What a difference a week makes - China resurgence or temporary reprieve?

Monday, 15th April 2019 07:25 - by Shant

It has been a strong week for risk sentiment, and as a result, we have seen Wall Street powering ahead again.  With global growth at the forefront of investors minds, the latest data metrics out of China have served up a timely boost for equities, just when we thought extremes were looking exhausted.  Earnings season is also upon us, but on that front also, we have pushed off on the front foot today with JPMorgan and Wells Fargo both beating estimates to add to the upturn on Wall Street. 

However, underpinning the latest moves have been the encouraging numbers out of China this week.  At the start of the month, the manufacturing PMIs revealed activity is picking up again with official figures backed up by the Caixin measure which tends to carry a little more validity.  Both indices have pushed back above the 50 mark, after what was a modest dip into contractionary territory.  However, to put it into perspective, the actions of purchasing managers do not ensure growth, they are a merely an indicator, and at a time when China has embarked on a fresh round of stimulus, we have to assume sentiment will have been emboldened but what is becoming a global habit. Central banks are poised to open the taps at the first sign of weakness, and this has been borne out by the U-turn by the Fed at the start of this year.  

There are growing fears that this may be the only real metric by which valuations can be judged.  Thankfully, the Fed has managed to build up a buffer which was somewhat slow in materialising under the previous Fed chair, though through 2018, Fed funds have been pushed up to 2.50% and as per the FOMC minutes this week, this is where they will stay through to the end of the year.  That markets are pricing in cuts into 2020 is perhaps also supportive of equity valuations, but as all and sundry have noted, the proof is in the pudding and earnings season has plenty more to reveal over coming months.  

It is also worth noting that the Shanghai Composite posted a negative week this week, while it was a mixed week in Europe as the Dax has bearly held onto weekly gains as Italy also stalls on the upside to end net down as of the Friday close.  The CAC 40 in France also managed a positive week, mirroring the Dax most of the way. 

Looking at the numbers on Friday, China also posted a trade surplus of a little over $32.5bln, far exceeding expectations closer to $7bln.  With ongoing trade talks with the US, one would expect this to be a temporary phenomenon if China is to appease the White House administration.  News today that the US will insist on exchange rate transparency from China, highlights the concerns over global competitiveness.  

So as US indices start to get closer to the all-time highs, it is worth taking stock of the real economy.  While default rates are still relatively low, debt growth outpacing output is a worrying dynamic that one should consider as the year presses on.  These are challenging times when margins are being squeezed and this may well be one of the reasons that US wage growth has been as slow as it has been at a time when job gains are approaching record levels.  As noted by Jamie Dimon in the results announced earlier today, lending has been a key part of the strong results for Q1.  Yes, increased lending.  Good for JPMorgan no doubt, but increased borrowing going through the system nevertheless.  Stock market investors seem to be riding the crest of the wave as the current data metrics continue to drive sentiment.  However, growth cycles are based on credit and at some point we expect fractures to start showing 'in the system'.  

US student and auto loans were in the spotlight not too long ago, though things have gone quiet since. I expect caution being exercised at these lofty levels in the broader indices which makes for an even stronger case for defensive stocks in the current climate. Strong balance sheets should also continue to outperform, though in both cases it is important to stress - in relative terms.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.