The Week In Hindsight, 24 January 2014

Chinese GDP topped forecasts on Monday with the rate of growth in the economy slowing less than analysts initially expected. Overall GDP came in at 7.7% VS a forecast of 7.6%.

Despite the positive growth news, global equity markets sold off sharply on Thursday as it became clear that Chinese manufacturing activity had contracted significantly during December. Close on the heels of this release was US housing data indicating a potential slow down in the sector which added to selling pressures throughout the day.

Despite the behaviour of developed market stocks, Chinese equities continued to recover during the final stages of the week following almost two months of heavy losses.

When it comes to China, most analysts will admit to an ever present feeling of discontent over growth prospects for the economy however, one area where there does tend to be a consensus belief is on the subject of valuations.

Chinese equities are cheap on a valuation basis and have been for some time. This has lead most analysts to believe that in amongst the heap, there is value to be found somewhere. This philosophy has contributed to bullish forecasts for Chinese stocks during 2014 and could still prove to hold some weight.

However, concerns do still exist when it comes to the Chinese investment case. These concerns centre on growing debt levels within the economy, particularly at a local government level. Large debt burdens, steady increases to funding costs, rising debt delinquencies and a slowing economy can present significant risks, not just to financial firms but the financial system and economy as a whole.

Such dynamics pose significant risks to the retail investor looking for an entry into China and will also require ongoing oversight on the part of policy makers. For these reasons and given current market conditions, our view is that the forecast Chinese growth story for 2014 is one best observed from a safe distance, for the time being at least.

SSE Composite Index

Emerging market currencies plunge following collapse of the Argentine peso

Despite concerns over the outlook for Chinese growth, the real driver behind weakness in global financial markets on Friday was a rampant sell off in emerging market assets, which began with a violent collapse in the Argentine peso.

USD/ARS (US dollar VS Argentine peso)

After posting a significant drop during Thursday’s trading, the peso entered free fall on Friday causing the currency to shed nearly 15% of its value relative to the US dollar.

The violent price movement in the peso also sent other emerging market currencies into a spiralling decline. This saw the Turkish Lira reach a record low against the dollar while the Brazilian real, Russian rouble and Indian rupee each suffered, along with other emerging and frontier market currencies.

The past two days have formed an extension to a trend that has been developing in emerging markets since the summer of 2013, when the FOMC first outlined intentions to taper off its asset purchase program.

This move was viewed as heralding the beginning of the end for an era of ultra low interest rates in developed markets. It also helped to push US and UK 10 year yields above 3%. Given that yields have improved in the west, along with genera economic conditions and now that political instability and civil unrest continues to be a predominant theme across developing nations; the incentive for investors to hold emerging market assets is greatly reduced.

As a result, emerging markets have experienced record levels of capital flight during the final half of 2013, as international investors have called time on their exposure to these economies. This has placed strong and ongoing downward pressure onto emerging market currencies which has, in turn, exacerbated their existing economic woes. A number of governments have responded positively to the recent developments through relaxing capital controls and by pledging direct intervention in the FX market to prop up the value of their respective local currencies, however, these moves are merely a temporary pain killer.

The permanent cure involves a program of both fiscal and economic reform which is likely to come with a wide array of bitter tasting medicines. For this reason, the general consensus at present is that economic conditions are likely to get worse in emerging markets before they begin to get any better.

ARS/EUR (Argentine peso relative to the euro)

US DOLLAR / OTHER EMERGING MARKET CURRENCIES.  (INDIAN RUPEE, USD/INR – BLACK), (BRAZILIAN REAL, USD/BRL – GREEN), (RUSSIAN RUBLE, USD/RUB – BLUE)