August Market Review: Delta, the Fed & China Equities

The Delta variant, China equities, the Fed. Investors certainly had no lack of headlines to contend with in August. As we head into the final four months of the year, here’s a review of markets last month and what September might bring.

Fed tapering

For weeks, investors had been anticipating the annual US Federal Reserve symposium at Jackson Hole, anxiously waiting to hear the Fed’s plans on tapering its easy monetary policy and when it will start raising interest rates.

The summit last Friday (27 August) was generally positive. Fed Chairman Jerome Powell indicated that the Fed would start tapering its monthly bond purchases before the end of the year, as long as economic progress continues. However, interest rate hikes are still well off on the horizon. 

His dovish comments sent stocks higher last Friday while government bond yields fell as investors pulled back their expectations for when the Fed may begin raising interest rates. His remarks also avoided setting off a repeat of the so-called 2012 “taper tantrum” when the Fed unexpectedly announced they would pare back asset purchases.

Why the need for tapering

The Fed has cut interest rates to near zero and committed to buy at least US$120 billion of Treasury bonds each month in order to support the US economy amid the pandemic. With rate cuts and the injection of liquidity through these asset purchases, the US economy has rebounded remarkably quickly, and the inflation rate has also crept up. Under such circumstances, it’s clear that the US economy has reached a point where it no longer requires that much policy support. 

The Fed has another scheduled meeting planned for 21 and 22 September. This will be closely watched for any indication of when the tapering would occur. While markets seem to agree that pandemic-era stimulus cannot go on forever, the pace of the tapering is another important signal that investors will be looking out for. 

Delta variant

The delta variant of the coronavirus has now spread to more than 130 countries globally, according to the World Health Organisation. Highly transmissible, it has caused a renewed wave of infections around the world. This could affect businesses and consumer sentiment and weigh on the global economic recovery. 

During his speech on Friday, Fed Chairman Jerome Powell cited the delta strain as a “near-term risk” for the US economy. Some signs of that may already be underway. The US Conference Board Consumer Confidence Index fell in August to its lowest level since February. If the virus spread worsens, consumer confidence will likely be dampened in the coming months.

Silver linings

Economists at Goldman Sachs have cut their third-quarter US growth forecast to 5.5% from 9%, given the likely impact of the delta variant on the US’ economic recovery. That said, 5.5% is still powerful growth. The US recovery may be moving at a slower pace than before, but it is still underway. 

Even if economic data declines in September due to the delta impact, that may not necessarily be a negative for stock markets. That’s because weaker economic data would mean that the Fed is more likely to stay dovish and continue with its stimulus efforts, according to Fundstrat. If the tapering is delayed to later in the year, that would “benefit financial markets”, the research house noted.

China’s regulatory crackdown 

China’s clampdown on industries ranging from technology to education has roiled financial markets and triggered a wave of sell-offs. This crackdown is part of the Chinese government’s plan to promote “common prosperity” by narrowing inequality and keeping capital expansion in check.

As we highlighted in our webinar on China’s market outlook, the regulatory reforms impact Chinese companies in several ways.

For one, we can expect to see greater transparency both in terms of how companies use and store user data and the way consumers are charged for goods and services. In July, 12 major tech companies, including Alibaba, Tencent and ByteDance, were summoned and given instructions on how to improve their operations to comply with China’s new Data Security Law.

With anti-monopoly regulation, competition is likely to intensify among China’s internet companies as well. This could lead to greater investment spending and organic growth within the tech sector, according to S&P Global Ratings.

China should still be part of a global portfolio

While regulatory doubt persists, Ray Dalio, the founder of Bridgewater Associates, the world’s biggest hedge fund, has urged investors not to panic.

“As for investing, as I see it the American and Chinese systems and markets both have opportunities and risks and are likely to compete with each other and diversify each other. Hence they both should be considered as important parts of one’s portfolio,” he wrote in a LinkedIn post. 

He has a point. Chinese regulators do not want financial markets to crash, or worse, trigger a downturn in the real economy and put growth targets at risk. As such, we may even see some potential support levers such as targeted fiscal measures being introduced. This generally bodes well for equity markets. 

In the long-term, the reforms will likely create a more sustainable and transparent market place, which translates into higher quality of growth and more stable returns. Taking these parts together, this means that we should expect to see higher short-term volatility but greater benefits and stability in the long-term.

Conclusion 

Just as it was last year, the path of the global recovery continues to depend on the course of the coronavirus and whether the delta variant proves to be better or worse than investors expect.

Although some of that uncertainty has already been factored into stock prices, the unpredictable nature of COVID-19 could mean short-term volatility may still be ahead. Our advice is to put emphasis on diversification, which will help provide a stabilizing effect to your portfolio as some sectors move higher and others move lower.