Strategy Outlook Third Quarter 2015

Our Global Investment Strategy service recently published their Strategy Outlook for Q3 2015.

The quarterly report highlights the following points:

  • Global growth should pick up in the second half of the year, but will remain too low to counteract the persistent shortfall in demand facing most major economies.
  • For now, contagion to the rest of Europe from the Greek crisis is likely to be contained. The longer-term viability of the common currency, however, is fraught with doubt.
  • Investors should remain modestly overweight global equities, stay neutral bonds and spread product, and underweight cash.
  • Within the equity portfolio, overweight the euro area, Japan, and China; underweight most other emerging markets and the U.S.
  • The dollar is likely to strengthen modestly against the euro, sterling, and most EM currencies. The yen has reached a bottom.
  • Oil prices have further to fall. Chinese stimulus could help metals in the near term, but the longer-term outlook is grim. Gold is due for a bounce.

Clients interested in reading the full Report can access it here: Strategy Outlook Third Quarter 2015.

China: The Economic Fallout From The Stock Selloff

It is premature to tally the economic damage from the equity market selloff while it is not yet clear that the market riot is over. However, based on what has happened so far, our China strategists expect the economic fallout is muted.

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  • The stock market turbulence is not echoed in other financial assets, a sign that the sharp selloff in A shares is corrective in nature rather than driven by fundamental economic issues. The corporate bond market has remained stable, interbank liquidity has in fact improved, and there is no abnormal move in the RMB exchange rate in either the onshore or offshore market. The CDS spread of Chinese sovereigns remains well behaved.
  • Aggressive margin accounts and equity leverage are the root cause of the market riot, but the financial sector is likely to stay immune. Anecdotal evidence suggests that the majority of margin lending provided by banks and brokers are accompanied by healthy amounts of collateral, and the leveraged positions provided by “shadow institutions” such as Internet finance companies and private networks strictly follow “stop loss” instructions. Investors with leverage who are being “stopped out” have borne heavy losses, but financial institutions have not been adversely impacted.
  • The stock market crash could be a blow to consumer sentiment, but the wealth effect should be small. As a share of GDP, the A-share market’s value has dropped from over 85% in early June to about 65% currently, a much smaller drawdown than historical bear phases. In fact, even during major bear markets in the past, falling stock prices had had little impact on business activity. Furthermore, despite rising significantly since 2014, Chinese households’ exposure to the equity market is still very limited.

Bottom Line: The A-share market will likely remain unsettled for a while as policymakers try to mitigate the downward pressure generated by liquidation among margin investors. The economic impact should be limited, unless the A-share market riot continues to deepen.