Key issues: China takes a relaxed view regarding lower GDP growth; Fed undecided: key interest rates stay at just above 0 per cent; Oil market remains oversupplied; Asset Allocation: equities continue to be overweighted
Following an unprecedented marketing campaign of the Chinese government, the Chinese stock market values tripled within nine months only. But since May, the bubble has been bursting and the radical crash of the Chinese stock markets led to a more cautious emerging markets evaluation.
Says Peter Brezinschek, chief analyst of Raiffeisen RESEARCH, an organisational unit of Raiffeisen Bank International AG (RBI), in the strategy publication Global Markets for the fourth quarter of 2015: "For 12 months, the Chinese stock markets have developed completely detached from the economy. The current concern about the economic growth in China is therefore rather the result of the Chinese economy's ongoing restructuring than of the stock market crash. The productivity margins in the service sector and the growth rates in domestic consumption are lower than in the industrial sector, which used to be the country’s growth engine. The analysts of the People’s Bank of China consider a 5 per cent GDP growth likely and not worrying. Obviously, the decreasing importance of the construction and industrial sectors in China will impact the export dynamics of different industry sectors in Europe."
Fed undecided: key interest rates stay at just above 0 per cent
Contrary to Raiffeisen RESEARCH’s expectations, the US Federal Reserve (Fed) decided to not increase its target rate. Different from earlier rate hike cycles, the Fed seems to put less weight on solid US economic data but more on possible risks for developments in emerging markets, especially China, and on the latest turbulences on the financial markets. Furthermore, the Fed seems to have shifted from a forward looking monetary policy to one synchronous with the business cycle. Key rates are therefore apparently supposed to increase only once full employment has been reached and inflation is close to its 2 per cent year-on-year target.
“We assume that the Fed will start policy normalisation at its meeting on 16 December. Although both full employment and inflation will not have fully met the mentioned criteria until year-end, we expect the first interest rate hike of 0.25 percentage points in December and another four of the same magnitude in the course of 2016. However, it has to be clearly stated that such a forecast is highly uncertain taking into account the Fed’s behavior in the past. In the end, the Fed could easily decide to refrain from hiking rates in December using the same argumentation as it did this time,” says Brezinschek.
The Fed’s planned rate hike cycle exacerbates the growth discussion in the weakening emerging markets (with the exception of India). Many Asian and Latin American companies funded themselves favorably in US dollars. Now, not only higher interest rates are looming, but also a rising US dollar, which will lead to a cut in investments without an income in US dollars. Based on this outlook, the unfavorable development of the emerging markets compared to established markets is likely to continue over the coming quarters. According to the analysts of Raiffeisen RESEARCH, increased interest rates make capital backflows into the US dollar realistic.
Impact on currency markets
The divergent monetary policies of the US and the euro area should further strengthen the US dollar. However, the euro is likely to remain stable against most emerging markets currencies, as those mostly orientate themselves on the US dollar. The Swiss franc has lost some of its strength and could, due to less favourable fundamental data, note at 1.10 against the euro over the year.
Impact on capital markets
This summer’s yield recovery in the US should be replaced by moderate increases. Over the next six months, the Quantitative Easing (QE) of the European Central Bank (ECB) will prevent a parallel development to the US. The yield curves remain flat for the time being. After the tensions in the third quarter, an upward movement of the equity markets is possible due to improving corporate profits. For 2016, the stock market environment could get rougher, as economic dynamics are expected to slow down towards 2017, the QE will come to an end and the US interest rate levels will be higher. Likewise, euro area corporate bonds should be friendlier on a six months view. However, a widening of the spreads has to be anticipated throughout 2016.
Oil market remains oversupplied
Sentiment on the oil market remains clouded. Following the relatively strong price recovery between mid-March and mid-May, the correction in July was also quite significant. The reason was the increasing US shale oil production in combination with the decreasing demand in resources and the assumption that the global oil supply is going to further expand due to the deal between the G5 states and Iran.
“In total, we expect an average oil price of US$52 per barrel of Brent for the fourth quarter. A quick price increase towards US$70 seems unlikely, given Saudi Arabia’s consequent strategy of defending and increasing its market share, as well as the currently quite negative sentiment for resources. Factors for a rising oil price would be a stronger reduction of the US shale oil production, ongoing sanctions towards the Iran or more positive economic data from China. Growing concerns about China’s economy as well as a stable shale oil production in the US might however lead to further price corrections”, says Brezinschek.
In this context it has to be said that the ECB’s QE is not a tool to prevent decreasing energy prices. The Raiffeisen RESEARCH analysts therefore expect that increasing raw oil prices could increase the inflation rate in the euro area over the one per cent mark in 2016.
Asset Allocation: equities continue to be overweighted
In their investment strategy for the fourth quarter, Raiffeisen RESEARCH’s analysts continue to overweight the equity segment. They expect yield increases in the established bond markets with simultaneously ongoing high liquidity supply from central banks. Euro area stocks benefit from the remaining weakness of the euro and the low prices for resources and their already high weighting in the portfolio remains unchanged. In the US, the economic growth should again positively impact corporate profits. The weighting of the US stock market was therefore increased.
The third quarter was characterised by a wide loss of confidence in emerging markets. The selling pressure not only impacted those markets and currencies with strong relations to China, but also those that were unable to clear up their structural weaknesses and that have severe political uncertainties.
“We assume that the expected turnaround in US interest rates will keep the risk awareness for emerging markets assets high. Hence, we have reduced the share of emerging markets assets outside of Europe by some percentage points. We do not think that a further reduction is likely, as the current very low levels should lead to a recovery,” explains Brezinschek.
In the bond segment, Raiffeisen RESEARCH’s analysts pay attention to short terms and prefer high quality US dollar bonds as well as investments on the money market. Central European bonds might also show yield increases, but they should be cushioned given the higher interest rate and the expectation of slight currency gains.
