By John Bilton, global head of Multi-Asset Strategy, JP Morgan Asset Management
Newsflow this August appears dominated by China: devaluation of the Renminbi, weak export data, and the ongoing volatility in the stock market are providing ample material for analysts and commentators alike during an otherwise quiet period. In our view, the sharp market reaction to the fall in china’s currency, and dark talk of currency wars, overshadowed the fundamental issues within the Chinese economy which were amply highlighted by soft economic data.
But for all the prevailing attention on China, it is not the only issue investors and asset allocators are grappling with as the August holiday season plays through. We believe that as investors shake the sand from their shoes and apply the aftersun lotion there are four themes which they should watch, and these will set the agenda for markets in the coming weeks.
First, the timing of the US Federal Reserve’s rise in interest rates continues to hold investors’ attention. We sit in the September camp, on the grounds that the job and housing markets support a move sooner rather than later, even if inflation continues to lag. We would have expected to see more wage inflation at this point, but on balance, the US economy is ticking the majority of boxes on the Fed’s checklist. Unless the jobs report in early September and the first revisions to second quarter GDP in late August are significantly off-track, September remains the most likely date for lift-off, in our view.
Ahead of the hike, markets are following a classic playbook – uncertainty and modest derisking in stocks, and mild flattening in yield curves. Performance of the S&P500 and the U.S. yield curve are broadly in line with the average of the run-up to the last five rate hiking cycles. There are, of course, many warnings that equities will struggle when rates start rising, and in the short run history bears this out.
In the three months following the start of a hiking cycle the S&P tends to dip by, on average, around 5%; but subsequently stocks tend to regain their poise and returns outstrip bonds for the remainder of the hiking cycle. History tells us investors should dump stocks on the last rate hike, not the first. As a result we remain modestly overweight stocks, and with a clear “buy the dip” mentality.
Second, a softening China has important global implications. China is in the painful process of changing how it achieves growth, aiming for consumption and productivity rather than exports and capital expenditure. Market liberalisation efforts, such as moves towards floating the currency, are fundamental to this process. Although there is real and concerning weakness in China, the notion that the drop in the value of the Renminbi was the opening salvo in a currency war are likely wide of the mark.
While it is true that the move is, at the margin, disinflationary, the scale of the Renminbi move must be understood in relation to moves in the Euro, Japanese yen, Australian dollar and other currencies. Simply put a 4% drop is large relative to the trading band of the Renminbi in recent years, but tiny compared to the recent price action in other currencies.