MARKET BULLETIN 25 AUGUST 2015 COMMENTARY // AUGUST 2015
STOCKMARKET MIST CLEARS... ONLY TO REVEAL AN ABYSS A sea-change has taken place in the world’s stockmarkets. Having been seemingly fog-bound for most of the year, unable to find direction or make headway, they have succumbed to fear and panic. It’s natural for investors to want to understand why markets move, especially when the movement is large. Perhaps by understanding what has happened we can derive some information that will help us predict what will happen next. Regarding recent stockmarket turmoil, however, that may be a pointless exercise. The movements have been so rapid and extreme that they defy explanation. It is always tempting to imbue capital markets with a higher knowledge, to assume that they have some kind of predictive power that will materialise in a new economic reality. But it would be wrong. What’s important now is our reaction, not the quest for an explanation. Our confidence in the rational behaviour of markets may have been shaken but our confidence in our investment process is intact. That process is telling us that stockmarkets are now cheaper, bond markets remain expensive but, crucially, the state of the world has barely changed. Such change as there has been, concerns Emerging Markets (EM) and, in particular, China. Two weeks ago China’s central bank spooked markets by devaluing the Chinese currency. The extent of the devaluation – a mere 4% – was not enough to cause much change in the economic landscape but the change of policy is important: China now has another tool in its arsenal for managing the economy. Markets seem to have taken this as implying that China’s economy is in a worse state than had been imagined. If that is the case, further devaluations may occur. We do not know when or how much - the People’s Bank of China is not accustomed to sharing information, and that creates uncertainty. If those devaluations were to occur they would probably be followed by competitive devaluations elsewhere among emerging nations. For this reason, yesterday we sold our remaining EM bond holdings. These were mostly US Dollar denominated, and had been relatively stable during the panic of the past few days. However, even they are ultimately at risk from further devaluation of the Chinese currency. This action raises cash of about 6% in our Balanced portfolios, bringing cash resources up to 15% of assets (the equivalent figure is 19% in Moderately Cautious and 7% in Moderately Adventurous). It also reduces our exposure to foreign currencies, now down to 15% in our Balanced portfolios. If stockmarkets continue to decline we plan to raise cash from other assets with a view to exploiting valuation opportunities. On the subject of China, we want to guard against surprises from an inscrutable central bank but we also see the glass as being half-full. If investors are supposedly concerned about a slowing Chinese economy they should be cheered by the policy of currency devaluation. One can hardly fault China for wanting a weaker, more flexible currency when so many other nations in the world have been actively devaluing their own! China’s economy has been slowing for years. Some of that slowdown is intentional, as the government seeks to rebalance the economy away from polluting heavy industry and construction towards services and consumer spending. The services sector now represents half the Chinese economy (see chart overleaf), up from 44% a few years ago, and is growing at a double-digit rate. The Chinese consumer is in great shape: retail sales are rising by 10% per annum. When it comes to soaking up this demand, Chinese companies are formidable competitors: when we hear CEOs complain about slow growth in China we should bear in mind that they are often just losing market share.