China’s Market Volatility, Delta Variant, Modest Risk
The major stock indexes all finished higher in August with solid company profits, ongoing economic recovery, and still-accommodative Fed offsetting concerns over the Delta variant spread. The tech-heavy Nasdaq Composite index (4%) outperformed the broad market S&P 500 Index (2.9%) and the Dow Jones Industrial Average (1.2%).
The resurgence of the Delta coronavirus variant seemed to weigh on the market’s sentiment throughout the month. Our propriety COVID model is now indicating a lower score, driven by modest declines in high-frequency signals across several categories, such as mobility trends, consumer spending, and financial market data. Nevertheless, we remain skeptical about the risks of a significant tightening of restrictions in the U.S. We may able to see the peak in Delta variant cases as the effective reproduction number (Rt) is declining in more than 40 states. In our view, the more acute risk is the potential re-intensifying supply chain pressures induced by the renewed lockdowns in China and Asia. Port closures could also increase shipping costs and boost U.S. inflation. Over the last two weeks, however, restrictions are starting to be lifted gradually and the suspended ports are reopened ahead of schedule, as new domestic COVID cases fell to very low levels in China. As a result, we haven’t materially changed our cautiously optimistic view that supply-side shortages will likely ease in Q4.
August also witnessed a steep fall in the Chinese equity market amid softening economic data and the regulatory clampdown on technology and education sectors, raising concerns about the risks and outlook for investing in Chinese equities. It’s not surprising for us to see emerging signs of economic slowdown in China, since China was the first major economy to bounce back from the pandemic last year. Headline PMI slipped to 50.4 in July. Rising producer price inflation (PPI: 9.0%) and moderate consumer price index (CPI 1.0%) indicate that higher input costs are cutting into profit margins, particularly for small and medium-sized manufacturers. At the same time, the recent market’s response to a series of regulatory actions has certainly been abrupt and severe. While we don’t expect the regulatory changes to end soon, we view these policies as redefining the role of capital against the objectives of common prosperity, which will likely foster more business opportunities and competition, boost domestic demand and strengthen the overall economy in the longer run.
Moving forward, the potential for a slowdown in China and the recent resurgence of the Delta variant are feeding concerns that economic growth may have peaked. We still hold our view that peaking growth momentum doesn’t mean the economy won’t do well through the rest of this year and beyond. As we indicated in August’s Navigator, the ISM manufacturing index fell below 60 to 59.5, with falling inventory attributing to most of the drop. The rising inflation along with surging COVID-19 cases appears to be weighing on consumer sentiment as the University of Michigan’s sentiment index fell from 81.2 in July to 70.3 in August. On the positive side, the labor market continued to recover with a strong employment payroll increase. CPI rose 0.5% in July, a deceleration from the 0.9% gain in June. The details of the report show that some of the temporary factors behind the past surge of U.S. inflation might be fading.
By the Numbers (Year-to-Date)*
International Equities (MSCI ACWI ex-U.S.) | 9.4%
U.S. Bonds (Barclays U.S. Aggregate Bond Index) | -0.7%
Global Bonds (JP Morgan Global Aggregate Bond Index) | -2.3%
The NorthCoast Navigator is a market barometer displaying NorthCoast's current U.S. equity outlook. This aggregate metric is determined by multiple data points across four broad market-moving dimensions: Technical, Sentiment, Macroeconomic, and Valuation. The daily result determines equity exposure in our tactical strategies.
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Valuation With the market hovering around a record high and the S&P 500 index increasing by about 21.2% YTD, valuations for equity are still under pressure. P/E ratios increased to 27.1 at the end of August from 26.4 at the end of July. The Forward P/E ratio also rose slightly to 22.4 from 22.0. Inflation-adjusted valuation metrics continued to be negative with inflation rising. |
Sentiment The PMI index dipped to 59.5, suggesting that the pace of growth in the manufacturing sector has moderated slightly from the preceding months but remained robust. Consumer sentiment fell noticeably, as measured by both the Conference Board and the University of Michigan, largely because of the recent resurgence of the Delta variant and rising inflation. Homebuilder confidence declined slightly to 75, but remained well above the 50-point neutral threshold, indicating strong building conditions. |
Technical Technical indicators remained positive but looked stretched. At the end of July, the S&P 500 was 12% above its 200-day moving average, 5% above the 100-day average, and 3% above the 50-day average. Volatility spiked in the third week of the month as the market digested the Fed minutes, which indicated a willingness to start tapering before the end of the year. However, the market calmed down after a more balanced speech from the Jackson Hole symposium and settled at a VIX level of 16.5, compared with 18.2 at the end of last month. |
Macroeconomic Payroll employment gains were strong in July, rising by 943,000 and beating consensus. The market was disappointed with the recent retail sales data, which in our view, a good chunk of the weakness is attributed to declining auto sales and the timing of Amazon’s Prime Day. Industrial production increased more than expected in July, partially due to a rebound in motor vehicle and parts production. The CPI rose 0.5% in July, a deceleration from the 0.9% gain in June, showing tentative evidence that some of the temporary factors behind the past surge in inflation might be fading.
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Important Disclosures