Shares have gotten off to a rather bad start for the year, triggered by many of the same worries seen last year: a fall in Chinese shares and the value of the renminbi, which in turn has triggered renewed worries about the Chinese economy; the weaker renminbi triggering more commodity price weakness and fears of an emerging market crisis; some soft US manufacturing data; and a H-bomb test in North Korea.
Consequently all share markets have seen sharp declines so far this year (with US shares down 4.9%, eurozone shares falling 5.6%, Japanese shares sliding 6.6%, Chinese shares tumbling 11.7% and Australian shares down 6%), commodity prices fell with the oil price falling to its lowest since 2009 and bonds rallied with safe haven buying, Shane Oliver wrote for Business Spectator.
The poor start to the year clearly warns that global growth concerns remain, that commodity prices are still under downwards pressure and that volatility in investment markets will likely remain high. However, it is worth putting these developments in some perspective:
The latest fall in Chinese shares may have a bit further to go but looks to have been exaggerated and driven more by fears and regulatory issues around the share market and currency rather than a renewed deterioration in economic indicators. While the Caixin business conditions Purchasing Managers' Indexes were weaker in the last week, official PMIs for December were stronger.
Circuit Breaker
Rather the main drivers were worries about new share supply following the scheduled end to a ban on selling by major shareholders, a new share market circuit breaker that commenced on Monday which appears to have added to market volatility rather than calmed it down because the 7% threshold for a market fall to trigger a shutdown was too tight and encouraged investors to bring forward selling in an effort to beat the shutdown and a continuing depreciation of the renminbi.
Looking at each of these: Chinese regulators have since announced a restrictive limit on the size of stakes that major investors can sell; the circuit breaker has now been suspended after the experience of the last week; and after a 6%-plus depreciation in the value of the RMB since July the PBoC is now likely to step up efforts to try and stabilize it again much as it did through September and October.
The depreciation of the renminbi is the key issue at present as its decline is helping fuel upwards pressure on the US dollar, adding to weakness in oil and other commodity prices and keeping alive fears of some sort of emerging market crisis.
Signs that global growth remains fragile and constrained will have the effect of ensuring that global monetary policy remains easy this year, with Fed tightening likely to be very gradual with maybe just two 0.25% rate hikes this year. Japan and Europe will likely continue with quantitative easing and China will further cut interest rates. The continuing global weakness also adds to the case for the RBA to cut interest rates again.
North Korea’s H-bomb test is a big concern but there is some debate as to whether it was really an H-bomb and it has already had three nuclear tests since 2006.
While confidence in Chinese shares is being tested again, it’s worth noting that Chinese companies listed in Hong Kong provide particularly attractive long-term value trading on forward PEs close to six times, less than half that of Australian shares.
Outlook for Markets
Worries about China and the Fed are likely to drive continued volatility in the short term until some stability returns to the renminbi and US dollar and hence in commodity prices.
Very low bond yields point to a soft medium term return potential from sovereign bonds, but it’s hard to get too bearish in a world of fragile growth, spare capacity and low inflation.
Commercial property and infrastructure are likely to continue benefiting from the ongoing search by investors for yield.
National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of the Sydney and Melbourne markets. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5% and the RBA expected to cut the cash rate to 1.75%.
The downtrend in the Australian dollar is likely to continue as the interest rate differential in favor of Australia narrows, commodity prices remain weak and the Australian dollar undertakes its usual undershoot of fair value. Expect a fall to around 60 US cents by year end.
