The traditional quiet summer months of thin and illiquid markets were certainly far from quiet this year. As we write this note in October, markets continue to go up and down on any missive; be it China, the Fed or the oil price. However, the first full trading week in October has seen global equity markets rally from their low points reach late in September.
Interestingly, Greece is no longer the hot topic, although it took until August for Greece and its Euro-group creditors to reach an agreement on the terms of a third bailout. Eventually, details were agreed and passed by the respective parliaments. Greece will receive loans of €86bn over the next three years, whilst they implement a programme of tax rises and spending cuts. So for now, there is relative calm around Greece, but it seems unlikely that the situation has been fundamentally resolved. At some point in the future, there is likely to be debt relief, undoubtedly very quietly and by another name, but debt relief nonetheless. It is worth noting that Greece returned to growth in Q2 (0.9%) which given the economic backdrop is miraculous.
The latest all-consuming thorn in the side of global markets is now China. Is it a managed slowdown or the start of a meltdown? Given its closed shop nature the answer is that no-one can be sure, but after they unexpectedly devalued the Yuan in August, markets have been extremely jittery and there is no consensus as to what this means. Is it a distress signal? Is China’s growth worse than the official 7% figure suggests, or do we believe Beijing when they say the move is about opening up its financial system and increasing competitiveness versus their Asian neighbours? Markets don’t know and they are not happy.
The knocks on effects of a serious slowdown in China are endless, but global deflationary pressure is the most concerning. At the current time the global economy (heavily indebted and maxed out on monetary policies) is not well paced to deal with it. Despite the recent rally, global markets are nervous and watching what China decides to do next.
The Chinese Yuan devaluation had an immediate impact. For example, commodity prices have been marked down further with oil currently standing at $48 a barrel (oil has been lower than this in the past 3 months though). Given the current global market volatility and also the deflationary concerns, it proved enough to persuade the US Federal Reserve to hold back on raising interest rates. In addition, in the UK raising interest rates appears to be on the back burner for some time, indeed it may be possible that the UK inflation rate turns negative again in Q3, and it may be Q2 2016 before things get more interesting.
Another factor in keeping the lid on UK interest rates rises is that the domestic picture hasn’t been as robust as the Monetary Policy Committee (MPC) had hoped. Although second quarter growth came in at 0.7%, which was positive, after a poor 0.4% in the first quarter, the Purchase Manager Indices (PMIs) have shown no pick up over the last few months, suggesting that it is unlikely that the Q3 growth number will not improve. Manufacturing continues to struggle in the face of weak global demand and strong sterling. Construction has remained firm although the service sector has reported a fall in growth; the PMI stood at 58.5 at the end of Q2 but has fallen to 55.6 as at the end of August. Whilst a figure above 50 does represent growth, it is the lowest figure reported in over 2 years, hardly the conditions for interest rate increases. The MPC will need to see an upturn going forward before looking to raise interest rates.
On a more positive note for longer term growth, business investment rates remain positive at 1.6% in Q2, with the Q1 figure revised up to 2.4%. This is essential if productivity levels are to increase.
With employment remaining firm it is important that businesses begin to look past the quantity of workers employed and invest to improve the quality. With the number of people unemployed falling, we are likely to see further wage growth from a moderate 2.9%. If this is not to feed through to rising prices (inflation), then businesses need to make efficiency improvements, which only come from investment.
The Eurozone has continued its economic recovery over the past few months, as business and household confidence improves. Q3 growth was 0.4% (not final) and with composite PMI at 54.3 in August being just above the Q2 figure, this level of growth looks set to continue in Q4 2015. Annual inflation has been just above zero for a number of months now and the European Central Bank (ECB) is ready to inject further stimulus if required, this is supportive of further growth and we are optimistic for the Eurozone going forward.
Despite the recent global equity market turmoil, we continue to be cautiously optimistic that global equity markets will finish 2015 higher than at the end of Q3 2015. We continue to believe in the benefits of a diversified investment portfolio with a focus on income, which should help smooth the return during these periods of extreme market volatility.