Markets in the last month were marked by the global correction triggered by China’s devaluation and the sharp leg lower in China equities. EM FX was particularly affected, with 5-10 percent declines across countries; commodities sold-off materially, with oil falling to its lowest level since the crisis; global equities often erased year-to-date gains, wiping out USD5tn of market capitalisation in a matter of days.
High valuations in many cases justified an adjustment. However the correction, attributed to concerns over China and global growth and imminent Fed rate hikes, was overdone and not supported by any change in economic fundamentals. The growth outlook in the US, the eurozone and the UK remains robust and if anything has improved in the last couple of months. As for China, the main source of concern, while the trend of gradual deceleration of the economy continues we see growth improving into year-end, and don’t buy into the thesis of a sharp slowdown ahead. EM remains the weak spot, with growth momentum sluggish.
The market correction has made valuations attractive in many cases, such as in equities and to some extent in credit. High volatility will likely remain, as it will take time for growth concerns especially in China to dissipate fully and markets to adjust to Fed hiking rates. In this environment, we remain constructive on US and Europe equities, and prefer sectors exposed to domestic demand. In credit, Europe should outperform the US given lower exposure to commodities and less sensitivity to US rates.
As we approach the September FOMC meeting, the final countdown toward Fed hikes has started. In a special report this month we review the case for and against Fed hikes. We expect the Fed to hike this year; the exact timing of lift-off, September vs. October vs. December, is a very close call but we continue to see September as most likely. In any event, we do not share the view that starting the hiking cycle will be a policy mistake. [more]