China's Growth Evolution: Opportunities and Challenges for the Global Economy

Economic

Summary:

China's economic transformation presents both challenges and opportunities for global markets.

China's economic landscape is undergoing a profound transformation, marked by significant shifts in its growth engines. The evolving composition of China’s economic drivers is likely to have long-term implications for global economies and asset markets, necessitating a re-evaluation of which sectors and asset classes stand to gain or lose from these shifts.

The country’s aggregate growth beta – a measure of its economic sensitivity or correlation to global growth – is declining. This trend mirrors Japan's experience in the 1990s and early 2000s, characterized by debt accumulation, ageing demographics, and a real estate bust (see Figure 1).

While we expect China’s growth beta to continue declining, similar to Japan’s trend in the 1990s, this does not diminish its importance in the global macroeconomic environment or financial markets. As the world’s second-largest economy, it retains dominant positions in global trade and commodity markets.

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Four key trends driving China’s growth over the secular horizon

We have identified four key trends that are set to drive China’s growth over the next three to five years:

Credit growth reduction: The size and composition of China's credit impulse (the change in new credit issued as a percentage of GDP) are changing. Historically, credit growth has been a major driver of China's economic expansion, which has often been countercyclical and volatile. However, structural changes are expected to temper future credit growth. The central leadership, increasingly aware of the risks associated with high leverage, is curbing debt growth, particularly at the local government level. Additionally, declining profitability in the banking sector has reduced its capacity to support the same level of credit growth as in the past.

Property sector contraction: Once a major engine of growth, the property sector is now a secular drag. We expect ageing demographics and significant overbuilt inventories to keep real estate investment and new starts weak. This decline in the property sector will have profound implications for both domestic and global markets, given that it has historically been a significant consumer of commodities, particularly iron ore, and a driver of economic activity.

Increased manufacturing capacity: China is increasing its manufacturing capacity, shifting from a surplus in property construction to a surplus in manufacturing production. Unlike the property surplus, this new manufacturing surplus is being exported, making it a global challenge rather than just China's. The government's policy direction has been heavily focused on the supply side, with less emphasis on demand-side stimulus. This could lead to economic imbalances, with early signs of rapid capacity expansion in sectors such as electronic equipment and vehicle production aimed at gaining cost advantages. This shift is already intensifying competition with other advanced exporter countries for market share.

Green energy investment: Investment in green energy is ramping up, signaling a shift towards sustainability and self-sufficiency. This trend will have varied implications for different sectors, particularly commodities. The rise in "green demand” for metals such as copper, aluminium, and nickel introduces a new dynamic, potentially offsetting the decline in traditional demand driven by the property sector's slowdown.

China’s recent Third Plenum supports continuation of these trends

At its Third Plenum in July, a key meeting of the Chinese Communist Party’s Central Committee, China’s leadership reaffirmed its long-term vision of pursuing reform and modernization.

Keyword analysis of the meeting’s communiqué shows a shift towards high-quality economic growth, particularly in advanced manufacturing and technological innovation. “Reform” remains the most common keyword, with “development” and “modernization” not far behind. There were limited additional easing measures outlined for the struggling property market. While there were more mentions about supporting domestic consumption, many of these measures are still supply-side led, such as providing greater variety and higher-quality services, rather than directly stimulating demand through fiscal transfers. We await further details on how these measures will be implemented. However, it was clear the government intends to boost the manufacturing sector and supply chains in more concrete ways, as well as technology sectors such as green energy, AI and biotech.

Given that the rhetoric largely represents a continuation of existing themes, we expect a continuation of the current trends driving China’s growth.

Implications for global markets

As China navigates the limits of debt-fueled growth and shifts towards new growth drivers, the effects of this transition will reverberate globally, affecting various sectors and countries over the secular horizon:

Disinflationary impulse: China is likely to be an exporter of disinflation to the global economy over the secular horizon. This is due to the combination of slowing growth and increased manufacturing capacity. Persistent deflationary forces in China could translate into lower export prices, affecting global inflation trends. However, disinflationary forces are likely to affect emerging market (EM) countries more than developed economies. Imports from China represent a larger share of final consumption goods in EM, and core goods have a larger weight in the CPI basket in these countries than in developed economies.

Commodity consumption: Despite the slowdown in growth, China's consumption of key commodities is expected to increase, driven by investments in green energy. However, this increase will vary as the property sector continues to contract. For instance, while demand for iron ore may decline due to reduced steel production, demand for metals like copper and nickel could rise significantly due to their importance in green technologies.Australia will likely be among the most affected countries given that China is the largest buyer of its iron ore. The poor outlook for China’s property sector and the limitations on its ability to continue exporting excess manufactured steel could significantly impact iron ore demand, with potential knock-on effects on the Australian economy (see Figure 2).

Greater competition with other EM: China's policy response to the property crisis, characterized by stimulating supply through export-led manufacturing growth more than boosting domestic demand, is leading to greater competition with other EM. By increasing manufacturing capacity and boosting exports, China is positioning itself to compete more aggressively in global markets. This strategy can lead to heightened competition for market share in various industries, particularly in manufacturing sectors where other EM also seek to expand exports. Consequently, this approach may intensify competitive pressures on these countries, potentially affecting their economic growth and market dynamics. One phenomenon we have already started to observe is that some emerging markets are exhibiting a reduced or even inverted beta to China’s growth. This contrasts with the positive correlation observed in the past couple of decades.

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Structural changes will require investors to rethink their approach to China

In conclusion, China's economic evolution will significantly affect global trade relations and the broader economy. As China shifts towards higher-quality growth, the composition of this growth will become more critical than the headline figures that investors have historically focused on. Investors must now evaluate which sectors stand to gain or lose from these economic changes by examining the long-term implications of the structural shifts driving China's growth.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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JanusHenderson

Central Bank

Economic

In the lead up to the Federal Reserve’s (Fed) September meeting, we’ve watched – with a degree of bewilderment – many market participants’ near obsession with the size of the rate cut. Whether 25 basis point (bps) or 50 bps, the data that guide monetary policy indicate that the time is now to step away from a restrictive stance.

More germane to investors is whether the Fed is behind the curve. Reducing rates into a resilient U.S. economy (the crowded soft-landing scenario) or cutting into a stalling economy marked by a rapidly cooling labor market (a hard landing) have very different ramifications for financial markets. Fed Chairman Jay Powell took great pains to frame the decision as what we would categorize as a bullish cut. Rather than a paradox, his rhetoric – peppered with words like balanced, confident and resilient – was aimed at signaling that the “strong” 50 bps reduction was not a cause for alarm, but a prudent initial step in normalizing policy.

When divining insight into how to position portfolios during this unique period of cutting rates when there are few signs of a struggling economy, our focus has been on how the Fed sees developments unfolding over the next year and how that will influence the terminal rate for this cycle.

The luxury of lower inflation

We believe the Fed’s larger move was justified as it signaled that this wave of generational inflation is behind us. Perhaps defying expectations, the Fed was able to keep rates at 5.50% for an extended period because the U.S. labor market proved more impervious to higher rates than expected. While not setting off alarm bells, recent softening within the labor market, in the Fed’s own words, has caused it to shift to a more balanced approach toward its dual mandate. Given the past year’s progress on inflation, the Fed had the luxury to go big with this initial cut without unduly spooking the market.

Data within the updated Summary of Economic Projections accompanying the meeting bear this out. Fed officials now see the unemployment rate finishing 2024 at 4.4% and remaining at the level through the end of next year. While still lower than levels that would be consistent with a material slowdown, the degree to which unemployment has risen has likely forced the Fed to be more vigilant with respect to potential downside surprises.

No Time Like the Present – the Fed Commences Rate-Cutting Cycle_1

Although the increase in the unemployment rate has been largely driven by workers entering the labor force, some leading indicators of labor market health have grown wobblier. Job openings are 37% beneath their post-pandemic peak, inflation-adjusted wage growth, while still positive, has trended down and the four-week average of initial jobless claims – a proxy for a feared wave of layoffs – has risen from 201,000 to 231,000 thousand. As with the unemployment rate, this level remains well below what would be associated with economic contraction.

Modest softening in the labor market is likely the price the Fed is willing to pay for making progress on returning inflation to its 2.0% objective. For that matter, even with the cut with core inflation at 2.6%, an upper rate limit of 5.0% is still restrictive. The Fed likely believes this level is sufficient to guide headline and core inflation toward its downwardly revised level of 2.1% and 2.2%, respectively, in 2025.

We believe it’s important to note that a 50 bps cut has not materially changed the Fed’s expectation of where the terminal rate for this cycle lies – still sitting between 2.5% and 3.0%.

The cycle lives on?

With the commencement of rate cuts behind us, the market can now focus on what type of landing will occur. Nailing a soft landing is notoriously difficult, and during the Fed’s historic stretch of rate hikes, the prevailing view was that this expansion would end – like most others – at the hands of overly restrictive policy. But over 2024, the pendulum has swung toward a soft-landing. After all, inflation fell without a spike in unemployment and U.S. consumer demand remains strong.

If the economy proved steady when facing a 5.5% policy rate, its resilience could now be buttressed by corporations and households benefiting from lower borrowing costs. The upshot is an extension of the economic cycle and a tailwind for riskier assets that have cyclical exposure or are faced with maturing debt over the midterm. Understanding the boost to the U.S. economy that a lower cost of capital would provide, the Fed, in our view, would have been more reticent to move 50 bps had it not been certain that wage-driven inflation on account of a red-hot labor market was less of a concern.

Some have interpreted the 50 bps move as evidence that the Fed may be behind the curve. Chairman Powell stated this was not the case, and the data seem to back up this claim. Still, one cannot entirely dismiss the risk that the long and variable lag of restrictive policy has yet to fully play out. In this hard-landing scenario, cutting rates would cease to be a luxury and instead become a lifeline seeking to stanch flagging investment and consumption. That cascading of events would mark the end of the post-pandemic expansion.

Taking what the market gives you – namely income and diversification

From a positioning perspective, we do not see the move as a game changer for fixed-income investors. The known knowns haven’t changed. Inflation is cooling. The U.S. economy resilient. And the labor market, despite some softening, is nowhere near levels associated with recession. This belies an extension of the cycle that should be favorable for riskier assets, especially higher-quality corporate credits whose fortunes are more exposed to consumer strength. Similarly, companies with higher debt loads should benefit from lower borrowing costs.

No Time Like the Present – the Fed Commences Rate-Cutting Cycle_2

While these companies would be hurt in a hard landing scenario, a fixed income allocation can still aid a broader allocation by offering the potential to preserve capital and serve as a diversifier to riskier equities. In either scenario, the arrival of the rate-reduction cycle means that many points along the yield curve could deliver capital appreciation. In this respect, we believe duration is an investor’s friend. And at current levels, the yield curve still represents levels of income generation that have been a rarity during the past 15 years.

As the unknown unknowns are just that, investors should view an allocation toward higher-quality bonds with sufficient duration exposure as an integral component of a well-diversified portfolio, especially as the Fed seeks to stick the elusive soft landing.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Justin

Cryptocurrency

The cryptocurrency industry will continue to grow, regardless of which candidate wins the U.S. presidential election this November. This is because cryptocurrency has emerged as a major player in election funding, leading to expectations that more favorable policies will be established, according to a report released by the Upbit Investors Protection Center.

Upbit is Korea’s largest coin exchange, operated by Dunamu.

The report highlighted the cryptocurrency-related pledges and positions of each candidate, predicting that, regardless of who wins the election, the growth trajectory of the industry will remain consistent, although the pace may vary.

“If Democratic presidential nominee Vice President Kamala Harris, who is expected to continue President Joe Biden’s policy direction, wins, the cryptocurrency industry is expected to see gradual growth within a regulatory framework,” the report suggested.

“On the other hand, if Republican presidential candidate and former President Donald Trump wins, the volatility of cryptocurrencies could increase significantly.”

Citing data from U.S. market research firm Morning Consult, the report noted that 22 percent of Americans were investing in cryptocurrencies as of last year, making them a voter base that cannot be ignored. This is prompting each presidential candidate to show pro-cryptocurrency tendencies in an apparent effort to win over these voters.

The report underscored that one of the most notable aspects of this presidential election is the sponsorship from cryptocurrency-related companies.

According to Washington-based nonprofit research group OpenSecrets, cryptocurrency companies contributed $119 million to federal election campaigns this year, accounting for 43 percent of the total. This was a significant increase from $4.6 million in 2022.

Currently, the leading contributors are Coinbase and Ripple. These companies are backing a blockchain-focused super PAC called Fairshake, which supports candidates across the political spectrum whose positions align with the crypto industry’s interests.

Unlike regular PACs, which support or oppose specific politicians or legislation, super PACs can raise and spend unlimited funds from individuals and organizations, provided they do not directly contribute to a particular candidate or party.

Since Fairshake has emerged as one of the wealthiest super PACs in this election, it is anticipated that policies and legislation favorable to the cryptocurrency industry will be further strengthened in the future.

Source: Koreatimes

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ACY

Economic

The Federal Reserve (FED) announced a 50-basis point (0.50%) cut in the federal funds rate, bringing it down to a range of 4.75% to 5.0%. This decision, aligned with market expectations, was driven by ongoing economic conditions that have shown both progress and challenges.

Here’s a breakdown of what the Fed's latest decision means, the key highlights from their rate statement, and what to expect for the U.S. economy moving forward.

Economic Context Behind the Rate Cut

The Fed's decision to lower interest rates reflects a blend of optimism and caution. Recent data indicates that the economy continues to grow at a solid pace, but certain key indicators, such as job gains and inflation, remain mixed:

Job Market: Employment growth has slowed down, and the unemployment rate has increased slightly, though it remains low by historical standards. This suggests a cooling labour market but still one that is relatively strong.

The Federal Reserve Cuts Rates by 50 Basis Points: What It Means for the Economy_1

Inflation: While inflation has made progress toward the Fed's long-term target of 2%, it is still somewhat elevated, particularly in core inflation, which strips out more volatile food and energy prices. The Fed remains vigilant on this front.

The Federal Reserve Cuts Rates by 50 Basis Points: What It Means for the Economy_2

The 50bp cut is intended to strike a balance between supporting further economic growth and managing inflation risks. By lowering the cost of borrowing, the Fed hopes to slow down investment and spending, while keeping an eye on inflationary pressures.

Key Takeaways from the Fed’s Statement

Confidence in Inflation Progress: The Fed is gaining more confidence that inflation is gradually moving toward its 2% target, though they acknowledge it's not fully there yet. Their current rate cut is partly a response to that progress.

Balanced Risks: The Fed emphasized that the risks to its dual mandate—maximum employment and stable inflation—are now more balanced. This suggests that the Fed is not seeing a strong tilt towards either overheating or underperformance in the economy, but rather a balanced outlook requiring careful management.

Unemployment Outlook: Projections show the unemployment rate is expected to rise slightly to 4.4% by the end of 2024. This forecast signals that while job growth may slow, the Fed anticipates a stable labour market without significant disruption. For 2025, the unemployment rate is projected to ease slightly to 4.3%.

Growth Projections: The Fed is forecasting real GDP growth of 2.0% for both 2024 and 2025, indicating steady, if unspectacular, growth. This is in line with long-term trends, reflecting a stable economic expansion without signs of overheating.

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Future Inflation Targets: By the end of 2024, the Fed expects PCE inflation to settle at 2.3% and core inflation to fall to 2.6%, approaching the desired 2.0% target by 2025. The Fed remains focused on achieving this goal and will adjust policy as necessary if inflation remains sticky.

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Projections for Future Policy Moves

Looking forward, the Fed’s economic projections indicate that the federal funds rate could reach 4.4% by the end of 2024 and fall further to 3.4% by 2025. This gradual easing of rates reflects the Fed’s expectation that inflation will continue to decline, allowing them to loosen monetary policy as economic conditions stabilize.

However, the Fed's path forward will depend heavily on how economic data evolves. As their statement highlights, any additional adjustments to monetary policy will be “carefully assessed” based on incoming data regarding employment, inflation, and financial developments. The Fed has also made it clear that they are prepared to adjust their policy stance if risks arise that could derail progress towards their goals.

What Happens Next?

If the economy continues its current trajectory, with inflation easing and employment holding steady, the Fed's medium-term target of 4.4% by the end of 2024 seems achievable. This would signal a gradual return to more neutral monetary policy, aimed at fostering sustainable growth without stoking inflation.

In 2025, we could see a further reduction to 3.4%, marking a more accommodative stance as inflation returns to its 2% objective. However, much remains uncertain, and the Fed will remain nimble in its approach, ready to adjust if inflation remains stubborn or if labour market conditions deteriorate.The Fed’s decision to cut rates by 50 basis points represents a significant but measured response to evolving economic conditions. While inflation is trending in the right direction, it remains above the Fed's target, and the labour market, while slowing, is still in relatively good shape. Looking ahead, the Fed will continue to monitor these key indicators and adjust its policies accordingly, with a long-term goal of stable inflation and maximum employment.

Readers should stay attuned to economic developments, as the Fed’s future policy path will depend on how inflation and employment unfold in the coming months. The key takeaway is that the Fed is committed to ensuring that inflation returns to its 2% target, and further rate cuts could be in store if economic conditions support them.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Goldman Sachs

Economic

The rise of generative artificial intelligence has stoked excitement and optimism among business leaders and investors alike. But sentiment toward AI has recently turned much more skeptical, and many are now wondering whether AI’s potential has been overstated.

Is the promise of generative AI overblown?

I don’t think the promise is overblown, but AI is still squarely in the build mode. And if you go back and look at almost every computing cycle we’ve been through – and I have been a combination of investor and analyst through a number of them – there’s a product that captures imagination, there’s a build cycle, and then there’s always a bit of disillusionment on the time between the build cycle and applications that have utility. So if you listen to the companies broadly at the conference the last couple days, we’re moving deeper into the build cycle, which is putting an upward pressure on capital expenditures. But we haven’t yet had the unlock moment on either the consumer side or the enterprise side. 99% of your computing habits are the same today as they were two years ago, even though we’ve had AI in the public domain for the last 19 months. But over time, typically those computing cycles play out and those habits change.

From a capital markets perspective, would you characterize this as a moment of investor impatience?

Investors generally want visibility and linearity. And with any computing cycle, there are points in time that we’ve called “troughs of disillusionment” where it’s not quite as linear, and it’s not quite as visible. We know there was a big tick up in capital expenditures around AI in 2024 compared to 2023, and we’re on an upward trajectory. We could be entering a period where there’s extended and outsized volatility, because of a lack of linearity or visibility around where technology is going over the medium to long term.

As a research group, what we tell people is: Betting on the long term in technology seems to have worked out over very long periods of time, but you do need some patience.

What happens if the application just don’t emerge, and AI proves incapable of profoundly changing businesses and the economy?

Well, the spending to date has been concentrated among a handful of very large companies. There are, in my view, components of both offense and defense in what those companies are doing. Eventually investors will call for a return on that spend. At least through 2025, these companies have all said that it’s better to overinvest than underinvest, so that they don’t miss out on the opportunity. But this idea that they will spend irrespective of the return profile is not what I hear from the companies I cover.

There’s also a debate about whether AI will benefit the mega-cap incumbents, or if it will displace them.

One of the key things to keep in mind with respect to AI is that you need a lot of capital, you need a lot of engineering talent, and you need a lot of data. That creates enormous barriers to entry. So even some of the most interesting private companies in the landscape have found their way to partnerships with some of the incumbents just because of the sheer scale of capital, the sheer need for engineering talent, and then the data required to scale these models. Keep in mind that a lot of the large incumbents have pretty big first-party walled-garden data pools, which can be very important in training and improving these models.

But ultimately, if AI does prove to be a massive driver of the economy, how much of that value will be captured by tech companies?

One area where it will be captured is compute needs. You arguably would take some element of what you pay for work today, redeploy that money into compute, and then the compute would handle the productivity dynamic. We’ve heard people on stage talk about “the virtual worker.” Well, you don’t have to pay the virtual worker, but there are compute costs underneath it.

Do we generally understand the types of impacts that AI will have at this point? Or are investors and business leaders still making educated guesses?

I think much more is unknown than known. Across all the enterprises we talk to, we generally hear a lot of “I’m testing,” “I’m learning,” “I’m seeing what can be built.” So I think if someone says, “I know exactly how AI is going to play out over the next ten years,” I wouldn’t put a lot of weight on that.  As a research department, we’ve tried to talk about probabilistic outcomes, and how the landscape can evolve.

Is there anything that investors consistently miss about the AI story?

Within the consumer technology space, I’ve found that the advantages of distribution are always underestimated by investors. If you have an existing base of billions of users, that is an incredible advantage. And if you then iterate by putting a little bit more consumer-facing AI into those products, that might not be where the bleeding-edge tech is, but it’s how the average consumer will experience it.

To stay updated on all economic events of today, please check out our Economic calendar

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Cohen

Economic

Private credit more than doubled in size from 2019 thanks to interest rate hikes that made its floating-rate debt more attractive to investors. Now, a Federal Reserve interest-rate cut is adding to the headwinds hampering the breakneck growth of the $1.7 trillion industry.

Lower benchmark rates will make fixed income, which locks in returns, more attractive to investors than variable rate. That’s set to become a more pressing issue after the Fed projected further easing later this year.

Regulators also have the industry in their crosshairs after growing concerned about the spillover impact any crisis could have on banks, which provide loans to private credit managers to add more firepower to their pools of investor commitments. On the fundraising side, institutional capital allocations are flatlining, falling oil prices may affect inflows from the Middle East and new US measures could make it harder for insurers to invest in the asset class.

The other big potential threat is a US recession. A soft landing for the economy is the central case, but a deeper slowdown would spell trouble, squeezing the pipeline of money, reducing the appetite for deals and increasing the risk of borrowers failing to repay.

According to Patrick Dennis, co-deputy managing partner at Davidson Kempner Capital Management, defaults in private credit are about 3-5%, partly due to covenant breaches and modifications.

“Defaults are kicking up in all three areas of the market that we focus on,” he said at the Milken Institute Asia Summit Thursday. “From a severity perspective, this is the biggest risk in the market that we’re trying to evaluate.”

Oil Money

Private markets fund managers have been flocking to the Middle East in recent years in an attempt to raise additional capital to deploy. That effort could become more challenging if oil prices continue to slip lower.

“A prolonged spell of depressed oil prices would inevitably weigh on the rate at which institutional investors in the region deploy capital into private markets,” said Cameron Joyce, head of research insights at Preqin. However, he noted there will still be appetite because many private credit allocations are below long-term targets.

One upside to lower rates is that they may encourage more dealmaking, which would provide more opportunity to deploy capital, as long as that’s accompanied by a soft landing that doesn’t lead to widespread defaults.

But there’s competition for business as traditional lenders fight to steal back buyout business after private credit made inroads into that area, which had long been a lucrative source of fees for investment banks such as Goldman Sachs Group Inc. and JPMorgan Chase & Co.

Tougher Scrutiny

In the regulatory area, the Financial Stability Board is examining how private markets interact as part of wider investigations into shadow banking. The European Central Bank is pressing top lenders for details of their exposure to private credit firms and their funds, while the Bank of Japan is also keeping an eye on the links.

“The exposure of Japan’s financial institutions to global private credit funds are increasing, with a concentration towards some big players,” Hirohide Kouguchi, an executive director at the Bank of Japan, said in an article in Eurofi magazine. “We need to remain vigilant,” he added, citing systemic implications.

In the US, new rules from the National Association of Insurance Commissioners that go into force in 2026 will give regulators more leeway to discourage insurance companies from investing in private investments and other assets viewed as excessively risky.

The measures allow the NAIC to effectively assign its own ratings to a wider range of bonds and other securities owned by insurance firms — which could mean stricter assessments. That’s a blow to insurers, which depend on those ratings in order to invest in everything from slices of corporate debt to pools of consumer loans.

To help it with the work, the NAIC plans to enlist outside expertise so it can accurately assess ratings, according to draft documents circulated last month.

The rules are “going to give insurance companies pause in investing in some of the more aggressive forms of rated note structures for private credit or asset based credit,” said Manish Valecha, head of client solutions at Angel Oak Capital Advisors.

Any pullback by insurers would be a blow to direct lenders’ growth ambitions. The average allocation by an insurance firm to private credit has doubled since 2019 to 4%, according to data compiled by Preqin.

Insurance capital has been one of the drivers of private credit markets, although the quality of triple B portfolios, which are popular with that industry, can be variable, according to Dennis.

“If you start to see defaults in those portfolios, you could risk a regulator or regulators overreacting in the other direction which could create some technical market disruption that frankly we would welcome but could create some risk of contagion a little bit more broadly,” he said.

Source: The edge markets

To stay updated on all economic events of today, please check out our Economic calendar

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Blackrock

Economic

It began in mid-July as a rotation away from crowded tech-names into under-owned U.S. small caps. The rotation quickly morphed into something nastier: a broad risk-off trade. While the worst damage was in semiconductor and other tech names, by Monday, August 5th broader equity indices were down close to -10% from their recent peak.

This may beg the question as to why a routine shift in market leadership turn into a rapid and violent sell-off? I believe that several factors contributed, including an abrupt reversal in the Japanese yen, which had been the funding source for many risk trades, as well as extreme crowding in several AI themed names. But the main catalyst was a pair of weak economic prints that raised recession fears. The good news: While the economy is normalizing from an inflated post-pandemic growth rate, a recession (i.e. negative growth) does not appear imminent.

Return to normal growth, not recession

Ironically, market volatility began rising in mid-July coincident to the rotation into U.S. small caps and regional banks. At the time, I was surprised by the move. Buying highly cyclical stocks into a well telegraphed growth slowdown seemed like an odd trade. As it turns out, it did not last long. Investor enthusiasm for riskier stocks quickly dissipated as recession fears rose.

While an economic slowdown is evident in the data, a recession is less certain. The recent ISM manufacturing report was soft, but manufacturing has been struggling since early 2022 and is not a big driver of the current economy. In contrast, the much larger service sector is growing at a reasonable pace, evidenced by the July ISM Services numbers.

Apart from tepid manufacturing, investors were also spooked by recent labor market numbers. While the July headline number was weak, the labor market is normalizing not collapsing. The spike in the unemployment rate was a function of higher labor force participation. Slowing job growth is a reversion to a more sustainable level after several years of above trend growth. The three-month average of net new jobs is around 170,000, consistent with modest economic growth.

Higher volatility underscores need for quality

However, while I think recession fears are overblown, I am sympathetic to investor concerns. Growth is slowing, seasonal factors are turning negative and if history is any guide, the upcoming election could be accompanied by rising volatility.

To be clear, this suggests managing risk exposure not abandoning equities. Stocks had a good run in the first half of the year, but unlike 2023 gains were powered by higher earnings not multiple expansion (see Chart 1). A trend that I think could continue in the second half of the year.

Emphasize Consistency to Navigate Volatility_1

Rather than dramatically reducing equity exposure, I would suggest a two-pronged strategy: trim stocks and moderate cyclical exposure in favor of more stable companies. This approach would suggest emphasizing stocks with consistent fundamentals: stable revenue, earnings and margins. Many of these companies can be found in pharmaceuticals, infrastructure plays tied to energy, as well as software and higher quality consumer companies. Looking ahead, I still believe equity markets can end the year higher, albeit with some volatile days between now and November.

To stay updated on all economic events of today, please check out our Economic calendar

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China's Growth Evolution: Opportunities and Challenges for the Global Economy

Four key trends driving China’s growth over the secular horizon

China’s recent Third Plenum supports continuation of these trends

Implications for global markets

Structural changes will require investors to rethink their approach to China

No Time Like the Present – the Fed Commences Rate-Cutting Cycle

The luxury of lower inflation

The cycle lives on?

Taking what the market gives you – namely income and diversification

'cryptocurrency Industry Will Keep Growing No Matter Who Becomes US President'

Source: Koreatimes

The Federal Reserve Cuts Rates by 50 Basis Points: What It Means for the Economy

Economic Context Behind the Rate Cut

Key Takeaways from the Fed’s Statement

Projections for Future Policy Moves

What Happens Next?

What Investors Are Missing About AI

Is the promise of generative AI overblown?

From a capital markets perspective, would you characterize this as a moment of investor impatience?

What happens if the application just don’t emerge, and AI proves incapable of profoundly changing businesses and the economy?

There’s also a debate about whether AI will benefit the mega-cap incumbents, or if it will displace them.

But ultimately, if AI does prove to be a massive driver of the economy, how much of that value will be captured by tech companies?

Do we generally understand the types of impacts that AI will have at this point? Or are investors and business leaders still making educated guesses?

Is there anything that investors consistently miss about the AI story?

Private Credit is Being Threatened by a Cocktail of Risks

Oil Money

Tougher Scrutiny

Source: The edge markets

Emphasize Consistency to Navigate Volatility

Return to normal growth, not recession

Higher volatility underscores need for quality

Risk Disclosure