Market Bulletin (24/08/2015)
Equity markets went into full retreat last week, as falling Chinese and US production indicators increased worries about a global economic slowdown. The reverse has continued in this morning’s trading, with the impact of investor fears exacerbated by typically thin trading during the holiday season – trading volumes in FTSE 100 stocks since 1999 are on average 50% lower in August than for the rest of the year.
The Caixin Purchasing Managers’ Index (PMI), an independent gauge of Chinese manufacturing activity, sank to its lowest level since 2009. It slipped from 47.8 in July to 47.1 for the first three weeks of August. This followed devaluations of the yuan and failed attempts to prop up China’s troubled stock markets, and added to growing concerns that the Chinese economy is running out of steam. Since China is such a large importer of raw materials – it consumes some 43% of the world’s metal production – and is a growing consumer of foreign manufactured goods, slower growth will ripple through the world economy. The sobering effect was compounded by PMI data from the US, which represented the weakest manufacturing growth in nearly two years.
After the strong market rally of recent years, we have seen a return to the volatility that is an inherent feature of equity markets. However, it is important to remember that this is a function of market makers marking down prices and not a stampede of investors heading for the exit door. All the major equity exchanges were at least 5% down on the week. The Shanghai Composite was down 11.5%, with further falls in morning trading taking the index deep into bear market territory, having dropped by around 30% since the middle of June. On Wall Street, the S&P 500 index fell 5.75%, wiping out all gains since January. Both the Dow Jones Industrial Average and the technology-rich NASDAQ indices were more than 10% below their recent record highs.
“Equity markets have been enjoying an extended bull run and have always provided good returns over the long term,” observed Chris Ralph, chief investment officer at St. James’s Place. “But they are prone to bouts of volatility, and during such periods it is vital that investors keep their longer-term perspective. These events underline the importance of maintaining a well-diversified portfolio.” We reflect on the weekly fall of over 10% in the St. James’s Place share price as a good example of the indiscriminate nature of the market reaction, which has come despite the fundamental attributes of the company being unchanged.
Richard Oldfield of Oldfield Partners maintains that the slowdown in the Chinese economy represents a “severe blip” rather than a hard landing, brought about by not only by a credit bubble but also by the government’s efforts to rein in credit. “In the medium term, we think China will continue to grow strongly as urbanisation and the shift to a more consumer-dependent economy continue.”
The recent falls in Chinese markets should also be put into context against the surge of 140% in the Shanghai Composite index from last August until the middle of June. Experienced investors will be only too aware that such dramatic rises can only end in tears; a fact that is more likely to have been lost on local Chinese investors new to the market than those who have considered investing in China only as part of a well-diversified approach.
China is the world’s largest consumer of most raw materials, so what’s bad for her is bad for commodities, not least for oil. Having staged a recent modest recovery, oil prices resumed their decline as the Chinese PMI news broke. North Sea Brent crude ended the week at $45.46 a barrel, its lowest level since mid-January and its seventh weekly loss in two months. Prices for industrial metals including aluminium, copper, nickel and zinc have all been trading down.
Lower prices and a weaker yuan are unhelpful for the emerging markets that produce these commodities. Emerging market (EM) equities have fallen to their lowest level since 2011 and investors have pulled $2.5 billion out of EM bond funds in the last week. EM currencies are also under pressure – the South African rand fell to its lowest level against the dollar since 2001, while the Turkish lira and Russian rouble both dropped by more than 1%.
Stuart Mitchell of S. W. Mitchell Capital finds it surprising that investors are only now questioning their consensually optimistic outlook for China. “We have been aware, from our many conversations with company management teams, that the Chinese economy has been slowing down for quite a few quarters now,” he says. “Curiously, the outlook for Europe has not looked as good for quite some time. Economic recovery is gathering momentum, while the process of quantitative easing has only just begun.”
In contrast to China and the US, the latest eurozone PMI numbers are heading upwards, and in August have climbed to one of the highest figures for the past four years. Economists say that the currency area’s recovery is mainly driven by domestic demand, but that a weaker euro is helping exports, particularly to developed countries. This is offsetting the negative effect of the slowdown in EMs.
The eurozone’s status as a relatively safe haven saw the euro strengthen against Asian and EM currencies. It also appreciated against sterling, closing the week at €1.38 to the pound. This was no comfort to European equities, however, and the FTSEurofirst 300 Index responded to the Chinese and US data by dropping 3.4%, its biggest one-day fall in nearly four years. It ended the week down 6.6%. Markets in Germany and France lost nearly 3% in early trading this morning.
Greek Prime Minister Alexis Tsipras, with high approval ratings at home, announced both his resignation and a snap election in September to consolidate his position. His country’s debt drama continued to play out but was no longer centre stage. When the German parliament voted in favour of the latest €86 billion bailout, it would normally have buoyed financial markets. Yet that same day the FTSE 100 Index fell to its lowest level since January.
London’s FTSE 100 Index is rich in mining companies, whose fortunes are highly sensitive to Chinese growth or the lack of it. So it reacted badly to the news from China, and wasn’t helped by an 8% drop in the shares of mining company Glencore, following disappointing results. Having fallen for nine consecutive sessions, the benchmark index ended the week 5.5% down, at 6,187. It began the year at 6,566. Mining stocks have continued to bear the brunt of this morning’s falls as the FTSE 100 was down a further 3% at the time of writing.
There was more cheering news about the UK’s public finances, which continue to improve, according to the latest official figures. These showed strong growth in tax revenues, with income and wealth taxes up 5.7% so far this financial year, compared with the Office for Budget Responsibility’s positive full-year forecast of 3.7%. Government borrowing for the first four months of the year was £24 billion, down from £31.3 billion the previous year and the lowest since 2008/09.
Such news provides further evidence that the short-term direction of stock markets does not always move in step with economic performance. Faced with such uncertainty, investors need to remember that, through holding a combination of asset classes within a portfolio, which will react differently to market and economic developments, they can help cushion themselves against the impact of events such as we are currently witnessing.
Oldfield Partners and S. W. Mitchell Capital are fund managers for St. James’s Place.
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