THE BRIE

E FF

September
2015
| Volume
October
2014
| Volume
2 12

T H E B R I E F offers a succinct round-up of key macroeconomic themes and recent geopolitical developments, with insight from our investment teams.
Events in China dominated headlines in

The build-up of negative sentiment around

The dataflow from Japan has been relatively

August and heavily impacted markets

China, coupled with surprise announcements

disappointing. Second-quarter GDP

around the world. Are there any positives

from policy makers, led to Black Monday on

contracted 0.4%, consumer sentiment has

to be taken from the turmoil?

24 August, when global equity markets sold

deteriorated, core CPI slowed to 0.0% in

off heavily. Emerging markets were the worst

the 12 months to July 2015 and industrial

affected, and are now trading at multi-year

production declined. Policymakers face some

lows. However, we believe the authorities in

tough decisions if prime minister Abes three

China are committed to their reform path.

arrows approach is to succeed.

momentum be maintained in light of the

Meanwhile, the US is materialising as an

Global demand for oil remains

challenges in emerging markets?

economic bright spot. Its economy registered

robust, but it has been insufficient

growth at an annualised rate of 3.7% for

to balance the market as supply

policy setting has not yet resulted in the

the second quarter of 2015 far surpassing

continues to remain stubbornly strong.

economic growth Japan is seeking. How

the initial estimate of 2.3%, while further

Though inventory levels are high, there

realistic are Japans targets and does the

positives can be taken from the health of the

is very little spare production capacity

Bank of Japan need to rethink its policy?

domestic housing market. The euro zone,

any supply-side shock could have a

too, is showing signs of promise, with recent

significant impact on the price.

The US consumer remains resilient,

although the manufacturing sector is
showing signs of weakness, and the euro
zone is holding up relatively well. Can this

Shinzo Abes three arrow approach to

The oil market is still volatile and in limbo.

Opec production is at near record highs,

economic data surprising to the upside.

but US production has started to decline.

Are there any more supply shocks to come?

The content of this report is intended for professional investors and those with a sophisticated knowledge of financial markets
(e.g. financial journalists, academics etc.) and should not be relied upon by anyone else.

THE BRIEF

September 2015 | Volume 12

China: Looking beyond fears of a slowdown

The principal driver of global market volatility

orientated daily fix, with the PBoC spending

and attain SDR status for the renminbi, which

in August was developments in China. On 11

a record US$94 billion in reserves over August

will require the currency to be more market

August the Peoples Bank of China (PBoC)

trying to maintain the renmnibis value.

driven.

surprised the market by effectively devaluing the

currency through announcing changes to the

What are we to make of all this?

daily fix to the US dollar, in an effort to make

The U-turn on equity market intervention (after

the currency more market-driven. This decision

US$200 billion had been spent failing to prop

was partly attributed to policymakers ambitions

up equities) and the PBoCs contradictory

of having the currency included in the IMFs

behaviour on the exchange rate has taken its

Special Drawing Rights (SDR) basket, and partly

toll on the credibility of Chinas policymakers.

seen as a competitive devaluation to support

However, we believe the view of the

economic growth. This acted as a lightning rod

omnipotent Chinese bureaucrat was always a

for long-held concerns that Chinese growth had

fiction. While this lack of policy coherence is a

been built on credit and that a smooth transition

cause for concern, we remain of the opinion

to a consumer-led economy would be hard to

that the authorities will not change their

achieve. Fears of a slowdown in China therefore

reform path in any meaningful way. Perhaps

led to significant volatility in global equity,

it is a healthy development that markets

commodities and currency markets.

no longer view Chinese bureaucrats as

infallible and it should be noted that Chinese

The result was to accelerate capital outflows,

driving equities lower and leading to a significant
tightening in liquidity. Policymakers subsequently
cut interest rates and reserve requirements to
bolster liquidity, which helped to ameliorate
markets. Subsequent PBoC actions showed the
extent to which the authorities were prepared to
support the currency despite the more market

policymakers have a long history of tampering

and experimenting with policy. The changes to
exchange rate policy should be viewed within
this prism. While the central bank has plenty
of ammunition (reserves stand at US$3.6
trillion) to continue intervening in the FX
market, over the longer term authorities are
still on track to liberalise the current account

It is important to remember that economic

fundamentals are largely unchanged: the
Chinese economy continues to gradually
rebalance towards consumption and less
commodity-intensive growth as demonstrated
by PMIs showing an expansionary service
sector activity and contractionary manufacturing
activity. It should also be noted that we
are seeing some indicators turning more
positive, helped by fiscal and monetary action.
Government spending on fixed asset investment
has recently ticked higher, implying higher
infrastructure spending. Meanwhile, monetary
easing has helped support a recovery in money
and credit supply growth and property sales
growth has also improved.

THE BRIEF

September 2015 | Volume 12

The US and euro zone: Lands of promise?

Figure 1: US housing market - prospective buyer traffic

Yellen pointed to signs that recent shocks to

80

global markets may restrain US economic

70

activity somewhat, though most policymakers

60

still forecast a rate rise before the end of the

50

year. What can be gauged with greater certainty,

40

however, is that the pace of any tightening

30

will be gradual. Furthermore, recent FOMC

20

minutes make it a distinct possibility that the

10

Fed will reduce reinvestment from purchased

May 2015

Sept 2014

Jan 2014

May 2013

Jan 2012

Sept 2012

May 2011

Jan 2010

Sept 2010

May 2009

Jan 2008

Sept 2008

May 2007

Jan 2006

Sept 2006

May 2005

Jan 2004

Sept 2004

May 2003

Jan 2002

Sept 2002

May 2001

Jan 2000

Sept 2000

Source: National Association of Home Builders, Housing Market Index, September 2015.

mortgage backed securities as another means

of tightening credit conditions.
Despite Augusts disappointing non-farm
payroll figure (173,000 new jobs were created
in August, fewer than expected), the labour

Amid mounting concerns over the health of

However, deflationary pressures, as captured

the global economy, the US has stood out as

by Julys year-on-year CPI figure of 0.2% persist

a relative economic bright spot. Its economy

- although core CPI (1.8%) is approaching the

registered growth at an annualised rate of 3.7%

Feds mandated target of 2%.

for the second quarter of 2015 far surpassing

the initial estimate of 2.3%. If preceding
months were synonymous with contrasting
fortunes between the US and the rest of the
global economy, August epitomised the very
dilemma facing the Federal Reserve (Fed). With
its economic recovery gaining pace, one side
of the Feds dual mandate has been satisfied.

market continues to tighten steadily and

US unemployment now stands at 5.1%.
Wage progression has been weak, however,
contributing to lower inflation. Further positives
can be taken from the health of the domestic

Following the meeting of the Federal Open

housing market, with prospective buyer traffic

Market Committee (FOMC) on 17 September,

almost returning to pre-crisis levels as shown

Fed Chair Janet Yellen announced that the rate

in Figure 1. This has supported a significant

hike many were expecting would be postponed

recovery in house prices and the number of

yet again. The dollar dropped on the news and

monthly housing starts as illustrated in Figure 2.

US Treasury yields rallied. In a statement that

contained some unexpectedly dovish signals,

Positives can be taken

from the health of the
US housing market,
with prospective buyer
traffic almost returning
to pre-crisis levels

THE BRIEF

September 2015 | Volume 12

The euro zone has similarly been showing signs

Figure 2: Case Shiller Home Price Index

of promise, with a string of solid PMI figures

220

complementing a consensus beating second-

200

quarter GDP figure; economic activity within the

180

region grew at an annualised rate of 1.5% during

the quarter, with Germany performing particularly

160

well. Moreover, it has been argued that the boost

expected from lower oil prices is yet to translate

140

fully into increased consumer spending, and

120

comments from the European Central Bank (ECB)

Source: Bloomberg, September 2015.

May 2015

Sept 2014

Jan 2014

May 2013

Sept 2012

Jan 2012

May 2011

Jan 2010

Sept 2010

May 2009

Sept 2008

Jan 2008

May 2007

Sept 2006

Jan 2006

May 2005

Jan 2004

Sept 2004

May 2003

Sept 2002

Jan 2002

May 2001

Sept 2000

Jan 2000

100

strongly suggest accommodating policies may

be expanded. Taking account of the slowdown
in China, emerging market headwinds and the
impending US rate hike, ECB staff conceded
that next years growth projection could be 0.2%
lower than previously thought. Consequently,
Mario Draghis monthly statements have become
increasingly dovish of late, alluding to the openended nature of the ECBs quantitative easing
programme, which was initially meant to end
in September 2016. While negative headlines
emanating from China continue to dominate,
US strength and a more pronounced euro-zone
renaissance can offer global bulls more than just a
glimmer of hope.

US strength and a
more pronounced
euro-zone renaissance
can offer global bulls
more than just a
glimmer of hope.

THE BRIEF

September 2015 | Volume 12

Japan: Fake it until you make it or move the goal posts

The Bank of Japan (BoJ) has remained

and energy, held level at 0.6%, while labour

stave off deflation. The monetary base has

to the BoJ are perhaps as limited as they are

steadfast in achieving its goals. Demographic

markets appear somewhat tighter, with falling

expanded with lower real rates and a weaker

unconventional. Aside from cutting interest

challenges, ingrained cultural attitudes and

unemployment and healthy job opening-

yen; fiscal policy has been revamped with a

rates into negative territory, many of the other

policy measure constraints have often been

to-applicant ratios. Services purchasing

consumption tax hike and corporate tax cuts,

options involve quantitative easing (QE); for

disregarded by policymakers rightly or

managers indices also rose to their highest

and reforms have helped in improving the

example, extending the duration of JGB

wrongly in a bid to pump inflation higher

level since October 2013. Ultimately, the

female participation rate in the labour market.

purchases or buying ETFs.

and drive the economy forward. Reasons

overall economy has not prospered as some

However, the real economy remains weak with

for optimism have often surfaced, only to

might have hoped and economic headwinds

meagre export growth and sluggish industrial

prove short-lived, with inflation at one stage

remain.

production, while inflation is below its 2% target.

The slowdown in China and its repercussions

We believe monetary policy is losing its

Japanese companies are still reasonably priced.

for other Asian economies, is a notable

marginal punch. More work should be done

Company level fundamentals are strong, with

challenge to Japans export industry. Not only

with the second and third arrows of fiscal

relative earnings growth created by operational

do they represent significant trade partners, but

stimulus and structural reform, respectively.

gearing and margin improvement translating into

as August has shown, expectations of further

A reliance on a weaker yen is not the

stronger earnings revisions. Furthermore, there

weakness can trigger a global risk-off event

solution and should be considered alongside

is incremental evidence of improving corporate

and cause the yen to rally given its safe haven

a broad array of tools. The BoJ governor

governance and a willingness to return capital

status. The pass-through from a weakening

Haruhiko Kuroda should also be cognisant

to investors. Stimulative monetary policy is a

approaching 2% and economic growth

seemingly firing on all cylinders, only to
fall away again. Now the economy faces
challenges on both a domestic and global
level, and the BoJ faces a question of whether
to continue to pursue what are arguably
unrealistic goals, or shift the goal posts and
accept the harsh realities facing them.
The dataflow from Japan has been relatively

While the current slowdown in the domestic

economy is a cause for concern, we believe
that the growth opportunities presented by

yen to stronger exports has been tenuous as it

of the implications of continued Japanese

positive for equity markets, especially if future

disappointing. Second-quarter GDP

is this by no means helps. A strengthening yen

Government Bond (JGB) purchases, which

QE takes the form of ETF purchases. Finally,

contracted 0.4%, consumer sentiment has

also serves to exert further downward pressure

we believe are not only threatening to make

domestic equity flows provide structural support

deteriorated, core CPI slowed to 0.0% in the

on inflation which has already been dragged

the market dysfunctional, but also starting to

for the market with the GPIF (Government

twelve months to July 2015 and industrial

lower by oil price weakness.

reach a practical limit. Furthermore, the 2%

Pension Investment Fund) and other pension

CPI target is clearly unrealistic. This should

funds increasing their allocations.

production declined. However, much of this

might be shorter-term noise and some of the
data has been positive. Core-core CPI, which
strips out volatile items such as fresh food

To some extent, the Abe administration has

fulfilled its promise to execute its three arrow
approach to help grow the economy and

be reviewed, or even perhaps changed to

Japans core-core CPI measure, especially in
light of current oil prices. The options open

THE BRIEF

September 2015 | Volume 12

Oil market still in limbo

The oil market remains in limbo with signs

However, while global demand remains robust,

of increased oil price volatility evident

it has been insufficient to balance the market

33000

between the end of August and beginning

as supply continues to remain stubbornly

32500

of September. While sentiment towards the

strong, with both Opec and many non-Opec

32000

sector has plummeted, and market dynamics

producers maximising production to increase

31500

continue to change, there has yet to be a

cashflow. While US production is slowing, Opec

significant pull in either direction to have

production through July and August remained

a material effect on the underlying supply/

near record levels, as shown in figure 3 (though

demand dynamics.

350,000 barrels per day (bl/d) below June). The

possible to grow inventories of refined

products like gasoline. Now the refining
system is feeling the pressure; fires and

products increased by approximately 750,000

bl/d in July.

29500
29000

31 Aug 2015

31 Jul 2015

30 Jun 2015

31 May 2015

30 Apr 2015

31 Mar 2015

28 Feb 2015

31 Jan 2015

31 Dec 2014

30 Nov 2014

31 Jan 2014

30 Sept 2014

31 Aug 2014

31 July 2014

30 June 2014

31 May 2014

30 Apr 2014

28500

31 Mar 2014

suggests that OECD inventories for crude and

30000

31 Jan 2014

Report from the International Energy Agency)

30500

28 Feb 2014

at close to full capacity, it has not been

31000

31 Dec 2013

Even with the global refining system working

oversupplied: the latest data (August Oil Market

Millions of barrels per day (000)

From the demand side things look better.

aggregate effect is that the oil market remains

Figure 3: Opec production

Source: Bloomberg, September 2015.

With global oil production exceeding demand,

market, not to mention all the other countries

the price of oil has been under pressure.

that will exhibit decline within that same period.

But with demand at an all-time high and US

However, it has not been easy to anticipate

production already having declined, where will

or account for the speed and rate of decline

the additional rebalancing needed to close the

in US production to date and the possibility

output gap come from? While there are many

of marginal producers coming back on line, in

roads that could lead to reduced global supply,

response to any modest recovery in oil prices,

on current trajectories it seems most likely that

is still alive albeit the probability is diminishing,

further declines in US production could play a

the longer rigs and equipment lay idle and

suggest: apparent oil demand grew 8% year-

leading role in narrowing the gap. An adjustment

skilled labour remains out of work.

on-year in July, up from 4% in June, bringing

from +1.5 million bl/d growth to -0.5 million bl/d

year-to-date total demand growth to 6%

in the US alone would be enough to balance the

unplanned downtime are on the increase

which should ensure stronger-than-normal
refining margins and relatively strong demand
through the traditionally quieter shoulder
season (the period between peak northern
hemisphere summer and winter fuel demand).
Chinese demand for crude oil has been more
robust than the local equity market would

(source: Cornerstone Analytics).

Chinese demand for

crude oil has been
more robust than the
local equity market
would suggest

THE BRIEF

September 2015 | Volume 12

We note that while inventory levels are high,

Iran has also been a major concern for

Furthermore, the recent Opec bulletin, which

there is very little spare production capacity.

energy investors. The Iranian oil minister will

was released on 31 August, provided a

The flip-side of Opec countries maximising

see several interviews in July and August

boost to short-term oil price sentiment. There

short-term production to pressurise higher

consistently stating that oil production will

have recently been calls from fiscally-weaker

cost producers is that the buffer of untapped

increase by 0.5 million bl/d immediately after

member countries (Venezuela, Algeria) for an

'potential' production is almost non-existent,

the imminent lifting of sanctions, and by 1

emergency Opec meeting the next official

which increases the vulnerability of the global

million bl/d a few months (or weeks in one

meeting is in December and the bulletin

supply system to outages, interruptions

interview) thereafter. In reality it is unlikely

suggested that the group as a whole might

and geopolitical events and may interrupt

that we will see sanctions lifted until there

be reviewing its stance. Separately, Russian

the global flow of crude oil. What further

has been verification of Irans commitment

president Vladimir Putin and his Venezuelan

measures, if any, can a Saudi-led Opec take

to comply with the agreement, and the

counterpart Nicolas Maduro are reported

to intervene if such shortages arise?

earliest this can happen is at the International

to be discussing possible mutual steps to

Atomic Energy Agency meeting this coming

stabilise global oil prices during a visit to

December, so production is unlikely to impact

China at the beginning of September.

In recent years the Saudis have increased

production every summer in order to maintain
export levels at a time when domestic
demand peaks, due to increased use of air
conditioning. Reports suggest that the Saudis
have turned away bids for further crude
exports this summer, suggesting they are
producing close to capacity. With the Saudi
oil rig count down 12% since April, we would
expect production rates to decline as Saudi
fields go into maintenance this autumn.

the crude market in 2015, in our view. In

Iraq, lower oil prices have led to a 50% drop
in the rig count since June 2014. We remain
unconvinced that Iraq will be able to continue
production at their current levels. Additionally,

While global oil

demand remains
robust, it has been
insufficient to balance
the market as supply
continues to remain
stubbornly strong

Our base case remains that Opec does not

cut production, but the oil price risk remains
significantly to the upside if Opec either agree to
a cut, or have any significant production outages.

we observe that many analysts fail to consider

production changes outside the US, Saudi
Arabia, Iraq, Iran and Libya. Given that the
remainder accounts for two thirds of the
global crude market, it would be surprising if

Click here for further

market views

production figures do not disappoint towards

the end of 2015 and through 2016.

Click here for long-term views

from the Investment Institute

23091-09/15

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