Mid-Year Report 2015: Where We Are
In this installment, Michael discusses what’s happening in the economy now, including higher stock valuation, volatility, and global risks.
Michael Conway: Welcome back. In this installment, we’ll look at what’s happening in the economy now. The current state of financial markets can best be highlighted by the following questions: Where are we in the bull market? Does volatility reflect the true risk of the global economy? How will the Asian Infrastructure Investment Bank affect US relations with the world?
Stocks have obviously had a tremendous run from the depths of the recession in March of 2009, and we had record corporate profits during the first quarter of 2015. However, recent disappointing earning results from Blue Chips, and a lower than expected earnings forecast have weighed on stocks. Meanwhile, investors continue to turn to riskier assets amid low yields in the bond market. As of July 23rd, the Schiller price-to-earnings ratio marked 27.14, suggesting the stock market is expensive relative to the median ratio 16. This higher than normal ratio reflects investor demand for return and an expectation for continued stability from the hand of the Fed.
China’s stock market had been in a melt up for many months. Hard facts and anecdotal evidence all suggested valuations far exceeded the economic fundamentals. People were actually selling their homes to invest in stocks, and the level of margin debt was easily the highest in the history of global equity markets, at about 3.5% of GDP>
Finally, China’s bubble found a pin. The market lost over a quarter of its value in only 13 trading days. An early June bull market was in bear market territory by July. In the end, fundamentals do actually count and valuations matter.
Is the fall an indication of economic decline? Perhaps, but not a guarantee. Will this negatively affect the Chinese economy? Absolutely. In an effort to bolster markets and avoid a crash, the Chinese government established significant trading limitations. At one point, investors could freely trade just 93 of the 2879 listed companies. As you can see in the chart, the green columns represent the percentage of freely traded stocks, which plummeted as the market sold off in mid July.
Meanwhile, the government pumped money into the market in hopes to maintain stable prices. However controlling fears of collapse seemed to worsen the problem, as many stocks slipped dramatically after resuming trading. The China-led Asian Infrastructure Investment Bank is an emerging strong public institution with a capital base of about 100 billion. It will finance infrastructure developments in Asia, competing with the World Bank and Asia Development Bank. The World Bank is essentially controlled by the United States and the Asian Development Bank is controlled by the Japanese bureaucrats.
The establishment of the Asian Infrastructure Investment Bank is a sign of strength by the Chinese to free itself from the frustrations with the World Bank and the Asian Development Bank. In addition, it’s a sign of Chinese leadership to increase economic cooperation between Asia and Europe. Many large economies throughout the world have joined the bank. The UK, closest ally with the United States, surprised even Beijing by joining the Asian Infrastructure Investment Bank despite the US pressures not to do so.
Now that we’ve discussed the past and the present, our final very video will discuss some expectations for the future.