Wednesday, 4 November 2015

Several of you have asked us for more market updates on this blog. In response we’re sharing with you some of the commentary we regularly provide our Investment Committee. This commentary is reflective. That is, taking as a starting point that the future is unknowable we consider a range of possible outcomes and how each may impact the portfolio. While ultimately we take a central view, we remain alert to and monitor the full range of risks as they evolve.

By sharing this we aim to give you an insight into what we’re thinking about and how we manage the various forms of market risk within the portfolio on behalf of you, our members.

In recent months markets have been concerned about the outlook for China and the rest of the emerging markets and how that could translate to developed markets. Economic data show that this phenomena is primarily presenting itself as a contraction in global manufacturing and trade (Figure 1).

Figure 1: Global manufacturing surveys1

Outside of Europe (which is recovering from a very low base given its multi-year downturn) and India (which is benefiting from reform related growth), manufacturing across the globe is largely in contraction. In contrast, the global services sector, which accounts for the majority of activity and employment (particularly in developed economies), remains robust (Figure 2). However, the pace of expansion in services activity is slowing in a number of countries (including the USA). 

Figure 2: Global services surveys1

 

The key to the outlook is whether:

  • This contraction in global manufacturing, led by emerging markets (and China in particular – which is also facing a slowdown in investment growth), will spill over into developed markets.

Or

  • The slowdown in China represents something more systemic and likely to lead to a hard landing, with global financial market spill overs.

We think that if the systemic case doesn’t eventuate (that is, China avoids a hard landing and is simply slowing), the portfolio and the global economy should remain robust to the emerging market slowdown. This also remains our central case.

A slowdown in manufacturing and investment in China is consistent with Government policy. Chinese authorities are trying to transition the economy towards more sustainable services led growth. By design, this necessitates less growth in the ‘old China’ (manufacturing and construction). In net terms, this will also result in slower global growth, particularly in emerging markets. Fortunately, we also think we are closer to the end than the beginning of this process. Much of the emerging world has already seen growth slow sharply. Also, partly offsetting this, we expect growth in Europe and Japan to strengthen in 2016. As a result, our central case marks 2015 as the trough of global growth. Also there are positive signs that Chinese activity is beginning to respond to previously enacted stimulus and thus could be easing the pace of economic consolidation. 

That said, we maintain a very keen eye on the risks to this outlook and think they are more elevated than usual. China remains our main concern. There are signs of significant overbuilding in the residential sector, growth is slowing and debt levels have more than doubled since 2009. There seem to be pockets of vulnerability within the economy and its opaqueness makes assessing the outlook extremely difficult. We are concerned that a residential downturn will manifest into something larger.

The potential impact on US (and global) economic growth from likely higher interest rates this year also presents a risk. While we don’t think modestly higher rates will derail the economy, the sheer period of time since policy has been tightened leads to some concern. Also, politics in the US is re-emerging as a potential tail issue, with the debt ceiling due to be debated again by the end of this year.

Our Balanced portfolio remains relatively defensively positioned and as such, has continued to perform comparatively well in the difficult market environment. If markets continue to suffer weakness, we will likely consider adding incremental risk to the portfolio, although valuations would have to improve materially before we moved to add significant risk. If market outcomes were to continue to worsen from here, we remain positioned to protect member outcomes. 

If you’re interested in learning more about these sorts of topics, we publish economic and financial commentary on a quarterly basis. Take a look at the Market updates section of our website for more.

1 Based on the latest data at 30 September 2015.

The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and you should get professional advice before relying on this information.

Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.