China, US, a moment of truth – Carmignac

In his latest market comment, Didier Saint-Georges (pictured), member of Carmignac’s investment committee and managing director of the firm, considered markets’ current situation as a moment of truth.

Renminbi’s devaluation by the Chinese government in August hides bigger issues involving major transitions both Fed and Chinese authorities try to undertake, he said.

“The crux of the matter is more complicated and also more explosive. It lies in the collision between the United States’ general transition away from the emergency measures that began in 2009, and China’s steadfast aim to overhaul its economy and open up its capital markets,” he summed up.

As an immediate risk for developed economies, Saint-Georges highlighted “a sharp decline in China’s balance of payments” rather than an aggravated slowdown in the country.

“The Chinese economic slowdown is well known and data published in August (industry, exports, investment) merely confirms the trend. What is less known is how fast the economy is rebalancing, with services already contributing over 15% more to GDP than industry.

“This economic restructuring is especially painful for China’s trade partners, who understandably must feel like a hard landing what we estimate is an economic deceleration down to around 5% per year (consumer spending on its own is growing by some 10%, and e-commerce by 38%),” Saint-Georges stressed.

Carmignac’s managing director also reminded that “economic slowdown and tighter liquidity conditions do not sit well together.”

“What makes the whole edifice particularly unstable is that the global financial system’s monetary stimulus since 2009 has seen financial asset prices rise sharply in value, but has not produced any more than a very modest rate of growth for developed economies,” he said.

“So as the markets’ liquidity relief is threatened, the Chinese slowdown, which is preventing global growth from picking up, is making asset prices vulnerable. It is also clear that central banks’ flood of liquidity has not taken inflation rates any further away from danger in the developed world,” Saint-Georges added.

What to do then in the current high volatility context ?  A significant reduction in exposure for all asset classes (equities, bonds, currencies) is justified as the risk of global liquidity conditions swinging is real, explained Carmignac’s managing director.

“Indeed, we have to bear in mind that any further dip in growth and resurgence of deflationary pressures would be incompatible with a still over-indebted world.”

“In our view, it would currently be very myopic to bet on a cyclical upswing. On the other hand, in a world in which companies able to generate strong earnings growth will be rarer than ever, selecting such champions – who are often global leaders in sectors with very high value added – could make all the difference in performance relative to turbulent stock indices.

“An extremely careful selection of corporate issuers could also be a source of absolute performance in the bond universe,” Saint-Georges commented.

Carmignac’s managing director concluded his note by referring to one of markets’ main challenges. He said that “whatever happens, an historic opportunity lies ahead for active management to prove its worth over passive management.”

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