What a difference a few days can make….While most of July showed equity markets continuing the trend higher, the last few days quickly reversed most markets into the red. What caused the recent downturn? Market pundits can pick the news to hang their rationale. US and the EU stepped up sanctions against Russia, pushing tensions higher. Argentina was deemed to have defaulted in their debt after a long-drawn negotiating process. Inflation in Europe stayed soft which, along with earnings growth slowing and continued slack in labor, has caused yields in Eurozone sovereign debt to creep to lower and lower. And, of course, there is always the “good news is bad news” mentality shown in US economic data. In the most recent economic release, the preliminary Q2 GDP growth rate came in at 4% (in addition to a slight positive revision to Q1 to -2.1% from -2.9%) – a strong bounce after the winter-induced freeze up. What caused most consternation, however, was the inflation indicators at a solid 2% – right at the Fed’s target and a step up from the prior reading. Market speculation that interest rate increases may be coming sooner than expected were fanned in the following day where certain Fed officials commented at the strength of the statistics and the potential impact to decision making. That said, we continue to feel that rate increases remain still a step or two away. First, we are more likely to see a shrinking of the balance sheet through stopping reinvestment of coupon/principal repayments or reverse repo activity to soak up liquidity before the blunt tool of interest rates are used – especially given the effect it has the housing market and the government financing costs.
July was a great month for China. Several data points started lift the spirits in Shanghai starting first with a GDP number that, not surprisingly, was right on top of government forecasts of 7.5%. What was most uplifting however, was the news that the second corporate issuer expected to default avoided it, that President Xi Jinping continues to clamp down on corruption with the indictment of Zhou Yongkang (the highest ranking party official ever to go to trial over corruption), and announcement of the plan to have a nationwide reform of the hukou registration system. The intent is to create a nationwide system supporting social infrastructure such as healthcare, pensions, and education which will drive the next round of urbanization as 100mm people migrate towards cities by 2020. October was announced as the timing of the Fourth Plenary session in which even more economic reforms are expected. The local Chinese equity markets rallied 8-9% with the local state-owned enterprise and cyclical companies benefitting the most. We continue to be bullish on the ability to reform and sustain growth in China and in our focus on where we see the long-term growth in consumer, healthcare, and technology sectors which participated in some but not all of the animal spirits this month.