22nd August 2023
From inflation to deflation
The past week has seen the return of deflation, which has been rearing its unpleasant head after more than a year of inflation controlling market performance in Western markets.
Inflation in the West has pretty well-established roots by this point. Pent-up demand skyrocketed after COVID-19, and it took longer for supply chains damaged by the pandemic to catch up. Several goods, including fuel and food, saw price increases due to the conflict in Ukraine.
China’s post-lockdown economic challenges
The Chinese market, however, has had a significantly different timeframe. At the end of 2022, it finally abandoned its own approach to lockdown, known as the zero-COVID policy. While some anticipated this would spark an economic rebound, it instead gave rise to a sluggish worldwide market, with dropping demand in many cases. Youth unemployment increased as China’s housing market, which had been in decline for some years, failed to recover. In fact, China recently suspended reporting its youth employment figure completely.
According to official statistics, China entered deflation in July as consumer prices dropped by 0.3%. While the high levels of inflation in the West may be problematic, deflation can also bring about problems of its own. Long-term deflation may encourage consumers and businesses to curtail spending and output, which could result in more unemployment and slower development.
Negative perception and potential opportunities in China
It’s maybe not unexpected that the Chinese market has suffered for a large portion of this year, given the current negative perception of the Chinese economy. Martin Hennecke, Head of Asia & Middle East Investment Advisory & Comms at SJP, cautions against acting impulsively while analysing the market, though. He notes:
“Very often when sentiment is at its most negative for any particular market due to negative headlines and poor past returns, it can also imply a significant valuation opportunity.
“While a recovery may take longer than anticipated, research by London Business School has shown that there is hardly a correlation between macro-economic growth and stock market movements, given that markets are anticipatory in nature. And just like during prior general market crises (for example, the 2008 financial crisis and the COVID-19 crisis), markets could rally back well before a normalisation of the economy. And it is not actually all only negative: Starbucks, Yum brands and Apple all reported strong China earnings rebounds in Q2. However, positive news is being mostly drowned out, for now.”
UK and US markets struggle amid Chinese concerns
Markets outside of China struggled last week, in part due to concern that the poor Chinese data would extend to other economies. The S&P 500 dropped 2.1% and the NASDAQ dropped 2.6% in the US.
An increase in US treasury yields can also be used to explain some of this fall. These sometimes have an inverse relationship with equities so therefore move in the opposite direction. Yields benefited from some economic data that came in stronger than expected, particularly industrial production and retail sales, which raised expectations that the US economy would escape a recession despite the Federal Reserve’s (Fed) rate-hiking cycle’s rapid pace.
The UK’s FTSE 100 fell 3.5%, lagging behind its international counterparts. Last week, headlines pointed to falling headline inflation, but obscured the fact that core inflation (which removes more volatile areas like fuel) remained flat. As a result, there is a higher chance that the Bank of England may raise interest rates again in the future.
The limited global impact from China’s slowdown
Neil Shearing, Group Chief Economist at Capital Economics, cautions that some may be overestimating the effect that a Chinese slowdown may have on the global economy, even while Chinese troubles may have contributed to some of these market difficulties:
“Markets are again getting worried about what a downturn in China means for global growth. But these concerns are based on fundamental misunderstandings about how much influence China’s economy has over the global cycle. Absent a crash, China’s slowdown is more a problem for those multinationals and emerging markets that do most business with it than a threat to the global economic outlook.”