Rothschild WM views on shadow banking in China. Leading indicators of global economic activity have moved back into growth territory but they are only slightly up from a month ago. This supports the view that risky assets will do well in the next few months, aided by the continuation of loose monetary policies from the world’s leading central banks. However, there have been some encouraging signs from major developed regions lately.
Notably, the US remains the strongest country with some surveys of economic activity reaching the highest levels since the end of 2007. Housing market data and employment figures have been mixed but also remain broadly positive. Job creation continues although at a slower pace than expected. We note that the four-week average of initial jobless claims is at its lowest level since November 2007.
Rothschild WM: Emerging from recession
The Eurozone appears to be continuing to recover from recession although it is starting from a very low base. The flash composite Purchasing Managers Index (the preliminary reading) rose a further 1.2 points to 51.7 in August. Figures for Germany and France were flat, which implies that conditions in peripheral countries have improved. These trends suggest the region could be on track to meet forecasts of 0.5% growth for the third quarter.
In Japan, prime minister Shinzo Abe has been working hard preparing the ground for the next phase of his reforms. The risks remain the same – that he will be unable to implement his plans or commit a policy mistake, such as increasing VAT by too much and derailing the recovery. In the meantime, we are prepared to give Abenomics the benefit of the doubt.
Rothschild WM: Emerging markets struggle
In contrast to the positive developments across the developed world, many emerging markets are struggling with a variety of challenges including large current account deficits. We are concerned this situation could be the start of a secular trend, during which financial markets in these regions will remain relatively unattractive. There would also be a significant impact on the pace of global economic growth.
The situation in China is the greatest concern. A credit boom has fuelled growth, and the total size of the banking sector has swelled to four times GDP. Since 2009, the government has slowed the pace of lending through the official banking system, encouraging borrowers into unofficial channels. This shadow system has expanded substantially but is unlikely to be able to cope with further government intervention to curb credit growth. In turn, this could cause the credit bubble to burst.
Rothschild WM: Where next for China?
The timing of this third act of global deleveraging remains uncertain, as does how the Chinese government will react. China is forecast to contribute around a third to global growth over the next 10 years. Therefore, this process is likely to have severe implications for a number of dependent regions and industry sectors as well as the global economy.
The greatest losers are likely to be those that have gained the most during the period of China’s stellar growth. They include commodity exporting countries, luxury goods manufacturers and Asia’s property markets. We have already reduced our investment exposure to these themes during the year and will continue to look at other areas that could be vulnerable as well as any potential investment opportunities.
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