China vs US – is the tide turning?
Over the last couple of years there have been 2 huge macro themes dominating global stock markets, and they involve the 2 largest economies in the world.
The first theme is whether the Chinese can maintain economic growth in the face of significant headwinds. The other is whether US inflationary pressures will grow triggering the first major round of interest rate tightening since the Great Financial Crisis of 2008.
Stock investors have been showing far less concern about the US than China over the last few years, but could the tide turn the other way?
Although China’s purchasing managers’ index (PMI) shows manufacturing is barely growing, the Chinese economy remains the single largest contributor to world gross domestic product growth.
The official target of the Chinese government is for GDP growth to reach 6.7% in 2016 – which is more-or-less in line with the International Monetary Fund's latest estimate (6.6%). Assuming no revision to the IMF’s current forecast of only 3.1% global growth this year, China would contribute well over a third of the total.
Even the contribution from the United States, which is growing at a relatively robust 2.2% this year, would be dwarfed by the contribution from China.
At the same time, Brexit has thrown a roadblock in the path of the European economy. Even prior to Brexit, expectations were not high, the outlook for Europe should be adjusted to reflect little contribution to world growth.
As for Japan, India, and the developing world, it barely adds a 0.1 percentage point. China's contribution to global growth is, in fact, 50% larger than the combined contribution forecast by all of the so-called advanced economies.
Admittedly, there are some good reasons to be concerned about the Chinese Renminbi. There have been substantial declines in offshore deposits of renminbi.
This is probably due to retail investors shunning the currency, exporters unwilling to convert foreign earnings into renminbi, and foreign investors unwinding.
The consensus seems to be that there will be more short term currency weakness, which is not encouraging for investors.
However, as China’s weight grows in the global economy, and with the easing of capital controls, China’s currency should eventually become more freely available for payments, and more like the US dollar.
And what of the US? Although the jobs news did not meet expectations, it was not bad enough to delay the Fed’s plans for a rate cut before year end.
However, with US interest rates having been stuck at abnormally low levels for 8 years, markets and economies have become very distorted. This means that the hopes for economic growth has not materialised, and there are even indicators from certain parts of the US economy that a recession may be on the way.
US August auto sales fell 4.9% versus July, while some of the US retailers have recently announced disappointing quarterly earnings.
As stock markets enter the statistically worst months of the year, tin hats should probably be removed from the cupboard. But perhaps the scarier market might turn out to the US rather than China.