Global Weekly: China holding up

News item -

This week, we saw stock markets declining significantly. The reasons predominantly lie in disappointing macroeconomic data and a decision of the World Trade Organisation (WTO) regarding illegal subsidies - both raised concerns about global growth.

On Tuesday, the eurozone manufacturing PMI was published. The manufacturing PMI monitors changes in production levels from month to month. A PMI above 50 means expansion, a PMI below 50 means contraction. The PMI fell to 45.7. The eurozone manufacturing PMI has been below 50 since February 2019, but this was the lowest level since October 2012.

Later that day, the US manufacturing PMI was published as well. The US manufacturing PMI was expected to be 50, but dropped to a much lower 47.8. It was the second month in a row that the US manufacturing PMI was lower than 50. It was also the lowest US PMI manufacturing in 10 years. European equity markets decreased 1.3% and the US markets 1.2%.

On Wednesday, the World Trade Organisation (WTO) concluded that Germany, France, Spain and the United Kingdom had given illegal subsidies to aircraft production company Airbus. The US asked for its judgement. Now, the US is allowed to levy import tariffs on USD 7.5 billion of European goods. Expanding the trade war to Europe could be the next step in the US trade war. Together with rising concerns about economic growth, this resulted in a decline in European equities of 2.7%, while the S&P500 dropped 1.8%.

This week, in which the People’s Republic of China celebrated its 70 year existence, the Hang Seng index did not experience the substantial declines that European and American stock markets showed. That was quite remarkable, as the protest in Hongkong continued. It even got worse, with a student being shot by the police. That did, however, not have a negative impact on the stock market in Hongkong.

We continue to be underweight equities in our portfolios as we believe the risk/reward ratio for equities is challenged by the global growth slowdown. Meanwhile, from a regional perspective, we favour the US over Europe and have a neutral position on emerging markets.

Signals from a low PMI

While European industrials enter the third quarter reporting season, signs of an end-market weakness are growing. Even though the manufacturing PMI in France oscillates around 50, Germany’s PMI level is at 41, the lowest level since the 2009 recession.

Manufacturing is key to Germany's economy and to the prospect of European industrials. As such, sustained declines in lead indicators point to weaker demand into 2020. German manufacturers face a perfect storm of trade-war uncertainty, Brexit and a domestic car industry that is struggling with structural changes. In short, this appears to have created an environment of reduced investments. Both German Bunds and UK Gilts have seen their yields rising during the last month. We do, however, expect them to lower and that is why we remain overweight on duration.

The market seems to have learnt to live with the unresolved China-US trade dispute, in the sense that every meeting brings hope, and new claims or breaches afterwards. Next week, China and the US will have higher-level meetings, so it is time to see if there would be any advances.

Even though almost all attention is focused on China, the US already received approval from the WTO to impose tariffs against the EU, which should retaliate any time soon. With a rising no-deal Brexit risk, this could add to the weakening of the eurozone. Nevertheless, even though the main trading partners of the US are slowing at a faster rate, the US economy is losing momentum as well, confirming that it cannot be immune to global trade forever. This is consistent with our view that eventually there will be two more rate cuts by the Fed before year-end.

In a risk-off mode, emerging markets bonds and other corporate high-yield bonds tend to become more volatile. Given the uncertainty and global slowdown, particularly in China, emerging markets currencies would need a far more accommodative Fed than we expect, and thus a weaker US dollar. Only that could revert the downward trend in these currencies. We do not see that happening and therefore we keep our emerging markets position exclusively in hard currency.

Within emerging markets, the most worrisome budget deficits are seen in Argentina, Brazil and Saudi Arabia. Argentina and Brazil have a stagnant economic growth, the most political risk and the highest debt-to-GDP ratios, while Saudi Arabia suffered a drag on oil exports after the drone attack. At the same time, Saudi Arabia has an insignificant debt level below 25% that should not concern investors. However, the countries with the biggest weight in emerging markets indices, have sound public finances and still have room for rate cuts, which justifies our overweight in emerging market debt versus high yield corporates.