The pace of events appears to be accelerating as investors and markets have to continuously incorporate significant, new developments in the economy and geopolitics.
Listen to the article
Investors have had to become adept at absorbing noteworthy news every few days. Over the last couple of weeks, we have had China’s new stimulus package, an escalation of tension in the Middle East pushing up oil prices, and a surprise rebound in the US labour market.
China – Local and wider impact
Let’s start with the news out of China. Chinese equity markets clearly welcomed a major new stimulus from Beijing: the MSCI China index has gained 30% since the 23 September, while the MSCI All Country World index has moved up by just 1%.
We have already covered the details of the package and their likely impact both in the short and medium term. One surprising aspect of the equity market moves since the announcements has been the comparatively limited impact on markets outside of China.
In contrast to the days when China’s position as the global motor of growth was predominant, the massive gains in Chinese equities have not been mirrored elsewhere.
One of the markets where one might have expected greater repercussions is Europe. That Europe is more exposed to China than other countries, is a commonly held view. It is in fact not the case. The latest data from FactSet shows that sales to China by companies in the MSCI Europe index represent just 6.4% of total revenues. This compares to 7.4% for the US and 9.3% for Japan.
Some countries in Europe have a higher exposure, notably the Netherlands (13.6%) and the UK (7.3%), but for Europe, sales to the US are much more significant (19%), to say nothing of sales within Europe itself. Marginally better growth in China is positive for European company revenues, but it is unlikely to change the outlook radically.
The returns for developed market indices immediately after Beijing’s announcements roughly aligned with the respective sales exposure. The indices for the Netherlands and Japan gained the most (4.2% and 4.0%, respectively), with slightly smaller gains for Germany and France (see Exhibit 1), while the MSCI China index advanced by 17% over the same period. Moreover, the China index has continued to move up (by 30% as of 4 October), while other indices have fallen back.
The lacklustre gains outside of China suggest that the performance of the Chinese equity market was more a reflection of foreign investor positioning before the announcement than a massive shift in the fundamental outlook. Many hedge funds were short the market and had to cover their positions when the market turned around.
An additional factor may be the challenges facing European car manufacturers. The dominance of Chinese electric vehicle producers means increased demand may not benefit traditional, European producers as it would have done in the past.
Middle East tension and oil prices
Developments in the Middle East have caught investor attention recently due to worries the conflict could impact Iran more directly – in particular the country’s oil production. A big jump in oil prices could reverse the recent trend of declining headline inflation as well as damp economic growth globally.
For now, that remains a risk, not a reality.
While the oil price has increased by 13% from this year’s low, at USD 74 per barrel of Brent crude, it is still below the average level in 2023 (USD 78/bbl). The recent announcement from Saudi Arabia that it will be increasing oil production should help to keep prices down.
Only if there is a sustained, significantly higher oil price would we expect to see a prolonged impact on risk assets.
US labour market – A strong picture
After several months of relatively weak job creation, US private non-farm payrolls showed a seasonally adjusted gain of 223 000 positions, more than double the average over the prior three months. Recall that one of the triggers for the summer sell-off in equity markets was a weak payrolls figure and worries that the US economy was sliding into a recession.
In addition to the payroll gains, the unemployment rate dropped from 4.2% to 4.1%, meaning the Sahm rule (which states an increase of 0.5% in the average unemployment rate over the prior three months signals a recession is ahead) was no longer triggered.
Following the data release, markets removed one of the 25 basis points (bp) in interest rate cuts expected from the US Federal Reserve (Fed) this year, and the odds of a 50bp cut at the next policy meeting fell. But in weighing the balance between stronger growth and higher policy rates, markets focused on the growth outlook and the S&P 500 gained 0.9%.
Two caveats
September, along with January, are the two months of the year where the actual level of employment typically declines, following summer and holiday season hiring, respectively. The non-seasonally adjusted change in payrolls for September was a drop of 458 000. Adjusting this to a positive seasonally adjusted figure is not as straightforward as adjusting the level of hiring for months when there are gains.
The second factor to keep in mind is the implicit assumption that inflation is no longer a worry. Certainly, the September Personal Consumption Expenditures (PCE) data was encouraging as the core index gained just 1.6% on the month (at an annualised rate).
But with economic growth so strong (the latest Atlanta Fed GDPNow forecast for the third quarter of 2024 is 2.5%), relative to a trend rate of 1.8% by the Fed’s estimate, one may wonder whether inflation will decelerate as much as markets expect (see Exhibit 2).
