IT has been a turbulent time for equity markets. A rout in Chinese stocks spread to the West, with US, UK and European equities selling off. Several stock indices around the world fell more than 10% from their last peaks. Worst-hit was the Shanghai Composite index.
The sell-off provoked some alarming headlines and much talk of Beijing’s “Black Monday”. China has replaced Grexit on the markets’ worry list. But we’d take this with a bit of a pinch of salt. Equities are skittish. The relationship between equities and economic activity is mixed; the equity market has predicted ten of the past six recessions.
China’s market may have tanked, but anyone who put money into the Shanghai composite a year ago would have seen their investment rise by 40%. Equities play a smaller role in China and their capacity to derail growth is lower. The market is far smaller relative to the size of the Chinese economy than Western markets are to Western economies. Chinese consumers have less than one-fifth of their assets in the equity market.
The crash has, however, focused attention on the challenges to China’s economy. After almost two decades, the era of fast Chinese growth is coming to an end. Abnormally high levels of outstanding debt, at 282% of GDP, and a housing bubble are major risks. Markets worry such imbalances may require a drastic slowdown in growth or a recession to get back to reality.
So far, the slowdown looks manageable. China’s growth averaged 9.2% in the five years after the financial crisis. The IMF expects this to slow to a respectable 6.5% over the next five years. The Chinese authorities have shown they are willing to cut interest rates, devalue their currency and ease restrictions on bank lending to bolster growth, and use levers such as these again in future.
A key reason behind this resilience is that consumer demand remains strong. Amid the Chinese stock market turmoil, Apple’s CEO, Tim Cook, revealed to a CNBC journalist that Apple continued to experience strong growth in China over July and August, which helped Apple regain $66bn (£42.8bn) in market capitalisation.
China’s economic slowdown is part of a wider story of weakness in emerging markets. Commodity-intensive economies, such as Russia and Brazil, have suffered from falling commodity prices. The prospect of higher interest rates in the US has tempted capital away from emerging market economies, further dampening growth.
Western central bankers seem outwardly insouciant in the face of the equity sell-off. Their confidence was no doubt bolstered by recent economic data. Second-quarter GDP estimates for the US and UK showed a good rebound in activity and strong growth in business investment and inventories. In Europe, Germany’s Ifo business climate index hit a three-month high.
We see two big positives for Western growth. First, falling commodity prices are a boon for Western consumers. Commodity prices have fallen by a third since last year’s peak, pushing down inflation and giving consumer spending power a timely boost. In the UK and US, a stronger dollar and sterling have made imports cheaper and have further boosted spending power. In the UK consumer confidence hit a 15-year high in August. In the US and Germany, retail sales showed strong growth through July.
Second, money is cheap in the US, the UK and the euro areas. While the US Federal Reserve and the Bank of England have indicated that they are contemplating raising interest rates, both stress that rises will be gradual. In the euro area the ECB’s quantitative easing programme has pushed private sector demand for credit to the highest level in ten years. And in response to the rout, central bankers indicated they would consider delaying rate rises to avoid market jitters.
So China’s Black Monday was not enough to change the big picture for growth in the West. We continue to look for decent growth in the US and UK and an unspectacular euro area recovery. ?
Ian Stewart is chief economist at Deloitte