this process and a bounce would not mean that everything was okay and investors could safely buy the dip as previously. European equities have now fallen below 15x earnings and offer a reassuring dividend yield of over 3.5% again now in a region where cash costs money – many 10 year bond yields are below 1% and generate negative returns after inflation, so that one is NOT protecting the purchasing power of your savings. European equity assets remain attractive as the increased bid from Monsanto this morning shows, and markets should in general be supported by the European Central Bank’s ongoing Quantitative Easing (QE) through to September 2016.
Looking into the rest of this year, for now it is clear that:

• Real world indicators in the emerging markets and Japan have weakened, and the global growth engine that is China has slowed.
• Policy makers have fewer and fewer policy options as interest rates are now at the zerobound globally.
• Further currency devaluations may exacerbate economic and trading activities and undermine further investment and employment, and have probably affected the movement of capital around the world, especially out of Emerging Markets.
• FOMC policy deliberations around raising rates have created highly one-sided and leveraged positioning, for example long US$ and short EU Euro, which is having outsized effects on daily market movements.
• Markets, ETFs and futures offer the prospect of liquidity which may be proving illusory.
• With seeming policy weakness in China towards its equity market and growing evidence that QE has not really kick started the economies of the USA and Japan over the last few years, investors are challenging the premise of the “Bernanke, Yellen, Draghi and Kuroda” put on markets.

The current market volatility in equities, credit and currencies has been long expected, and reflects the AllianzGI view that we remain in a period of financial repression where growth is low and fragile, and where investors still need to accept a level of risk to generate returns from their savings.

The Goat in the Chinese zodiac is a symbol for calmness, stability and gentleness. Let’s hope his true character starts to show through soon after a bad few weeks…

Neil Dwane – Europe CIO Equity – Allianz Global Investors