The price of tea in China – the nature of global marketsSeptember 29, 2015
The phrase “Well, what does that have to do with the price of tea in China?” is a phrase often used to respond to a question that is off-topic or irrelevant. Yet, when speaking about the global economy today, the price of tea (and oil) in China may not be so off-topic after all. In fact, Bill Gross of Janus Capital speculated that the Fed’s decision not to raise the federal funds rate had to do with concerns about the recent volatility and central banking actions in China. Data show that The Fed has been presiding over a strengthening U.S. economy that has also been experiencing a strengthening dollar and falling commodity prices. The stronger dollar could lead to disadvantageous trading relationships that damage our ability to grow through exports. The fall in oil prices seems to be driven in part by a perceived slowdown in Chinese demand for energy. The weakness in oil and other industrial linked commodities is putting strain on the companies in their respective industries and also serves as a deflationary force. Both the increasing dollar strength and sell-off in the energy sector could potentially threaten the continued growth in the U.S. and the Fed’s response to these risk factors was to maintain the “status quo” by not increasing the federal funds rate. There are events happening all over the world that are affecting bond and equity prices globally; the market and our institutions seem to be more intent than ever on pricing global news into securities.
Market pundits and investment managers have sorted through the data and created a narrative that includes both layers of expectation and mystery.
- It is clear that the world economy is interconnected and central banking actions have been at the forefront of market movements since the financial crisis of ’07-’08. Correlations between securities seem to be substantially higher than previous norms and prices are often driven up or down in near unison based on macroeconomic conditions or events.
- For some time, the story behind the “emergence of a middle class Chinese consumer” has been a major growth theme in global investment portfolios and remains one of the largest growth stories there is. This story is now being tested and many investors have stopped for a “pause” due to their expectations surrounding their growth projections in the region. It is clear that there is fear regarding the potential for a Chinese slow-down or recession.
- It appears that the Chinese want to transition their currency to be pegged against a basket of global currencies instead of the U.S. dollar alone. Their decision to “re-peg” their currency was initially seen as purely a monetary reaction but further stimulus measures signaled that there may be more to the story. The market viewed the move from the Chinese as a potential sign that they may be fighting off a recession and are looking to deploy fiscal and monetary stimulus.
- The Japanese and Europeans seem to be committed to continuing their Quantitative Easing programs, which makes a rise in the federal funds rate a unilateral move versus some of our largest trading partners. Japan and Europe have lagged the U.S. coming out of the global recession of ’07-’08 and they are looking to kick-start their economies by purchasing securities on the open market.
- Many emerging markets countries with current account deficits such as Brazil seem to be facing a head wind caused by the stronger dollar and potential for rising interest rates. Aside from disadvantageous currency movements, Brazil is also heavily levered to commodity prices and industrial growth, as is Russia. It is now mainly the contrarian value investor that is looking for “deals” in the two regions due to the souring sentiment and negative momentum in the regions.
- It seems that we do not know the potential severity behind the possibility of a Chinese recession. There is a lack of transparency in their financial system that makes it difficult to gauge the health and aptitude of their financial institutions to stimulate real growth in the region. The Chinese seem intent on taking actions to stimulate economic growth through monetary and fiscal policies but it is difficult to gauge the impact of their policy decisions. It is also unknown how a potential slow-down in China will affect other markets around the world or the financial system as a whole.
- We do not know the indirect positive effects that cheap oil may have on nations and economies that are net importers or consumers. It seems as though investors have become bullish on many companies in the consumer cyclical space as consumers will essentially have a “tax-break” from the cheaper oil. Cheap oil should be a positive for the consumption driven economic activity in countries such as China, the U.S., Europe and Japan. It is unknown if the benefits from cheap oil can outweigh the costs from an economic growth standpoint.
- We now have a cloudy outlook as to if or when the Fed will finally raise the federal funds rate. Fed Chair Janet Yellen has guided the markets to continue to expect rates to rise by the end of the year. That of course is still data dependent and seems to be dependent on a set of interconnected global data that is ever more complex and unpredictable.
- The money multiplier in the U.S. and other developed nations seems to be far lower than in past economic cycles. Institutions and ultra-high-net-worth individuals seem to be sitting on large amounts of cash and credit lending seems to be tight in many areas of the economy. If the Fed raises rates, will this be a further disincentive for banks to lend and savers to invest their savings into the economy? Investors will need to see enough growth investment opportunities to outweigh the increased opportunity cost of higher interest rates on savings or deposits. This is most likely the reason why ‘growth data’ is so paramount in the Fed’s decision making process.
With the interconnected nature of global markets, “the price of tea in China” matters when talking about investing right now and it matters more so than ever before. The price of tea and everything else in China seems to be less of an irrelevant non-sequitur than it may have been in the past when speaking about the U.S. and global economy. As profits and growth surrounding Chinese industrial demand continue to be at the forefront of market sentiment, it is prudent to assess direct and indirect exposures to the region. As with any volatility, there is noise and there is news. In the case of China, the lack of transparency and structural stability seems to add a layer of “haze” or “mystery” that has many investors unable to differentiate between the two. As a result, the uncertainty may cause investors to diversify their thematic or direct exposure to China. And if “the price of tea in China” is truly having a greater impact on security prices here in the U.S. and around the world, it may cause investors to lose conviction and diversify their investments by moving to more passive instruments, thus increasing the levels of correlations as we’re seeing in global markets today.
This blog post was contributed by Tyler Mull, research analyst at FDx Advisors.