MARKETS

Global markets have recently experienced a series of stumbles due to concerns about China's economy and higher sovereign bond yields. Last week the S&P 500 dropped 2.1 %, worryingly, with every sector ending in the red. Banks faced a significant decline of 5%, while consumer stocks only did slightly better. Earnings reports were mixed; Walmart raised its outlook but hinted at the potential strain on discretionary spending, whereas Target revised its guidance downwards.

We are also receiving a timely reminder of the market concentration risk the Technology sector poses. Last week, several prominent stocks within the S&P 500, such as GOOGL, TSLA, META, AMZN, MSFT, AAPL, and NVDA, all underperformed compared to the broader market index. This dip in performance is attributed to the recent surge in interest rates, with yields on 10-year US Treasuries concluding the week at 4.25%. This upward rate movement has exerted downward pressure on longer-duration assets with longer-duration assets.

In recent months, stocks have bounced back as investors continued to buy the dip despite initial pessimism at the start of 2023 due to concerns about a possible recession. The economy has shown resilience, which has led to an improvement in sentiment. Many indicators suggest a bullish sentiment, with the Investors' Intelligence Survey showing bullish sentiment at over 55% compared to bearish sentiment at under 20%. This is a significant change from late 2022, when the opposite was true.

But investors are currently facing a challenge of a different sort with increasing, not decreasing, bond yields. The 10-year Treasury yield has gone up to 4.3%, causing the gap between earnings yields and bond yields to narrow. The S&P 500's forward earnings yield is around 5.4%, resulting in a difference of only a little over 1 percentage point compared to 10-year Treasuries. This change has effectively eliminated the significant gap during the past decade when rates were ultra-low. Although this may indicate overvalued stocks, it is essential to note that this difference was typically between 1.5% and 2.5% before the financial crisis.

These are indeed unusual times within this stage of the cycle. Usually, when the market sniffs out a peak in official rates, longer-term rates tend to decrease gradually in anticipation of forthcoming cuts in those rates. However, the current situation appears to differ, with the most noteworthy shift, however, has been the diminishing expectation of numerous rate cuts. This evolving outlook, which foresees fewer future rate cuts, has contributed to the ongoing trend of higher longer-term rates.

CHINA

Renewed apprehensions regarding China's economy have come to the fore. These concerns were prompted by a set of economic data for July that fell below expectations. Metrics such as retail sales, fixed asset investment, and industrial production displayed signs of weakness. Additionally, notable events unfolded, including payment defaults by a significant homebuilder (Country Garden) and a prominent trust company (Zhongrong International).

While these developments may not be entirely surprising, they have rekindled fears about the ongoing deterioration of China's housing market instead of a recovery, potentially leading to heightened risks to financial stability.

Furthermore, mounting unease surrounds the adequacy of China's efforts to support its economy. However, it's important to note that Beijing is unlikely to employ a sweeping fiscal stimulus akin to the Bazookas utilized during the Global Financial Crisis. I suspect policymakers believe there is no one-size-fits-all solution for reigniting economic growth as in yesteryear.

Even if the authorities unveiled a large-scale stimulus program centred on cash transfers or new infrastructure projects, it would not offset the economy's multifaceted challenges. These include pressures from the debt buildup (local government and corporate) over the last decade; the escalating trade war with the U.S.; 2021's tech/regulatory crackdown; and the ongoing property crisis.

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