Why China’s slowdown is playing second fiddle to America’s volatile economy and markets
- Nicholas Spiro says while China is understandably seen as the source of global financial market turmoil, the US economy may have investors more concerned
As any investment strategist will readily admit, trying to disentangle the myriad factors responsible for the current turmoil in financial markets is no easy task. Yet, last week, the finger of blame was pointed squarely at China.
While the sharp slowdown in the world’s second-largest economy – and Beijing’s response to the downturn – has been one of the main determinants of sentiment ever since markets came under pressure last year, the importance of China has risen significantly since worries about global growth intensified in the final quarter of 2018.
Two catalysts for the continued selling pressure last week put China firmly in the spotlight. The first was the publication of two separate purchasing managers’ index surveys showing a contraction in China’s manufacturing sector last month, the latest sign that the double whammy of slowing domestic demand and US trade tariffs continues to crimp growth. A second market-moving event was last Wednesday’s surprise announcement by Apple of the first cut to its quarterly revenue outlook in 16 years, citing weaker demand for its iPhones in China as the overriding factor.
Taken together, the two developments have heightened concerns about a China-driven global slowdown.
Markets are becoming more sensitive to the underlying problems of China’s economy which have little to do with the trade war and are exacerbated by tensions between recent stimulus measures and the government’s 2½-year-old deleveraging campaign.
While investors have been fretting about China’s downturn for some time, its spillover effects on the global economy are becoming more pronounced. The question is whether the current turmoil in markets is mainly attributable to China.
Global growth has certainly taken a knock of late. A gauge of manufacturing activity across the globe in December fell to its weakest level since September 2016, with 10 of the 30 countries surveyed, including China, reporting a contraction in activity, according to data provider IHS Markit.
Even America’s resilient economy is showing signs of succumbing to external headwinds. Manufacturing activity in December fell at its fastest pace since 2008, according to a survey published by the Institute for Supply Management last Thursday. Fears about slowing demand in China are also affecting US corporate fundamentals. Data from Bloomberg shows that 46 per cent of companies issuing earnings estimates for the final quarter of last year revised their outlook lower, the highest percentage since Donald Trump assumed America’s presidency.
Economic weakness in China, the biggest consumer of semiconductors and a crucial plank of the global electronics supply chain, has proved particularly damaging to US chip makers. The Philadelphia Stock Exchange Semiconductor Index has plunged 19 per cent since early September as part of a brutal sell-off in once high-flying technology stocks. The share of investors with an overweight position in the tech sector has dropped to its lowest level since 2009, according to Bank of America Merrill Lynch’s latest fund manager survey.
Yet, ascribing the current vulnerabilities in markets solely to the slowdown in China is misconceived.
In the case of Apple, whose share price has plunged 36 per cent since early October, other factors are at play. While the sharp decline in consumer confidence in China – Apple’s third-largest source of revenue when Taiwan and Hong Kong are included – has hit the nation’s smartphone market, some local companies’ sales are still increasing, mainly because Apple’s iPhones are twice as expensive as its Chinese rivals’ top-end devices. Just as importantly, users in other big smartphone markets, notably America, are holding on to their iPhones for longer.
From a broader market standpoint, moreover, the degree of China-induced selling pressure is much less severe than in early 2016 in the aftermath of the surprise devaluation of the yuan. The rampant capital flight that wreaked havoc on markets three years ago has been conspicuously absent this time round. Indeed since late November, China’s currency has moved further away from the psychologically significant 7 per US dollar level in a sign that investors are more sensitive to other factors that have been weighing on sentiment.
While markets are concerned about Chinese policymakers’ room for manoeuvre, given the constraints imposed by the deleveraging campaign, at least Beijing is moving in the direction favoured by investors. Expectations of more forceful stimulus measures were heightened on Friday when China’s central bank implemented the largest of five cuts in the required reserve ratio enacted since early 2018.
The Federal Reserve, on the other hand, has spooked investors and has been a more potent driver of sentiment than China. Having unnerved markets last month by pledging to keep tightening policy this year despite the slowdown in the global economy, Fed chair Jerome Powell sparked a fierce rally in equity markets last Friday by signalling a more cautious approach, particularly with regard to unwinding the Fed’s balance sheet. The benchmark S&P 500 index shot up 3.4 per cent, adding to the US-fuelled volatility that has pervaded markets in recent months.
While China’s economic downturn is an increasing source of investor angst, it is playing second fiddle to America’s economy and markets, which have only recently come under strain and are proving far more turbulent.
Nicholas Spiro is a partner at Lauressa Advisory