October 2015
Schroders
Talking Point
Chinese challenges and rate risks
Peter Harrison, Head of Investment and Keith Wade, Chief Economist & Strategist
We think the concerns that prompted recent market volatility have been overplayed. Over the medium-term,
the prospects for global growth remain reasonable. While a slowing emerging world (particularly China) may
cause global growth to weaken, the developed world is still growing well. Lower oil prices seem to be feeding
through into stronger consumer spending, especially in the US, Europe and UK while real wages are rising in
some parts too.
Investors need to look at the pockets of value arising as a result of the selloff in emerging markets and
commodity prices. High-yielding stocks are one area of the market which have become quite depressed, and
the value style of investing has been out of favour. We think you’ll start to see a return to those types of
themes.
In terms of asset allocation, we are waiting to upgrade emerging markets. The problems facing the emerging
world are well known and that in the next few months, investors should consider re-orientating themselves
back towards this area of the market.
Chinese authorities regaining grip on economy
One of the main factors behind the summer’s equity market selloff was investor concern that the Chinese
authorities had lost their ability to stabilise the economy and markets. However, since then, policymakers have
made it clear that they do not plan to devalue the yuan significantly. A fiscal package has also subsequently
been announced. The authorities are regaining their grip on the economy again and people are beginning to
feel a little more comfortable that policymakers will be able to stimulate growth.
However, if the Chinese economy were to experience a “hard landing”, we could see a global recession as well
as a potential currency war. For such a scenario, investors could choose lower risk fixed income and dollar
assets. That said, the trade-weighted dollar is already nearly at an all-time high, which indicates investors are
hiding out there already.
The world’s major policymakers appear to be working together in a covert form of “international cooperation”
by avoiding policy action that would significantly disrupt markets. For example, the Chinese authorities have
not devalued the yuan, the Bank of Japan has not boosted its quantitative and qualitative easing (QQE)
programme and the Federal Reserve (Fed) did not raise interest rates as had been expected in September.
Not the right environment for US rate rises
The decision to further postpone the first US interest rate rise was due to a lack of conviction that inflation can
get back to the Fed’s target of 2%. Headwinds from weaker emerging markets and a strong dollar have had a
deflationary effect on the economy, even though the domestic economy is performing well with a tightening
labour market. Wages are not rising yet but we expect them to start to do so soon. We think the next rate rise is
probably not on the cards until March next year. In the near term the US economy will continue to grow but not
by enough to push up inflation.
SchrodersTalking Point
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A stabilisation in Chinese growth and some stronger wage growth in the US are the likely triggers for an
eventual rate rise. If we see some signs that wages are picking up, the Fed will feel more comfortable raising
rates.
The lack of liquidity
As a result of interest rate rises, liquidity issues are back in the spotlight. In late August there was a substantial
selloff in some really big ETFs and some ETF providers were talked talking about a crack in markets. This
could be a ‘canary in the coalmine’. If liquid instruments are not working at a time when they should, that is a
big warning sign that things are not right.
The low interest rate environment is only going to exacerbate the situation because investors will continue to
look for yield in alternative, income-generating assets. Very often, investors have to sacrifice liquidity in the
search for yield.
Opportunity amid the volatility
While the deterioration in liquidity is a concern, as is the prospect of a “hard landing” for the Chinese economy,
the volatile market environment is something investors should welcome, as it could present opportunities to
add quality to their portfolios.
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