By any measure July was an eventful month for global financial markets. At a time when volumes are usually less than normal due to the northern hemisphere holiday season, markets had to digest the twin issues of China and Greece, as well as the occasional speed hump from elsewhere.
China – Chinese government, meet Mr Market
There’s nothing like a stock market crash to focus the financial mind, and to get the media in a feeding frenzy. But as we wrote previously, the Chinese stock market had risen 150% in 18 months – around 15-20 times the long-term global average. When the only thing that rises faster than the stock market is not company earnings but margin lending, you know trouble is coming.
China’s Shanghai Composite Index
The amazing thing has been watching the response from the Chinese government. It appears they were happy to accept all the good things a stock market can bring – allocation of capital, investment opportunity – but none of the bad. Having beaten their chest and thumped the table, the Chinese government tried all sorts of things to reverse the tide: standing in the market and propping it up, forcing brokers to buy shares, suspending trading in two-thirds of stocks, prohibiting new listings and the old stalwart, banning short selling.
It was, of course, all useless. As we saw when western governments tried the same thing in 2008, the market has a way of finding its natural level. It is not short sellers who determine market prices, it’s fundamentals. By the end of July the Chinese market had still returned more than 70% in a year, which is remarkably high. This correction may not be over yet.
As we’ve said before, the correlation between stock markets and GDP growth is literally zero – they are entirely unrelated – and we don’t see the stock market crash in China as presenting anything more than a short-term speed hump for the broader economy, However, we’ve also said Chinese growth statistics should be taken with due scepticism. So when annual GDP growth was reported at 7%, bang in line with the government target, you have to suspend disbelief for more than a moment. Particularly when annual growth in power generation was only 0.5% – services don’t represent that much of their economy just yet.
Commodities – still coming back to earth
Fears over Chinese economic growth are largely behind the Bloomberg Commodities Index halving since its peak in April 2011; in just the last month it fell 10% to a 13 year low.
Bloomberg Commodity Index
While China continues to be the main source of angst for commodities, there are others. The weakness in July was broad based, as you can see from the four charts below.
The oil price fell more than 17% after the U.S. reached agreement with Iran to lift sanctions in return for monitoring of their nuclear program. It could be jumping the gun a bit since analysis suggests it could take four years for Iran to reach full production capacity. Iron ore looked like it was going to break the $50 barrier on softer demand in China, where cabbage now costs more than hot rolled steel!
Gold fell 6% after the Peoples’ Bank of China revealed it was holding less gold reserves than had been expected. Given what’s happened over July, this price movement is particularly sobering for the gold bulls who typically argue it is a safe haven. And copper, where China accounts for 40% of global demand, fell 10% over the month to a new post-GFC low.
We remain very pleased to avoid commodity-based investments.
Greece – crisis averted or just postponed?
As we wrote earlier, the resolution of the Greek debt crisis was not really a resolution, more of a postponement. By giving in to the EU’s demands for austerity the Greek government bought some time and got the short-term debt relief it was after: but the money that came in from the ECB went straight back out again to pay interest on debts. Those debts haven’t disappeared and nor has the interest, it’s almost guaranteed we’ll see a repeat of the same process down the track.
Part of the EU’s relief package is trying to force Greece to deal with some of the massive structural issues it has studiously avoided. Just by way of example, some time ago local dairy farmers successfully lobbied to have use by dates that were so short they effectively prevent any other EU dairy imports. As a result, Greeks pay 35% more for milk than they otherwise would and Greek dairy farms remain too small and unproductive to be genuinely competitive. The pharmacy lobby is the same, successfully preventing supermarkets from being able to sell basic medicines. The industrial infrastructure has been so underinvested that Greece’s famous Kalimata olives are almost entirely exported to Italy and surrounding countries to be bottled and distributed. It’s estimated about €15bn of cash was pulled out of the banking system in the week before it was closed, and the government is so desperate for cash that it is getting Greek companies to pay their 2016 tax a year in advance. So much for cash flow planning.
The issues are difficult and entrenched. But they are idiosyncratic, meaning they’re largely peculiar to Greece. As we’ve said all along: it will be extremely difficult living in Greece for years to come, but at 0.2% of global GDP, it’s not going to have any meaningful impact on global growth and nor should it have any impact on global markets beyond the shrill, short-term, attention-grabbing headlines. Only three weeks after it was front page news, it’s hard to find any mention of it in today’s papers.
What the Greek debt crisis did do however is make European equities even cheaper. While U.S. equities traded at a 17.5x PE ratio, Germany’s DAX was trading on a PE of about 14x, which is roughly the same as it was when German 10 year bonds were yielding 4%, now they’re at 0.8% those PE’s should arguably be comfortably higher. Inflation in the EU remains very low at 0.8% p.a. but industrial production continues to inch up, now 1.6% more than last year and confidence has hit a four year high. But with unemployment not budging from 11.1% there’s no chance the ECB will be changing its QE course any time soon.
Another of our preferred markets, the U.K., saw GDP growth of 2.9% year on year and core CPI up 0.8%. So far so good with the low growth, low inflation call.
Australia – a new normal?
Reserve Bank governor Glenn Stevens seems to be trying to inject some reality into economic expectations, at least for the government. He questioned the long-standing orthodoxy that the Australian economy’s ‘normal’ growth rate should be 3-3.25% p.a. Given economic growth has been less than that for 11 straight quarters, in fact for 24 of the last 27 quarters, it just seems to be acknowledging reality. The implications, however, are a little farther reaching: the government’s budget forecasts are predicated on 3.5% growth for five straight years, and if the RBA revises down its expectations of growth perhaps they will be less likely to cut interest rates if the numbers don’t come in at the higher level.
One of the other areas the RBA has been focused on of course is housing. We are starting to see more evidence of the banks heeding their regulator’s (APRA’s) call to slow investor lending. The line in the sand had been 10% p.a. growth and in June it was running at 11%. We’ve seen both the major and regional banks cut back on investment lending by increasing interest rates, raising the deposit required and generally being a bit fussier about who qualifies. Watch this space as to the effects it has on both bank earnings and the property market.
Something that would have made Governor Stevens happy is the currency doing some of the heavy lifting for him. Amidst the problems on the Chinese stock market and plunging commodities prices the A$ fell to a six year low – an overall positive for our exports.
The emerging markets have seen a similar decline in their collective exchange rates, as shown on the chart below. According to Bloomberg their EM currency index is trading at the lowest since it started in 1999, having fallen 20% in the last year. The biggest hits have been to the commodities-exposed currencies, like Brazil, Russia and Colombia, where falls have been up to 30% in the past year, thanks largely to oil and China. But fears over the potential for capital to be withdrawn from the emerging markets once the U.S. starts to raise interest rates has also played a role. Perhaps as a consequence, according to BlackRock, the world’s largest funds management company, emerging markets are trading at 36% of historic norms.
Emerging Market Currencies in Free Fall
U.S. – another day closer to lift off
The U.S. economy is moving closer and closer to full capacity and consumers are responding. In 2009 there were six unemployed workers per job opening, now it’s approaching one yet the fed funds rate is still zero.
Federal Reserve Chairman Yellen said the Fed is still on target to raise rates this year. However, with inflation running at 1.8%, below the Fed’s target of 2%, and June Q GDP growth at 2.3%, again below the phantom ‘capacity’ level, the market is currently rating the chances of a September rate rise at only 40% and December at 70%. As we’ve said before, we think it’s immaterial when the Fed raises rates, it’s by how much they raise them that matters.
The good stuff…
Late last year scientists in America injected human brain cells into the brains of baby mice, and the mice got much, much smarter. As the mice grew the human glial cells completely took over and changed the brains into ones that learned far more quickly and had far better retention. Other than the rather spooky prospect of smarter animals and the ethical issues that go with that, it may present the possibility of boosting human brains for those suffering degenerative diseases or genetic disorders.