Monthly update: China’s economic slowdown dampens the market mood

1. WHAT’S HAPPENING IN FINANCIAL MARKETS?

August can often be a volatile month for equities and this year was no exception. Global stock markets lost ground at the beginning of the month after sentiment appeared to take a hit from rising bond yields and concerns about the slowing Chinese economy. Despite the initial volatility, the market’s mood lifted as the month drew on, boosted by a run of strong earnings reports.

After recovering in the early spring China’s economy slowed during the summer due to falling exports and sluggish domestic demand. With home sales falling since April, the Chinese property crisis is also deepening, with two major developers facing severe financial difficulties which also created stress in the financial system. All these factors caused a deflationary effect and the world’s second-largest economy inflation reading from July is now at -0.3%. To top it all, youth unemployment has reached an all-time high, exceeding 20%.

With this difficult mix of data, China’s central bank has cut key interest rates for the second time in three months in a bid to revive the economy, but most analysts agree it will have little impact. Since the end of August, the central bank started again to inject liquidity into the financial system in order to counter the negative momentum. The downturn in China is already weighing on Germany’s economy, which is most dependent on Chinese demand. Germany is Europe’s biggest economy and its slowdown could ripple out and affect the wider euro area. The US has limited economic exposure to China but many of its successful companies rely on Chinese demand as well.

2. WHAT DOES THIS MEAN FOR YOUR INVESTMENTS?

The global economic outlook is brighter than it was at the beginning of the year, mostly due to a resilient US consumer and undersupplied labour markets while Inflation is trending down in most developed economies and markets project interest rates to peak in the coming months. While we're still exercising caution overall, we've recently increased our investment in equities across our portfolios and funds to the benchmark weighting. We’ve sold some emerging market bonds and used the proceeds to increase our exposure to US equity markets. Solid US consumer spending and labour markets account for much of this improvement. The US recession indicator remains elevated but has somewhat eased over the summer.

We've also tweaked our bond investments to reflect global interest rate rises, focusing on where we see opportunities. With European economic momentum falling, we've reduced our allocation to US government bonds and increased our holdings in European government bonds. Furthermore, we've increased our holdings in UK corporate bonds, which look attractive after recent yield increases and could gain from the ongoing drop in British inflation into year-end.

3. THIS MONTH’S SPOTLIGHT: Shoppers keep the US economic engine humming

The US economy has continued to grow this year, performing better than many other wealthy nations. Out of the G7 countries, it has managed to record the strongest post-pandemic recovery, while also seeing inflation come down faster than other western economies. The labour market shows strength, with the unemployment rate remaining near record low levels.

The economy is holding up well thanks in large part to a spending spree by shoppers, whose pay packets have been boosted by strong jobs growth and rising wages. Despite the US Federal Reserve’s most aggressive rate-rising cycle in 40 years and still-high inflation, retail spending in July rose for the fourth month in a row, going up by 0.7%, according to the US Commerce Department.

However, there are some signs consumers are having trouble keeping up with rising prices. The Federal Reserve Bank of New York reported that US households have racked up more than $1 trillion in credit card debt and late payments are rising which could spell problems for the economy further down the line.

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Coutts’ clients can find out more about what’s happening in the investment markets and how it impacts their investments by speaking to their private banker.