Observations: 2 October
In my view, there are two key risks to a cautious market stance — as highlighted in “A Framework for Equity Allocation” and “What Can FedEx tell us about the cycle?”
First, there is an increasing likelihood of monetary and fiscal support in China. In the past week, Chinese authorities have taken measures to firm up the currency by (1) tightening controls in the FX market and (2) ratcheting up restrictions on Bitcoin, which was suspected to be a means of circumventing capital account restrictions in the past. Some Chinese policymakers have suggested in the recent past that a strong currency is in their interest (a change in view) and monetary easing is often accompanied with currency weakness. Moreover, members of the PBOC also now appear to pivoting toward the need to support growth during 4Q.
‘Wang Yiming, a member of the central bank’s monetary policy committee, said policy fine-tuning should be ready to hedge against economic slowdown risks in the fourth quarter, as well as the first half of 2022, before a projected bounce in the second half of next year…. “The proactive fiscal policy could be stronger, focusing on accelerating local government bond issuance and injecting funds into investment projects as soon as possible”….[PBOC governor Yi Gang noted:] “if the deposit rate is needed to float downward in the future, it could be decided by market entities” - China Daily (as translated)
The second (positive) possibility is that the increase in savings rates (globally) has created a balance sheet “buffer” to weather higher inflation. Increases in savings rates tend to boost economic activity with a lag (as below) as those funds get spent.
The chart above omits “covid period” data on the savings rate to maintain scale.
However, there is little evidence (so far) of increased consumer spending in services to compensate for the reduction in demand for manufactured products that FedEx (and others) have highlighted.
There are also two key factors working in the other direction. Supply chain disruptions will be exacerbated by electricity rationing in China and economic activity will also feel the impact of a surge in natural gas prices in Europe. In addition as the likelihood of a large infrastructure package diminishes in the US., there will be a drag on growth from fiscal retrenchment, which will hit developed economies the hardest.
Source: IMF. Change in cyclically-adjusted primary deficit as % of GDP.
As I will further detail in the ‘Portfolio strategy’ section, I think Australian equities offer an attractive risk-reward option considering the above.