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China capital curbs reflect buyer’s remorse over market reforms

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Categorized | Capital Markets, Equities

Investors need holiday after testing July


Posted on July 31, 2015

BENIDORM, SPAIN - JULY 22: People sunbathe at Levante Beach on July 22, 2015 in Benidorm, Spain. Spain has set a new record for visitors, with 29.2 million visitors in June, 4.2% more than the same period in 2014. Spain is also expected to be the main destination of tourists seeking a value-for-money all-inclusive holiday after the Tunisia attack. (Photo by David Ramos/Getty Images)***BESTPIX***©Getty

Holidaymakers flock to Levante Beach in Benidorm in Spain, which has reported a record number of tourist visits this year

Investors could be forgiven for feeling they deserve a summer holiday. Over the past month financial markets have been rocked, first by negotiations over Greece’s bailout then as attention turned to global growth worries with the fall in China’s stock market and plummeting commodity prices.

The big theme dominating markets is divergence, as economic cycles and monetary policy approaches move out of sync. While China slows, Europe is recovering; and while the US is expected to raise rates, Japan will keep them low for a while longer.

    “We’ve got for the first time a dispersion in central bank activity. Economies are doing different things right now,” says Tony Lanning, a portfolio manager at JPM Fusion.

    While a rate rise by the US Federal Reserve is widely anticipated for September, “in two other developed markets — Europe and Japan — the quantitative easing experiment is just beginning”, Mr Lanning says.

    In the past week investors have moved out of US and emerging market bond funds, particularly US high-yield funds, which are heavily exposed to energy companies under pressure due to the falling oil price. Investors pulled a net $4.5bn from EM funds in the week to July 30, according to data from EPFR, compared with $3.3bn a week earlier.

    At the same time European and global bond funds have seen inflows, according to the latest data from EPFR.

    It is the same story in equities: investors shifted out of US funds and into European, Japanese and global funds. As well as a decoupling of monetary policy, economies are at different points in the wider economic cycle. Europe has more room for earnings growth than the US, having been in recession for longer.

    And stock market performance reflects this. Despite the volatility, buying European stocks was one of the best bets this month: the Euro Stoxx 600 returned 3 per cent this month whereas the MSCI emerging markets index fell more than 8 per cent. The S&P 500 recorded more modest performance, up 1.5 per cent. The Nikkei was a laggard with growth of only 0.3 per cent.

    Commodities, however, plummeted: in July the price of oil fell 12.7 per cent; gold and industrial metals were hit too, losing about 7.5 per cent of their value.

    Chart: How assets performed in July

    Investors fear this is due to a slowdown in China and a reduction in its appetite for importing base materials, but emerging markets were hit in general, particularly commodity exporters such as Russia where the rouble fell 8.1 per cent in July.

    So will investors finally get to take a break and enjoy their summer holidays or is volatility here to stay?

    After that punishing month many funds are now looking to protect their positions rather than bet on the European recovery, says Alexander Altmann, global head of European equity trading strategy at Citi. A lot of managers “are trading their profit and loss and not their view”, he says, referring to managers’ caution due to losses from Greek bailout volatility.

    Volatility tends to be higher in August anyway: as traders and asset managers leave their desks volumes get thinner and so news tends to have a bigger impact, he says.

    Gregor MacIntosh, head of global and emerging market fixed income at Lombard Odier Investment Managers, points out that the effect of quantitative easing is to erode returns while at the same time the “will-they won’t-they” concern over when it comes to an end is creating volatility.

    And this year summer will be accompanied by a packed calendar of closely watched data releases as investors attempt to figure out whether or not the Fed will go ahead with an interest rate rise — for the first time since 2006 — as anticipated in September. Any surprises could rock the market.

    While most analysts think China’s stock market fall has little impact on the country’s wider economy the concern is that it signals slower growth as the authorities try to pump up share prices to ward off a slowdown. Similarly, lower prices for commodities may show that demand is falling faster than anticipated.

    About half of all US earnings calls since the beginning of June have mentioned the slowdown in China, according to data from Factset. Industrial companies that export to China have been hit particularly hard.

    “What we have seen in China is a global deflation trade,” says Manish Kabra, European equity strategist at Bank of America Merrill Lynch. Although he believes the European recovery trade is still alive, deflation would make it harder for governments and companies to pay down their debt, while lower demand from China would harm Europe’s exporters.

    The German Dax index was particularly hurt by news of falling commodity prices as investors worried that if mining companies and Chinese manufacturers reduced their capital expenditure, the German companies that produce the machinery used would be hit hard, while German car manufacturers have looked towards China for growth.

    Instead, domestically focused stocks are favoured by strategists. Many point to the banks, which Nick Nelson at UBS says have provided the bulk of profits growth in Europe as they return to profit after a long period of rebuilding their balance sheets. As well as having more room to rise than other stocks, a banking recovery should support the market more broadly as credit expands in the eurozone.

    This is all underpinned by accommodative monetary policy, which is supporting the market through a lower exchange rate and cheap credit, which should limit the possible downside for investors.

    As long as investors keep pumping money into Europe it should help suppress any volatility in the market, says Mr Altmann. “And I see no reason why they wouldn’t, given they continued to through the Greek debacle.”