Equity investment outlook October 2015: global growth scare: is it warranted?
<p>During the third quarter, global markets were roiled by heightened investor uncertainty and downright fear that China’s slowing economic growth might tip the global economy into recession. The selling pressure that took hold in mid-August had all the elements of a mini panic. The only assets that held their value or posted gains were cash and investment grade bonds. The further out one looked on the risk spectrum, the worse the decline. Non-investment grade bonds traded off 3-5%. Even the 6% decline in the S&P 500 Index during the quarter was relatively benign compared to smaller cap stocks that pulled back nearly 12% and emerging market equities that tanked nearly 18%. China and the economies that depend most directly on China’s demand were hit hardest: the Chinese market fell 30% and Brazil was down 33%.</p>
<p>The key development precipitating the sell-off was China’s decision to let its currency devalue versus the U.S. dollar. This was read by global markets as tacit acknowledgement by the Chinese authorities that China’s growth was flagging and needed a lift from a weaker currency. Given the leading role that China has played in driving global growth over the past decade, investors ran for the exits, fearful that a recession in China could trigger a global recession. Our response is “not so fast.” In China and the economies dependent on it, concern is completely justified by the facts. The “miracle” hyper growth phase of China’s economic development may very well be over, leaving China to manage a potentially difficult downshift into an extended period of much slower growth (slow growth, not zero growth). This could have serious, lasting implications for many emerging market economies and stock markets. That said, the implications for the U.S. are much more nuanced and the current level of investor concern may be unjustified and overdone. We think a strong case can be made that the U.S. economy can decouple from a Chinese slowdown. Some even argue that the U.S. economy will prove to be a net beneficiary of the cooling-off in Chinese and emerging market growth. This Outlook will look at the growth scenarios for China and China-dependent countries compared to the U.S.</p>
<p>China is experiencing a significant slowdown in its growth rate, a change that is having wide-ranging spillover effects. Year after year of double digit Chinese gross domestic product (GDP) growth helped power global growth over the past 15 years (Figure 1). Since the year 2000, the emerging markets’ share of the global economy has increased from above 45% to 60% now (Figure 2). Investors are rightly concerned about the impact of a Chinese slowdown on global growth, but we think that the brunt of this slowdown will be borne by China and its main suppliers (not the U.S.). China’s voracious appetite for commodities during its go-go days helped lift growth for many commodity and goods producing countries. Now that China’s growth is slowing, demand for these commodities is waning and prices are plummeting. This, of course, is devastating to the profitability of commodity producers and the countries dependent on them (e.g. Brazil, Russia, Indonesia, Malaysia, South Africa and Australia). The big question is: could this commodity deflation be good news for the U.S. consumer? We try to answer this question later in this Outlook.</p>
<p>Source: Cornerstone Macro, Economic Research, October 11, 2015 (end date: 6/30/15). Year-on-year growth rate.</p>
<p>Source: Cornerstone Macro, Econ</p>