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What in the world is going on in the stock markets?

In this article, Danske Invest's chief analyst Bo Bejstrup Christensen explains what is going on right now in the stock markets.

With the past couple of days' movements in the global stock markets, August has so far presented the worst price falls in 2015. Emerging markets are hit the hardest, as their currencies also appear to have gone into a free fall. However, no regions, countries or sectors seem to be spared. What in the world is going on?

The growth in the global economy is on the decrease
We sold stocks on behalf of our clients mid-July to reduce the risk in our portfolios to a level reflecting the long-term average. The question now is whether we are to regret that we did not sell off even more stocks. However, to answer whether this would be the right thing to do now, we must first try to explain why stocks plummeted during the past few days. We see three primary reasons - falling growth in the global economy, uncertainty as to China and the impending change in the US monetary policy course.

In general, we take a positive stance towards stocks when global growth is on the rise and a neutral stance when we expect declining growth.

Right now, the growth in the global economy appears to decrease. In our view, the slowdown is headed by China and Europe, while the present oil price falls and the strengthening of the US dollar render it more and more likely that also the USA will experience a moderate decrease in growth. Basically, this is bad news - but no catastrophe.
European growth decreases because we no longer to the same extent enjoy the benefit of a continuously falling currency, and at the same time, most of the positive effects from lower oil prices are behind us. However, we do, once again, highlight that the banking system is healthy and will ensure that growth will remain at some 2%.

In China, growth is decreasing because the easing campaign, which in particular boosted growth during the second quarter, is losing its impact. In the USA, growth is currently peaking at some 3%, since the normalisation in wake of the oil price chock and the strengthening of the dollar from the autumn 2014 and the beginning of 2015 has taken place by now. In short, the stock market does therefore not receive a flow of positive economic data that can push up prices.

As always, China disturbs the picture
Once again, Chinese stocks are moving southwards and are sending shock waves through global financial markets. In addition to the recently disappointing economic data showing a renewed decrease in growth, the authorities have signalled that the supportive campaign that they initiated in June and July to prevent additional stock price falls is no longer quite as effective as it was to begin with. In addition to closing down the trade in a large number of stocks, the authorities have also facilitated direct purchases of stocks to prevent that the price falls in the market be too significant. This appears to have come to an end now. Most recently, China has changed its exchange rate policy allowing the value of the yuan to weaken after having developed in tandem with the dollar for ten years. Moreover, with the usually poor communication style, these actions give rise to doubts and worries in a market that is already characterised by a lack of transparency.

The Fed is crying wolf – if not now, then later
In our view, the final negative driver is the impending rate hike in the USA. We have just postponed our expectation for a rate hike by the US central bank, and the markets are currently doing the same. However, our most important message for 2015 has been that regardless of the date for the notorious rate hike, this event - the first rate hike since 2006 - will following a long period with historically easy monetary policies have a great impact and will particularly in the period up to the hike imply stagnant stock markets.

As opposed to our view on growth, which is based on hard data, our assessment of the effects from the coming rate hike is primarily a "gut feeling". As it is, our view is that there are still a lot of people who simply do not believe that we will ever see a rate hike, and some people simply believe that the central bank is about to make a mistake and may potentially kick-start a new recession. However, even though the first rate hike has been postponed, we are becoming increasingly convinced that it is only a matter of time before the first rate hike will materialise.

Are we to sell off even more stocks - or buy?
Right now in our view, it is too late to sell stocks. We are already some of the way into a slowdown in growth, and we maintain our view that we are alone witnessing a slowdown. Not a renewed recession. Once again, the European banking system has become healthy and will contribute to ensuring that growth will be at some 2% going forward.

We have written much about China, and we recommend that interested readers read our other blogs about the subject. However, the short message is that growth has been boosted to a level above its long-term potential (some 5% in our opinion), and since the authorities no longer step on the gas, growth drops from the artificially high level above 6% during the second quarter. The Chinese housing market, however, is improving following a very poor first quarter, the banking system is stable and the authorities are highly focused on ensuring financial stability, and that is why the decreasing Chinese stocks will not have any economic implications.
Finally, the US housing market has not yet returned to normal - something that will keep US growth above 2.5% until the end of 2016. One or more rate hikes will not change this. In short, stock markets are overreacting.

Nevertheless, we are not buyers here. First, we do not feel like trying to catch the "falling knife". In a situation like the present one characterised by significant price falls, we prefer to stay at the side-line. However, if our assessment turn out to be correct and growth does not collapse into a renewed recession, the US central bank is waiting around the corner, and this implies that persistently positive stock markets will not be just around the corner either. Since we invest with a time horizon of two through 12 months when we make these short-term (tactical) reallocations of our portfolios, we will for now stay where we are. The closer we get to the point where growth is bottoming out, and the closer we get to the inevitable rate hike, the more likely it becomes that we will buy stocks again. However, it is not time for that yet.

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