Risk assets enjoyed welcome and big gains last week, after the sharp falls in their value through much of Q3 2015. The falls in value through Q3 seemed to be driven mostly by a softening global economic growth outlook and specific concerns about the US interest rate outlook and fading economic growth in China. The fact that many major share markets, especially China’s share market, started Q3 priced for strong to exceptionally strong growth in earnings left them ripe for a sell off. The strong bounce in share markets and risk assets in October so far may just reflect that the sell down in Q3 went too far, or it could reflect that the global economic growth outlook is not as negative as widely feared in Q3. Depending upon which explanation of the bounce in share markets is closer to the mark is likely to determine whether the early October rally continues or gives way again.
In the immediate term, the relative strength of the economic data coming out of the US and China may cast a little light on which explanation seems more credible. Out of the US two quite important September economic readings will be released later this week, September retail sales and industrial production. If the US economy is starting to gather more growth momentum it has to show through in rather stronger growth in retail sales than has been evident so far in Q3. Retail sales started the quarter on a relatively firm note lifting by 0.7% in July, but then followed up with a less than impressive 0.2% gain in August. The market consensus forecast for September is an even less impressive 0.1% improvement.
Despite strong US employment growth (although even that is less robust than it was earlier in the year with non-farm payrolls showing sub 150,000 gains in both August and September while averaging well above 200,000 earlier) US consumers still appear relatively cautious about spending. The US economy needs stronger consumer spending to outweigh the parts of the economy that are weakening. Industrial production falls in this category, our second important US economic reading due later this week. Rather like retail sales, industrial production started Q3 on a positive note, up by 0.9% in July, but then fell by 0.4% in August and is expected to fall a further 0.3% in September. Manufacturing purchasing manager surveys have taken a much weaker turn in August and September heralding even weaker industrial production in the months ahead.
The balance of strength in the US September retail sales and industrial production readings – including revisions to earlier months – should provide a small clue to whether US economic growth is holding up or fading. If US growth is fading, as seems more likely to us, it can temporarily provide balm to troubled markets by delaying when the Federal Reserve starts to lift its Funds rate, but the benefit from rates staying lower for longer is likely to be short-lived this time around, implying as it does a weaker US economic growth outlook and at a time when the global growth outlook is troubling too.
In terms of the troubling global global growth outlook the focus in markets remains squarely on China. Over the past week or so the balance seemed to move slightly in favour of optimists concerning China’s economic outlook – GDP growth basing near 7% in Q3 2015 with prospect of mild improvement in Q4 and beyond – rather than pessimists looking for a hard landing with the authorities floundering in their policy response.
Over the next week just about every September economic reading of any consequence plus Q3 GDP will be released in China. Among the September readings exports and industrial production are still likely to be quite weak. Exports are expected to fall 6.6% y-o-y after falling 5.5% in August while industrial production growth may ease to a 7-year low point of 5.9% y-o-y from 6.1% in August.
In contrast, greater budget spending should start to show in relatively stable urban fixed asset investment spending, around 10.8% y-o-y from 10.9% in August while the rebalancing of growth drivers in China’s economy should show through in retail sales edging up again to 10.9% y-o-y from 10.8% in August. All important Q3 GDP growth may slip below 7% to around 6.8%, but it is unlikely that it will come in much lower than that.
On balance, there may be just enough in China’s economic readings to support the optimists. Having said that, it is unlikely in our view that the numbers will be strong enough to temper views that global economic growth is likely to remain slow for some time.
Approaching economic readings out of the US and China seem likely to provide limited support at best for the global rally in shares and risk assets so far in October. Best to treat the rally as a short truce in the selling that prevailed through Q3. Interest rates, in contrast, look set to fall further.