Over the past two volatile weeks, besides weak Chinese manufacturing data, arguably the most important data point moving markets – was the US second quarter gross domestic product (GDP) figure. It was revised upwards on August 27 from 2.3 percent to an impressive 3.7 percent. This helped power last week’s market recovery – with the Dow Jones adding more than 1 000 points from its recent lows, an almost 6.5 percent recovery.
The US economy, led by the housing recovery and increased corporate spending, powered a large portion of the 2nd quarter GDP revision. Most positive was business investment growing by 3.2 percent. Net exports also boosted GDP, as imports fell. This was backed up by increased government spending, especially at the state and local level. Other pockets of good news show the past few weeks of US weekly initial jobless claims declining to the lowest levels seen in many years – around 270 000. This is well below the prior levels of around 300 000 earlier in the year.
Developed world stocks remain attractively priced when considering their dividend yields outpace bond yields in the following comparison (respectively): UK 3.8 percent versus 3 percent, France 3.4 percent v 1.8 percent, Germany 3.1 percent v 1.6 percent, US 2.1 percent v 2.2 percent and Japan 1.4 percent v 0.7 percent.
Global stock markets are definitely not out of the woods yet, as we await the first US Federal Reserve rate increase in almost a decade. The positive August jobs report showing lower US unemployment (5.1 percent) and new hiring of 173 000 points to a 0.25 percent rate rise by the Fed by October.
The US will continue to pull the global economy along and will likely still record 3 percent annual GDP growth for the rest of the year. These additional factors provide optimism:
- US and developed country inflation levels remain largely benign.
- US interest rates are low – and given the interest rates on both the 10-year treasury (2.1 percent currently) and the 30-year treasury (2.7 percent), we expect them to remain relatively low indefinitely. Ultimately interest rates are related to inflationary expectations.
- The US has an accommodative Fed and solid corporate profits – so at most a 25 basis points increase will be seen in 2015 and likely very slow rate hikes into 2016 to 2017.
- The earnings yield on the Standard&Poor’s 500 is now 3 times the interest rate on the 10-year treasury – a ratio that is typically 1:1 over long periods of time. Owning equity in a group of superior businesses producing returns of 6 percent is attractive compared with bonds.
- The lower energy prices (oil around $40 a barrel) are a re-allocation of wealth from the oil and gas companies to consumers – and will eventually cause an increase in consumer spending.
- The US is largely a self-sufficient economy and will not be materially affected by problems currently present in emerging market economies. Less than 1 percent of US exports go to China;
- US employment growth is expected to remain firm at around 200 000 new jobs coming each month, though wage growth has been weak.
- With the unemployment rate falling to 5.3 percent and 215 000 jobs being added in July, the broader economy is strengthening. However wages, remain stagnant, with no move up in hourly earnings – so the US is well positioned for further growth without much inflation.
- US manufacturing shows renewed growth based on both the Institute for Supply Management (ISM) and Markit surveys in July.
- The large US services sector continues to outpace manufacturing growth – the ISM non-manufacturing index recently hit its best level since 2005.
Fragile markets
The most fragile emerging markets are not those relying on manufacturing, but rather countries such as Brazil, Indonesia, South Africa, Russia and Malaysia dependent on commodity exports to China and running large current account deficits.
Their local stock markets, debt markets and currencies will remain under pressure until certain structural reforms are put in place. We expect the weakest of these emerging markets including South Africa to remain under pressure until such time as the commodity cycle begins to turn (that is, higher prices) and confidence in Chinese GDP growth returns.
Unfortunately the commodity super cycle has been proven to be mostly a myth. With oil, copper and iron ore down between 50 percent to 70 percent from their recent highs, emerging markets need to retool their economies fast. Lifting domestic demand is crucial as foreign capital takes flight. Sadly too few emerging markets took advantage of the commodities boom to diversify their economies and invest in other areas including their labour skills.
Sadly the related credit fuelled boom in many emerging markets is also coming home to roost. GDP growth is expected to be around 3 percent for emerging markets – well below levels required to power these economies which contribute almost 40 percent of world GDP.
Declining trade levels due to depreciating currencies has also stymied growth in these countries, while almost $1 trillion (R13.91 trillion) has fled the 19 largest emerging market countries over the past year.
Over-reaction
With Chinese exports flat during the first half of 2015 and electricity and cement consumption declining this year – it is clear the Chinese economy is weakening. However, the recent market turmoil is likely an over-reaction to weakening Chinese purchasing manager’s index data.
Many analysts do not believe China is still growing at 7 percent GDP levels as officially reported recently. China continues to grow (perhaps at 5 percent to 6 percent) – albeit far slower due to the emphasis away from infrastructure and resource-heavy investment growth, to more domestic consumption based growth. Worth noting is the Chinese services sector remains robust, posting positive numbers for August.
While China recently surprised investors by lowering its exchange rate to the US dollar by just under 2 percent – the decision is not the start of any currency war and in fact makes much sense:
- China’s policy to peg the renminbi to the dollar has caused its currency to soar in relation to most of its trading partners and particularly the euro and the yen this year. China is simply seeking to stabilise its currency following strong gains of some 60 percent over the past seven years to the euro.
- In order for China to become a global reserve currency (part of International Monetary Fund’s special drawing rights) – its currency needs to be more market orientated and freely usable. Prior to the devaluation it was seen as a one way bet.
- China faces deflationary risks as its rising currency pushed prices lower. Inflation is just above 1 percent by most estimates. A slightly weaker currency will alleviate the deflation risk by increasing the price of imported goods slightly.
* Anthony Ginsberg is the managing director, GinsGlobal Index Funds (www.ginsglobal.com)
** The views expressed here do not necessarily reflect those of Independent Media
BUSINESS REPORT