Black Monday and a cautious recovery

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The financial markets appeared to be caught on a runaway rollercoaster last week. Prices on the global stock markets in particular fluctuated to a degree seldom seen. The principal cause was the on-going concern about the Chinese economy.

Most of the markets managed to close last week up from Monday’s low point Ben Steinebach Ben Steinebach Head of Investment Strategy

The devaluation of the Chinese yuan in the week of 10 August has made the global stock markets very uneasy, and prices plummeted in the week of 17 August. Last Monday saw the climax of the gradual seesawing build-up that had begun the Friday before. The trigger was a decline in the purchasing managers index for China’s industry, down to 47.7 in August against 47.8 in July. Although any score below 50 indicates a diminishing output, the same was already true in July and this new drop was in fact a very minor one. Moreover, China’s industrial sector is now smaller than its service sector. Nevertheless, the drop was interpreted as conclusive proof that China’s economy is on a rapid slide, and stock prices nosedived once more. On Friday 21 August the AEX – the index with which readers are perhaps most familiar – slid 17 points to 442, a loss of 3.7%. This was matched, and exceeded, on Monday, as the index fell 23 points to 419 (-5.2%), even slipping down to 402 points (-9.2%) during the afternoon. The mood then turned, and the index has since clawed its way back to above 440 points. It is too early to say whether this was a temporary correction that was amplified by panic and a shortage of common sense, or whether more is yet to come. Personally, I believe it is the former, and the markets’ reaction was very much over the top. In my view, the devaluation of the yuan should be seen more as preparation for it to become a world currency than as an attempt to boost China’s economy: the Chinese authorities have a plethora of other means for achieving this that are moreover geared more closely to the domestic economy. It is also remarkable that the falling stock prices carried over to Europe and the US: on the one hand because those regions have relatively few ties with China, and on the other because their economies are strong and the growth rates appear to be picking up once more during H2 (as explained in more detail in the following paragraph).

Encouraging signs in positive macro data

Most of the markets managed to close last week up from Monday’s low point. Apple’s CEO Tim Cook did his bit, and macro data from the United States and Europe also helped. On Thursday most of the leading indexes in the United States and Europe were 4-6% up from Monday’s closing figures. Asia’s markets, most of which continued to slide on Tuesday, did not recover to the same degree. In an unusual move Tim Cook, CEO of Apple, sent an e-mail to CNBC reporting that his company’s sales in China have surged: a blatant attempt to lift the sombre mood among investors, including Apple’s. Presumably, however, last week’s macro data carried greater weight, showing that economic growth in the United States and Europe is recovering. Confidence indicators such as Germany’s Ifo (business confidence) and the Conference Board in the US (consumer confidence) have improved much more than predicted in August. In the United States new residential sales showed a strong recovery in July (5.4%) following the decline in June, and prices again rose slightly. Orders for durable goods in the US also continued their upward trend in July, recording a 2% climb on top of June’s 4.1% increase (after upward adjustment). The Q2 economic growth in the United States was also higher (3.7% on an annual basis) than the 2.3% rate reported previously. In the eurozone, the Economic Sentiment Indicator – which combines producer and consumer confidence – improved in August, contrary to expectations. Lastly, the money supply in the eurozone increased more than expected in July (5.3%), indicating that the monetary situation has eased. The carryover of the worries about a slower growth rate in China to the Western markets therefore appears baseless. The recovery on the stock markets also helped oil prices to surge by around 10%: their previous decline was likely amplified by the pessimism surrounding the Chinese economy. Last week DSM announced plans to slash its costs by €125-150 million, by streamlining its support services and cutting 900-1100 jobs. These measures are urgently needed to improve the company’s returns: with a price-earnings ratio of more than 17, its valuation is quite high. Last week we modified our recommendations for two oil-related companies from ‘hold’ to ‘buy’. Although neither Fugro (exploration) nor Vopak (storage) published very encouraging Q2 figures, both companies have been censured hard by the markets and as a result are valued so low that they are now attractive once more – and they will only become more attractive if oil prices continue to rise, as we expect them to do during the coming quarters.

Macroeconomic data and speeches

The focus this weekend was on the monetary conference in Jackson Hole (Wyoming) and the announcements expected there. This week a series of macro data are expected, and a few more companies will publish their quarterly earnings. The conference in Jackson Hole, which began on Friday, is traditionally an occasion for policymakers, scientists and academics to express their views on monetary issues. Despite the presence of Janet Yellen and Mario Draghi, the spotlight was on the speeches by Stanley Fischer (Vice Chair of the Federal Reserve) and Governor Mark Carney of the Bank of England. Both these central banks are expected to raise their policy rates shortly – the timing is now even more interesting in light of the present turbulence on the markets. This week will be busy in terms of macroeconomic data too: several countries are scheduled to publish their final data about the August sentiment among purchasing managers, both for industry and for services. Movements in inflation will be highlighted, with data about producer prices (July) and consumer prices (August) in the eurozone as well as consumer prices (August) in Italy. Consumer spending and retail sales in Germany and the European Union as a whole will also be presented, as will July’s factory orders in both the United States and Germany. On Thursday the European Central Bank will meet to discuss its monetary policy. Undoubtedly that meeting will look at the recent pronouncements by its chief economist, Peter Praet, about expanding the scope of the stimulus programme. In the corporate sector some interesting companies have yet to publish their Q2 earnings: Air France-KLM, Toshiba and Vivendi.

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