Market Commentary

Global markets were generally down in August. While we tend to shy away from creating the narrative of “why” markets do what they do, it’s pretty clear that market participants are worrying about the Federal Reserve’s interest rate increase (September or December) and how the global players will deal with China’s slowing economy.

For August, U.S. equity markets slipped about 6% , putting us down close to 3%YTD. Global markets were widely varied however, and generally they were down slightly further . Although our “safe” investments added some ballast, even bonds were slightly down .

Though we tend to dismiss most official Chinese data, we did take notice today when the official PMI (Purchasing Managers Index) figure was released, slipping from 50 to 49.7. As anything under a 50 is considered contractionary, we can see that the Chinese government is, in fact, admitting a slowing of the economy. This is unusual for the Chinese government. China has voiced they want to move more towards a market and consumer oriented economy. Previously, they had an investment focused economy, building infrastructure within China and devouring energy and commodities to do just that. Their recent stock market rout has introduced them to the painful side of converting to a more market oriented economy. They have responded with extraordinary fiscal and monetary support, and have significant dry powder to continue this if they so choose.

However, the Chinese economy is negligible to the United States. We hear of China’s importance to the U.S.; however, the direct connections are small. U.S. exports to China are less than 1% of our GDP. For some industries (commodities, microchips, etc.), there is a real Chinese focus; for most industries though, it’s just not that important. Also, unlike the “Asian Contagion” in 1997, China is a creditor country, not a debtor country. There shouldn’t be (famous last words!) an insolvency crisis, at least not in China.

What the global market players are balancing are the knock-on effects. If we grossly oversimplify and think about China as the factory for the world, then we know that the raw materials (commodities) that are sold to China as the inputs to that production had a rough month and year as well. Taking it a step further, countries who are reliant on commodity based exports (Australia, Canada, etc.) have had a tough time, which will likely show through their economic statistics (Canada just registered a negative GDP this morning) and through their currencies. While they have already been punished, it seems strange that we haven’t yet seen a debtor country that is reliant on oil revenues implode. A poorly performing foreign stock in a country with a poorly performing currency, relative to the US, will appear to a US investor to have a double whammy against it. This has, for the most part, been the story for the past year, as commodities have been trounced and the U.S. dollar has appreciated significantly.

That negative flow has to be balanced against the backdrop that prices have significantly retraced. The market is clearly pricing this in to an extent, and is struggling to find the clearing price for the majority of the inputs of the world. Volatility of equity indexes has spiked, along with volatility in the price of commodities.

1 S&P: August returns -6.03%; YTD returns -2.9%
2 MSCI EAFE: August returns -7.4%; YTD returns -.2%
3 Barclays US Agg Bond: -.14%

By, Clint Edgington