With Greece avoiding exit from the Euro Zone last month, anxious investors have turned their attention towards China and the price of oil. The weak economic data coming out of the developing markets in Asia caught up to Chinese markets in mid-June and the exponential gains in the first half of the year have been erased. At the same time, Oil has dropped below $40 a barrel for the first time since 2009. So what’s causing all of the concern? Let’s take a look at both the emerging market economies and the commodity markets. Then we’ll take a look at some of the positive market news that is not making headlines.
Before that here’s how some of the major equity market indices have performed lately. But don’t panic given the splash of red. ead on and focus on the positive developments that haven’t made strong headlines lately.
Weakness in China
Although China would rather be referred to as a developed economy it is still very much an emerging one which can experience volatile market swings in excess of 2% in any given day. And while China consumes about half of the world’s industrial metals, infrastructure investment has been weak as of late. Growth in the manufacturing sector has also slowed to its weakest level in a decade.
The Chinese currency, the renminbi, is pegged to the US dollar which has surged in recent years and has made it more expensive for other countries to purchase goods from China, exacerbating the weak economic situation. Last week, in an effort to reduce the impact, China devalued the renminbi against the dollar by about 3%. This unexpected move sent waves through global markets as it signaled that “a primary engine of the global economy is sputtering” (FT). The result has been a pullback in markets across the globe. Commodity producing developing countries have felt the impact as their currencies have devalued, as weaker global demand would mean less exports.
That brings us to commodities, almost all of which – agriculture, metals, and energy – have fallen 10% to 20% recently. The drop seems pretty natural given the expectations in global economic growth, but there is more to the story.
Driven by years of development and rising commodity prices, suppliers increased investment, drilling new wells, opening new mines, and finding more efficient ways to get the end product out (fracking, for example). The result has been a glut in supply, and the fact that producers have found cheaper ways to do business, they can bear the lower prices a bit easier.
In addition, some industries, like the steel business, receive government support in the form of subsidies. Those surpluses are exported, adding further pressure to prices.
Until we start to see less efficient producers close their doors, commodity prices are likely to stay depressed, which in the long term could be a good thing for resource-seeking developing countries, in particular.
Some important data that didn’t make the headlines
Data out of developed markets has been particularly positive as of late. In the US, existing home sales increased 2% in July, jobless claims have fallen to their lowest levels since 1973 and manufacturing expanded for the 31st consecutive month. Warren Buffet himself made news last week making a $37 billion bet on the manufacturing industry. Other developed markets including Canada, Europe and Japan have seen similar news in manufacturing and their currencies have stabilized against the increasing dollar.
The impending rate hike by the Fed, typically seen as a sign of a strengthening economy, now has more headwinds. While the negative implications may be highlighted, Americans themselves are enjoying real wage growth as their dollar goes a longer way with the cheaper commodity prices and imports.
What to look for going forward
Despite the market correction on the back of a seven-year bull market, the economic data is still very positive. And while we have seen a pull-back from the high equity prices, the overall global picture is not all doom and gloom.
Good news has a way of being overwhelmed by the bad news.
While there are certainly some disruptive events, they are the result of the seven-year bull market trying to tame excesses. The bright spots are in the developed markets which tend to suggest economic fundamentals are improving, and have stabilized an otherwise volatile few months.
In the midst of this market turmoil, let’s not forget that what drives the markets in the long term are corporate earnings. While the Q2 earnings season in the US was solid, earnings growth expectations have faded.
However, given that the consumer in the US and most other developed markets have been resilient and key economic data in the US (jobs, housing, and manufacturing, in particular) showing strength with low inflation expectations, we should expect stronger real earnings growth to return, although at a slower pace. Volatility will likely persist, but those who do not react quickly to market spasms will benefit the most in the long term.
A portfolio globally diversified across stocks and bonds is the simplest way to build resilience against volatility like this. And in an environment of low to moderate growth expectations, reducing cost of owning an investment portfolio is of utmost importance.
Read past the headlines, take the emotion out of any decisions you make with your investment portfolio and as always, stick to your plan.
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