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Brewin Dolphin Markets in a Minute: Markets mixed as US GDP growth disappoints

Please see below for Brewin Dolphin’s latest ‘Markets in a Minute’ article, received by us yesterday evening 03/08/2021:

Global equities were mixed last week as weaker-thanexpected US economic data offset strong corporate earnings reports.

In the US, the S&P 500 and the Nasdaq slipped 0.4% and 1.1%, respectively, after gross domestic product (GDP) growth and durable goods orders missed expectations. Amazon’s warning of slower growth in the months ahead weighed on the consumer discretionary sector, whereas utilities and real estate stocks outperformed.

The pan-European STOXX 600 ended the week flat amid ongoing concerns about the spread of Covid-19. The UK’s FTSE 100 was also little changed after a spike in the number of people told to self-isolate continued to disrupt production.

Over in Asia, Japan’s Nikkei 225 lost 1.0% as new Covid-19 cases reached record levels, resulting in Tokyo’s state of emergency being extended until the end of August. China’s Shanghai Composite slumped 4.3% following the country’s regulatory crackdown on the technology and education industries.

Delta woes weigh on markets

US stocks closed slightly lower on Monday as concerns about the Delta variant were compounded by softer-than expected manufacturing growth. The Institute for Supply Management’s index of national factory activity fell from 60.6 in June to 59.5 in July, the lowest reading since January and the second consecutive month of slowing growth.

Asian markets followed Wall Street lower on Tuesday, with the Nikkei 225 and Hang Seng tumbling 0.5% and 0.4%, respectively, as fears about the spread of coronavirus overshadowed strong US corporate earnings.

In contrast, the FTSE 100 and the STOXX 600 added 0.7% and 0.6%, respectively, on Monday, following news that British engineering firm Meggitt has agreed a £6.3bn takeover by US company Parker-Hannifin. Shares in Meggitt surged 56.7% from Friday’s close.

Market gains continued into Tuesday, with the FTSE 100 and the STOXX 600 up 0.4% and 0.3%, respectively, at the start of trading.

US economic data misses estimates

Last week’s headlines were dominated by the latest GDP figures from the US. According to preliminary data from the Commerce Department, the US economy expanded by an annualised rate of 6.5% in the second quarter. This was better than the 6.3% increase seen in the first quarter but was significantly below forecasts of 8.5% growth.

Personal consumption was the biggest driver of growth, as the stimulus cheques issued between mid-March and April fuelled an 11.8% year-on-year increase in household spending. This was partially offset by lagging property investments and inventory drawdowns.

Separate data from the US Census Bureau showed orders for cars, appliances and other durable goods in June were also weaker than expected. Orders rose by 0.8% from the previous month versus estimates of 2.2% growth, although May’s reading was revised up to 3.2% from 2.3%. It came amid continued shortages of parts and labour as well as higher material costs.

Meanwhile, the Labor Department reported that 400,000 people filed initial claims for unemployment benefits for the week ending 24 July, above the Dow Jones estimate of 380,000 and nearly double the pre-pandemic norm.

More positively, US consumer confidence was little changed in July, hovering at a 17-month high of 129.1. Economists polled by Reuters had forecast a decline to 123.9.

Inflation picks up in Europe

Over in the eurozone, inflation accelerated to 2.2% in July from 1.9% in June, according to figures from Eurostat. This was the highest rate since October 2018 and above the 2.0% reading forecast by economists. Higher inflation came amid faster-than-expected monthly GDP growth of 2.0% in the April to June period. Compared with the same period a year ago, GDP surged by 13.7%. The eurozone economy is still around 3% smaller than at the end of 2019, but the expansion marked a strong rebound from the 0.3% contraction seen in the first quarter of 2021.

Germany missed expectations with a quarterly expansion of 1.5%, as supply constraints left manufacturers short of materials such as semiconductors.

Half a million come off furlough

Here in the UK, more than half a million people came off furlough in June. The gradual reopening of the hospitality sector drove more than half the total fall in jobs supported by wage subsidies, according to data from HM Revenue & Customs.

Shortages of labour and materials and problems recruiting staff meant manufacturing output and order book growth slowed to its weakest level in four months in July. The manufacturing PMI stood at 60.4, down from 63.9 in June. IHS Markit said July’s performance was still among the best on record but would have been even better had it not been for supply constraints.

Nevertheless, the International Monetary Fund (IMF) upgraded its 2021 growth forecast for the UK to 7%, meaning that together with the US it would have the joint fastest growth of the G7 countries this year. In 2020, the UK’s economic contraction was the deepest in the group.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well

Paul Green DipFA

04/08/2021

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AJ Bell: Why Chinese stocks are still not partying

Please see below for one of AJ Bell’s latest articles, received by us yesterday afternoon 22/07/2021:

Tomorrow (23 July) heralds the one-hundredth anniversary of the first meeting of the Chinese Communist Party and the country’s leadership continues to mark its birthday with a series of high-profile events, speeches and actions

Whether the centenary is anything that investors can mark with pleasure remains more of a moot point, even if the benchmark Shanghai Composite index trades some 15% above the levels reached just before the news of the pandemic seeped out of the Middle Kingdom in early 2020. These doubts persist for three reasons:

First, the president and general secretary of the Communist Party, Xi Jinping, marked the anniversary of the party’s foundation on 1 July with what many in the West saw as an aggressive speech as he warned any foes would be met with a ‘wall of steel’.

Second, China continues to intervene in financial markets, often in not-so-subtle ways. The crackdown on internet giants such as Alibaba and Meituan, and cybersecurity investigation into ride-hailing app Didi immediately after its stock market flotation in the US looked like expressions of displeasure with a trend toward overseas listings and a reminder to entrepreneurs of who was really boss.

Finally, China’s second-quarter GDP growth figure of 6.7% year-on-year undershot economists’ forecasts. This perhaps serves as a reminder that China is trying to combat the economic fall-out of the pandemic and keep the economy going on one hand, yet seeking to avoid letting financial markets, asset prices and debt get out of hand on the other.

Beijing and president Xi are hardly on their own in this respect – the UK, US, the EU, New Zealand, Australia and Canada are also members of what is a hardly exclusive club – but political legitimacy perhaps rests most fundamentally upon economic progress, employment and increasing prosperity than it does in China than anywhere else, not least because the authorities really have no-one else to blame if anything goes wrong.

DEBT DILEMMA

The last point is perhaps the easiest to tackle. Granted, China has a relatively low government debt-to-GDP ratio of 67% but that number is rising quickly. Moreover, the opaque structure of Chinese State-Owned Enterprises, let alone the so-called shadow banking system, mean the overall national debt-to-GDP figure is a less healthy 270%, according to China’s own National Institution for Finance and Development.

China may therefore be generating growth, but the quality of that growth looks questionable, given its reliance on fiscal stimulus and cheap debt. This perhaps explains why the Shanghai Composite index is trading well below its 2007 and 2015 highs even as the economy keeps expanding. A timely reminder that investors should never use macroeconomic data alone when it comes to selecting stocks, indices and funds (be they active or passive) to research and follow.

In the interests of balance, it must be noted that China’s currency is trading relatively strongly against to the dollar, after a six-year slide, so markets may not be too worried about the economic foundations (although again the US faces the same challenges).

POWER PLAY

Geopolitical risk is something which with all investors must live but there is little they can do about it, barring factor it into the risk premiums they demand when buying assets in certain countries – or in plainer English, pay lower valuations to compensate themselves for the potential dangers involved.

Sino-American relations remain strained, to say the least, as Beijing and Washington wrestle for supremacy in key industries, notably mobile telecommunications and semiconductors.

This is prompting talk of a new Cold War, a view perhaps supported by president Xi’s powerful speech on 1 July. Investors will be hoping it does not spill over into a hot war over Taiwan, for example, whose strategic importance is only heightened by the global semiconductor shortage.

But if investors can do little about geopolitics, they can do everything when it comes to corporate governance, either on their own or by paying a fund manager to do the donkey work for them. And perhaps the greatest concerns lie here, at least when it comes to Chinese equities.

Beijing’s indifference to the damage done to Didi Chuxing’s share price in the wake of the security investigation and assertion that US regulators cannot check Chinese audits of firms with listings in America is a big red flag (if you will pardon the expression). No-one, from a private individual to a trained fund manager, can invest in a firm if audited, verifiable and reliable accounts are not available.

This reminder that China has its own agenda – one that is designed to preserve the Communist Party’s hegemony well beyond the first hundred years – affirms that investors’ needs are secondary.

They are welcome to keep buying stakes in Chinese firms, or funds which track Chinese indices or own Chinese equities, if they wish. But they need to be sure they are paying suitably lowly valuations to accommodate the potential risks, which should also be in keeping with their overall tolerance levels.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well

Paul Green DipFA

23/07/2021

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Invesco: Emerging markets, China, and the road ahead

Please see below for one of Invesco’s latest investment articles, received by us yesterday 07/07/2021:

A year and a half after the first reported cases of a new SARS-like virus in Wuhan, China, we can now look back with greater clarity on a period of some of the most dramatic volatility since the Asian and global financial crises. Here, we assess what this volatility and the associated policy responses have meant for China and emerging markets and plot a dotted line for the road ahead.

Looking up after locking down

At the time the pandemic hit, the unresolved US-China trade war loomed large and global manufacturing was in the early stages of restructuring to accommodate new trade patterns. Despite this, China stood out from other countries in terms of its fiscal, monetary and industrial policy response.

Beijing’s policy decisions focused on maintaining domestic productivity and employment with as little disruption on the demand side as possible. Manufacturers were given liberal access to capital to maintain operations, and refunds on social security tax and unemployment insurance incentivised businesses to retain staff without layoffs.

At the same time, the central bank lowered its reserve requirements and removed blocks on certain loan extensions and renewals. Investments were made in traditional infrastructure projects like housing and transportation, and spending on the nationwide 5G network was accelerated.

As a result, China moved from having a GDP contraction of almost 6% for the first quarter of 2020 to being the only major world economy to print a positive GDP growth number for the year.

A dolorous relationship?

While China’s growth in 2020 is unmatched, the road ahead is not unwinding, particularly when we consider the impact that US policy decisions could have on the US dollar.

The growth of the US fiscal balance sheet in 2020 (accommodated via easy monetary policy) appears to have stimulated real inflation in the US economy – an outcome which has led to talk of tightening. If asset purchase programmes are tapered or rates increased, the likely outcome is a stronger dollar.

Historically, a strong dollar has been negative for emerging markets, as it increases the burden of US dollar-denominated debt. This is less of a factor today than it was prior to the Asian and global financial crises. However, the fact remains that this could dampen growth prospects in some emerging market economies.

Commodities buck the trend

In spite of the observation noted above, it is likely that a stronger dollar will benefit firms selling commodities into US dollar-denominated markets, as long as there is global demand for these products. This factors into the dramatic outperformance we have seen from steelmakers, iron miners, commodity chemical companies, and even coal producers.

The demand behind this outperformance is not part of the same super-cycle seen after China’s admission to the World Trade Organisation, when investment in capacity and infrastructure facilitated the country’s transition to the so-called ‘world’s factory’.

Even when we account for the fact that some of this capacity has moved to other countries in the context of trade realignment, the overall demand for commodity materials is not in the same league as two decades ago.

Instead of a broad, sustainable growth in demand, we are seeing a short-term build-up of inventories that reflects ‘new normal’ uncertainties about tariffs and pandemic lockdowns. This goes all the way through the product cycle, from raw materials to finished goods.

Although these dynamics are almost certainly near-term and should subside in the medium-term, they do attract speculation that disrupts the market.

The road ahead

What does this disruption mean for emerging markets? In the absence of significant inflows, there is a conservation of capital within the asset class. The sharp and transitory shifts described above get funded by parts of the market that have outperformed — in this case growth companies, in particular those in China. In this sense, China has been a victim of its own success as far as its response to the pandemic is concerned, as some investors look to lock-in potential gains.

That said, in our opinion, these sharp transitions do not signify a change in the long-term view for emerging markets. The types of firms that create and capture value for shareholders remain the same.

Even with an ageing population, China remains a large economy with an outlook for sustained, high-speed growth. The growing middle class offers opportunities for investment in education, real estate services, and world-leading innovative technology platforms that facilitate consumption.

It is worth adding that the size and scale of the domestic market should make it less susceptible to external volatility than other markets in the asset class.

What these transitions offer, then, is the potential to invest in the best long-term opportunities at more attractive valuations than normal market conditions afford. 

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well.

Paul Green DipFA

08/07/2021