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Falling Chinese markets should remind investors of equity opportunities
August 26 2015: The devaluation of China’s yuan last week appears to have set off panicked selling action in global markets as investors speculate over an even weaker Chinese economy and increasing global deflation pressure. However, according to Peter Brooke, Head of Old Mutual Investment Group’s MacroSolutions boutique; the current downturn in global markets is a correction rather than the beginning of a bear market and investors should be looking for opportunities rather than fleeing.
The carnage started on Tuesday after the Shanghai exchange dropped 8.5%, exacerbating rising concerns over the Chinese economy. Europe also saw aggressive selloffs from the FTSE 100 (-4.5%), the DAX (-3.7%) and the CAC40 (-4.6%). Emerging markets exposed to China have also experienced falling markets and back home, the All Share Index was down 5% at one stage yesterday, but regained some of its losses by the time markets closed, but is now entrenched in a market correction.
Brooke points to the news out of China remaining poor as incoming data shows a renewed loss of growth momentum over the past few months. Indeed, a survey among mostly private sector manufacturers found that sentiment has slumped to the lowest level in two years, raising concern that the policy measures implemented so far this year have had little effect in arresting the slowdown. Consequently, concerns continue to flare that the economy is heading for a harder landing than expected.
“We need to remember that while the growth in China’s economy has been slowing recently, the growth in its market had continued to climb, which just wasn’t sustainable,” explains Brooke. “We’ve been concerned for some time now that China’s economic growth had to slow given its previous growth rate. What level it slows to, remains to be seen, but it will be lower than what we’ve seen in the past and lower than the 7% forecast.
“So what we are finally witnessing is a clear correction in the markets to reflect the slowing growth rate. The trigger for this could be a combination of the devaluation of the yuan, concerns that the Fed might hike US rates as early as September; and the fact that markets have been expensive up until now. Whatever the reason, investors are nervous; but we’ve been pre-empting this overheated market environment and, as such, have been cutting our exposure to equities and building our cash position since earlier this year.”
“Corrections, or a 10% fall in the market, are a common feature of equity markets all around the world,” explains Brooke. “The S&P500, the British FTSE 100 and the Japanese Nikkei 225 have all averaged a 10% fall once annually since 1928. South Africa is much in line with the global trend of average annual 10% falls. Recently, global markets have been very robust with the US not having had a correction since April 2011 implying statistically that one should have been expected. Generally corrections average 12.5% in South Africa, meaning the recent selloff may have a little further to go but should be nearing the end.”
Brooke emphasises that although the Chinese growth rate appears to be slowing more than previously expected, the Chinese authorities have the ammunition to prevent a collapse of their economy. “One could interpret the devaluation of the yuan as an attempt to support their economy as it supports their local industries and their export market. In addition, they announced today that lending rates and deposit rates will be cut by 0.25% and that the reserve requirement ratio is lowered thereby allowing for increased lending.”
Ultimately, Brooke says that the most important thing for investors to remember is that it is situations like these that create opportunities in equity markets. “There will always be periods when markets run too hard, but then they give back again,” he says. “Investors should avoid panicked selling as this will only mean missing out on the opportunities that are created by falling markets. The only question they should be asking is where and how these opportunities will present themselves.”