Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.
Theme 1: The Renminbi devaluation
China moved towards the floating end of the spectrum of exchange rate regimes, and due to the dynamics around relative monetary policy it is logical to see some depreciation in the CNY.
The People’s Bank of China (PBOC) made a significant announcement – that it would move to a more market driven method of setting its exchange rate. The first thing to note when it comes to exchange rate regimes is that you have a spectrum – at one extreme is a pure fix, where the exchange rate is a set amount (e.g. 1 cowry shell for 1 US dollar) and at the other end you have a pure float (e.g. the AUDUSD). China had been closer to the fixed end of the spectrum, but with this move it is now positioned closer to the floating end. This was partly in response to recommendations by the International Monetary Fund (IMF) in the lead-up to the likely inclusion of the RMB into the IMF’s SDR basket. In my view, some short-term depreciation is a logical result of a more market-based exchange rate. The reason for this is demonstrated in the below charts – monetary policy is beginning to diverge (PBOC is cutting rates while the Fed is set to hike rates) and foreign exchange reserves have been declining. The other useful piece of context is the significant appreciation of the Chinese yuan in real effective terms – this has put a significant drag on exports (in an environment where global trade growth has been slumping) so it is perhaps convenient for China to see a weaker currency in the short-run in terms of easing financial conditions and supporting the export sector. In my view, it has some parallels to the interest rate cuts we saw last year, where the People’s Bank of China introduced incremental changes to the floor and ceiling around lending and deposit rates respectively (a step towards interest rate liberalisation). This demonstrates the challenge and skill around managing short-term economic headwinds and longer-term reforms.
Theme in pictures
Source: AMP Capital, Bloomberg, Thomson/Reuters Datastream, People’s Bank of China
Theme 2: The death cross
The “death cross” can be a useful indicator in identifying major turning points, but its record is a mixed one.
Quite a few analysts have been pointing out the Dow Jones Industrial Average making a “death cross” – this is when the 50 day moving average crosses below the 200 day moving average. This indicator is used to try and figure out when a market has undergone a trend change (down). The opposite of the death cross is the gold cross, where the 50 day moving average rises above the 200 day moving average. I tend to look at the S&P 500 as the main index for the US, so we will look at the S&P 500 in this analysis. There are a couple of points to make – first is the death cross (which hasn’t happened yet for the S&P 500), which has been a useful signal at major market turning points in the past (e.g. late 60’s, early 70’s, the dot.com crash and recently the GFC). However, outside major market turning points it has quite a mixed record, and in an uptrending market often coincides with market bottoms rather than turning points. Taking another lens on it, this time from a breadth perspective looking at the proportion of S&P 500 sectors which are in the death zone (50dma below 200dma) – currently half of the major sectors meet this criteria (energy, materials, utilities, REITs, i.e. basically all victims of the commodity slump). As an indicator, it functions similarly to the other breadth indicators, when it hits extremes it’s usually at the bottom of the market. So there is some use for it. Overall, the “death cross” can be a useful signal for identifying turning points, but as with most indicators it’s best to factor in other aspects.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream, Bloomberg
Theme 3: Global consumer confidence fell in July
Consumer confidence dropped around the world in July as Greece and China weighed on sentiment, but it’s worth monitoring closely in case it is a warning sign of a deterioration in demand.
Consumer confidence deteriorated in most countries in July, although I suspect some of the deterioration was due to concerns around the situation in Greece/Europe and the market volatility in China. While it was most likely sentiment effects rather than fundamental deterioration (which will be confirmed at the end of August if sentiment rebounds) it is worth paying attention to the trends in global consumer confidence, as it generally tends to reflect the prevailing global macro winds. Indeed, if you track the trends in consumer confidence against changes in bond yields, you can see a loose relationship (which would be logical as falling demand is consistent with falling bond yields). In terms of levels, consumer confidence is generally at healthy levels, so you might discount the signal to some extent. The further drop in oil would tend to be supportive for consumer confidence in that it increases real incomes, likewise labor markets are generally improving and asset markets are generally positive; so you probably would expect to see a rebound in the August numbers (which will be available in early September) – something to keep a close eye on as a warning sign for global demand.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream
Theme 4: Oil market dynamics
The responsiveness of the rig count in the US means that supply is likely to bounce back as fast as price bounces back, locking oil in at a lower range – at least until producers elsewhere around the world make more substantial adjustments.
As oil prices grind down below the lows of the short-term bottom seen earlier this year, it’s worth checking in on the rig counts. Globally, you can see a notable expansion in rig counts across regions over the past few years (hence the general and notable rise in supply). The rig count has rolled-over across the regions, and this will also ultimately show-up as economic stress, as we have seen in the major net oil exporting economies (this is the flipside to the positive consumer story – a transfer from producers to consumers). Looking at the US situation, it’s worth noting the responsiveness of rig counts to changes in the oil price. Generally a big fall in commodity prices will kick off an adjustment process, where producers cut back capex. This in turn tends to rebalance the market by constricting supply growth. In a perfect world, suppliers would increase and decrease supply in real time in response to demand. In practice, the supply cycle tends to be a very long one, but the shale factor in the US appears to have resulted in that cycle speeding up. In fact, the rig count has already started to increase as producers redeployed rigs in response to the price rebound that we saw. Ultimately, this probably means that oil gets locked into a lower range, certainly at least until producers elsewhere around the world make more of an adjustment.
Theme in pictures
Source: AMP Capital, Baker Hughes, Bloomberg
Theme 5: Convergence – what is the trend in global (in)equity?
The past 10-15 years has seen a significant catch-up from poorer countries to richer countries, and there could be further to go.
This builds on analysis in a previous edition of this bulletin, around the possibility for upside in China from “catch-up” effects of the poorer inland/western provinces, catching up with the wealthier coastal provinces. To assess the trend in equality, we look at the richest vs poorest countries, as measured by taking the upper and lower quartiles of GDP per capita across 135 countries (using the IMF WEO database). From the 1980’s to the turn of the century, the rich countries had become richer than the poor countries, but this started to turn (e.g. the ratio of the upper to lower quartile countries went from 10.52x in 1999 to 6.45x in 2014, and are projected to stay around that level through to 2020). The shift in trend came as emerging markets saw a golden age of growth, and admittedly made a further stride during the global financial crisis as the poorer countries managed to maintain growth (thanks to less convoluted and innovative financial systems) while the richer countries saw a deep contraction.
Theme in pictures
Looking forward, there is reason to be optimistic on the prospect for catch-up by the poorer emerging world, as many countries there still have substantial catch-up to do in terms of improving productivity and undertaking structural reforms. While there are limits to it, the examples of regional dispersion in the US and Europe would suggest there is further upside from here.
The view within countries:
Source: AMP Capital, Thomson/Reuters Datastream, IMF
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