Pallett Wealth Management Team
Global Economic Update
03/09/2021
Summer has culminated with a noteworthy, but expected, development - an acknowledgement from the U.S. Federal Reserve that it is nearing a decision to withdraw some of its monetary stimulus, given its confidence in the economic outlook. The withdrawal will initially consist of staged reductions in bond buying. Fed Chairman Jerome Powell was careful to reassure investors that any interest rate hikes are likely to be a year or more away. Global equity markets responded favourably, with many markets making new highs. Emerging markets, however, remain mired in a relative slump. We discuss this in more detail below.
Canadians tend to focus on North American markets, given their greater familiarity with and exposure to stocks north and south of the border. Nevertheless, the importance of the emerging markets has grown meaningfully over the years. EM now accounts for more than 10% of the global market, versus just 1% nearly thirty years ago. Much of this growth has been driven by China, which now houses the world’s third largest equity market. 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 global commerce, policy and finance.
The Chinese equity market has been treading water year-to-date, with very modest gains. China 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. It is the world’s second largest economy, the biggest consumer of many commodities, and the world has depended on it for growth when other regions have struggled. While its growth has been slowing through much of the first half of this year, China has sufficient means, both fiscal and monetary, with which it can redirect its near-term economic trajectory.
China may have already begun to do so. Its central bank reduced its reserve requirement ratio a few months ago. This move suggests that it is willing to let banks increase lending 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.
Investors should, however, 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. These objectives help explain why the government has targeted its real estate and online industries with recent regulatory actions. For the former, it wants to ensure that 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 is possible the Chinese economy and equity market may improve toward the end of this year should its policy become more inflationary. This would add an additional tailwind to global equities, which 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. This is something worth monitoring given China’s growing economic and market influence.
Should you have any questions, please feel free to contact me. Drew M. Pallett LL.B. CFP www.pallett.ca