Summer has culminated with a noteworthy, but expected, development: an acknowledgement from the Federal Reserve, the U.S. central bank, that it is nearing a decision to withdraw some of its stimulus given its confidence in the economic outlook. Fed Chairman Jerome Powell was careful to reassure investors that any interest rate hikes are still a ways off. Global equity markets responded favourably, with many making news highs. But, one asset class remains mired in a bit of a slump, relatively speaking: the emerging markets. We discuss this in more detail below.
Canadians tend to focus on North American markets given greater familiarity with and exposure to stocks north and south of the border. But, the importance of the emerging markets has grown meaningfully over the years. It now accounts for more than 10% of the global market, versus just 1% nearly thirty years ago. Much of this has been driven by China, which is now the third largest equity market. And while Canadians may not have direct exposure to China or the broader emerging markets, it is important to be mindful of the developments in these areas given the global nature of the capital markets, and the interconnectedness of policy and finance.
The Chinese equity market is treading water year-to-date as it has barely eked out any gains. It is largely responsible for the struggles of the broader emerging equity markets. There have been two factors at play: a slowing of its domestic economy in recent months and regulatory restrictions undertaken predominantly in the real estate sector and a variety of “new” technology industries, among others.
Global investors understandably worry from time to time about the Chinese economy. After all, it is the world’s second largest, the biggest consumer of many commodities, and the world has depended on it for growth when other regions have struggled. And while its growth has been slowing through much of the first half of this year, the country has sufficient means – fiscal and monetary - with which it can redirect its near-term economic trajectory.
It may have already begun to do so. Its central bank reduced its reserve requirement ratio a few months ago. The move suggests it is willing to let banks lend more to businesses and consumers in an effort to stimulate growth. As China’s monetary and fiscal policies ebb and flow, so too will its equity market.
But, investors should be mindful of the longer-term objectives of the Chinese government. It is focused on addressing wealth equality and building towards “common prosperity”, a term it recently coined to describe its longer-term ambitions. More specifically, the government is taking aim at issues such as mobility, income, public services, and social security to reduce the imbalances it believes exist and foster a stable and sustainable future. This helps to explain why the government has targeted the real estate and some online industries with recent regulatory actions. For the former, it wants to ensure debt levels are manageable and housing prices are affordable. For the latter, it wants to ensure that wealth is not overly concentrated in a few sectors or companies, but rather distributed as evenly as possible.
It’s possible the Chinese economy and equity market may improve towards the end of the year should policy become more inflationary. That will add an additional tailwind to global equities that have already performed well this year, largely on the back of the developed markets. Nevertheless, China’s approach to regulation may not be temporary, but longer lasting in nature, suggesting there is some risk that profitability and valuations of some pockets of its equity market may be vulnerable for some time to come. It is something worth monitoring given the country’s growing economic and market influence.
We are pleased to share the latest investment strategy report from RBC Wealth Management: Global Insight Weekly.
Heading toward uncharted territory
As the dilemma of increasing federal debt continues, and with no concrete proposals for a slowdown on the horizon, more debt may lead the U.S. government and taxpayers to a financial destination to which they have not been before.
Regional developments: Clean sweep by the Canadian banks; Can U.S. stocks extend the monthly winning streak?; Jump in eurozone inflation unlikely to shift ECB position; Slowing growth momentum in China
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