When old news reveals future risks, but uncovers new opportunities
By Jim Caron, Managing Director, Morgan Stanley Investment Management
The global economy is slowing – this is old news. The consensus of professional forecasters, including the IMF, have been pointing to a global growth rate over the next few years at approximately 3% since late 2014.
It was also well known that the primary source of the slowdown was driven by weakening economic conditions in China.
What is new news, however, is that, seemingly all of a sudden, the markets started to care about this risk in August and worried what it might reveal about future risks.
These worries have been overplayed in market pricing and it is creating new investment opportunities.
What changed in August to make old news suddenly relevant to the future was the poor handling of the China currency devaluation by the People’s Bank of China (PBoC) and Chinese officials.
The market had previously assigned a smaller risk premia to slowing global growth stemming primarily from China because, as consensus indicated, it believed Chinese policy makers could engineer a soft-landing.
Conventional wisdom suggested that a command economy with highly technocratic policy makers could tweak the knobs and fine-tune stimulus where needed with almost surgical-like precision.
And if all else failed, China had a war chest of over $3.5trn in reserves that could pay for any lingering issues in case their other measures fell short.
Market performance in the month of August told a different story that ran counter to this popular wisdom. August was fraught with volatility that was not just restricted to China but also spilled over into the rest of the world’s risky asset markets.
For instance, from the beginning of August to the trough in that same month, the Shanghai composite dropped 21%, S&P prices dropped 11%, the Nikkei dropped 13%, Euro Stoxx dropped 14%, according to Bloomberg data.