Schroders Live: Chinese challenges and rate risks
Looking past short-term volatility
The concerns that prompted recent market volatility have been overplayed, according to Keith Wade.
“Over the medium-term, the prospects for global growth remain reasonable and, while a slowing emerging world (particularly China) may cause global growth to weaken, the developed world is still growing well.
"Lower oil prices seem to be feeding through into stronger consumer spending, especially in the US, Europe and UK while real wages are rising in some parts too.”
Peter Harrison pointed out that investors need to look at the pockets of value arising as a result of the sell-off in emerging markets and commodity prices.
“High-yielding stocks are one area of the market which have become quite depressed, and the value style of investing has been out of favour. I think you’ll start to see a return to those types of themes”, he said.
Elsewhere, in terms of asset allocation “our finger is on the trigger, waiting to upgrade emerging markets,” Peter said.
He believes that the problems facing the emerging world are well known and that in the next few months, investors should consider re-orientating themselves back towards this area of the market.
Chinese authorities regaining grip on economy
Focusing on China in particular, Keith believes that one of the main factors behind the summer’s equity market sell-off was investor concern that the Chinese authorities had lost their ability to stabilise the economy and markets.
However, he points out that since then, policymakers have made it clear that they do not plan to devalue the Yuan significantly. A fiscal package has also subsequently been announced.
“I think the sense is that the authorities are regaining their grip on the economy again and people are beginning to feel a little more comfortable that policymakers will be able to stimulate growth”, Keith said.
However, if the Chinese economy were to experience a “hard landing”, we could see a global recession as well as a potential currency war, according to Keith.
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The safest places to hide from such a scenario are the traditional so-called “safe havens”: low risk fixed income and dollar assets, said Peter Harrison.
That said, the trade-weighted dollar is already nearly at an all-time high which, he suggests, indicates investors are hiding out there already.
Keith pointed out that the world’s major policymakers appear to be working together in a covert form of “international cooperation” by avoiding policy action that would significantly disrupt markets.
For example, the Chinese authorities have not devalued the Yuan, the Bank of Japan has not boosted its quantitative and qualitative easing (QQE) programme and the Federal Reserve (Fed) did not raise interest rates as had been expected in September.
Not the right environment for US rate rises
On the topic of interest rates, Keith believes that essentially, the decision to further postpone the first US interest rate rise was due to a lack of conviction that inflation can get back to the Fed’s target of 2%.
Headwinds from weaker emerging markets and a strong dollar have had a deflationary effect on the economy, even though the domestic economy is performing well with a tightening labour market.
Wages are not rising yet but Keith expects them to start to do so soon.
“We think the next rate rise is probably not on the cards until March next year…in the near term the US economy will continue to grow but not by enough to push up inflation”, he said.
A stabilisation in Chinese growth and some stronger wage growth in the US are the likely triggers for an eventual rate rise, according to Keith. “If we see some signs that wages are picking up, the Fed will feel more comfortable raising rates”, he said.
The lack of liquidity: a canary in the coalmine
As a result of interest rate rises, liquidity issues are back in the spotlight.
“This is the one subject that keeps me awake at night”, said Peter.
“Those who weren’t away on 24th August saw some remarkable things. 1200 stocks in the US were suspended but what was really interesting was you saw a substantial sell-off in some really big ETFs (Exchange Traded Funds)1.
"One of the low volatility ETFs was down 46% (the underlying basket was down 7%) and a US value ETF was down 35%. We have big ETF providers talking about a crack in markets and I think this could be a ‘canary in the coalmine’. If you’ve got liquid instruments that are not working at a time when they should, that’s a big warning sign that things are not right”, he said.
Keith went on to point out that the low interest rate environment is only going to exacerbate the situation because people will continue to look for yield in alternative, income-generating assets. “Very often, investors have to sacrifice liquidity in the search for yield”, he said.
Opportunity amid the volatility
In conclusion, while the deterioration in liquidity is a concern, as is the prospect of a “hard landing” for the Chinese economy, the volatile market environment is something investors should welcome.
“The good news is that you’re going to get some volatility and that is a great opportunity for people to make some money”, concluded Peter.
1. An Exchange Traded Fund is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.↩
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