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The Chinese government’s zero-COVID policy took the wind from the sails of its economy. When the government finally ended the policy earlier this year, many economists anticipated that pent-up consumer demand would refill China’s economic sails, lifting the global economy, reported Malcolm Scott of Bloomberg. Instead, China’s economy is in an economic doldrum, recovering far more slowly than anyone anticipated. As a result, economists have steadily lowered 2023 growth forecasts for the country, reported Yahoo Finance and Diane King Hall.
The economy isn’t well-positioned to move ahead. From April through June, it advanced a desultory 0.8 percent. Unemployment among young people is so high that China stopped releasing the data in July, reported Minxin Pei of Bloomberg. In addition, a banking crisis may be on the horizon as China’s real estate sector, which comprises about 20 percent of the country’s economic growth, is experiencing a downturn. Also, government stimulus may be limited as China’s debt-to-GDP ratio is about 300 percent; the highest among emerging markets, reported economist Tao Wang in an interview with Vincent Ni of National Public Radio.
Recently, China attempted to stimulate growth and restore confidence by cutting a key interest rate, but investors were not impressed. The benchmark CSI 300 Index, which tracks the performance of 300 A-share stocks traded on the Shanghai Stock Exchange or the Shenzhen Stock Exchange, has fallen by 9 percent in recent weeks as overseas investors moved more than $10 billion away from Chinese stocks, reported Xie Yu and Yoruk Bahceli of Reuters.
Meanwhile, the U.S. economy continues to grow faster than anticipated. “Despite umpteen predictions of a slowdown, it keeps going and going. Recent data suggest it may even be on track for annualized growth of nearly 6% in the third quarter, a pace it has hit only a few times since 2000,” reported The Economist via Yahoo Finance.
The strong U.S. economy has impeded efforts to lower inflation. Last week, Federal Reserve Chair Jerome Powell confirmed that U.S. inflation remains too high. “As is often the case, we are navigating by the stars under cloudy skies…At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks…we will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data,” Powell said.
His comments were generally well-received. The Standard & Poor’s 500 and Nasdaq Composite Indices finished the week higher, while the Dow Jones Industrial Average moved lower, according to Barron’s. Yields on shorter-maturity U.S. Treasuries generally moved higher over the week.
Higher bond yields may be good for income investors – and not so good for stock markets.
After more than a decade of near-zero interest rates, the “free money” era – a time when people and businesses could borrow money and repay it with very low (or no) interest – may be over.
Last year, rising inflation caused the Fed to begin raising the federal funds rate aggressively. Yields on bonds moved higher, too. At the end of last week, the yield on a one-year U.S. Treasury bill was 5.35 percent, up from only 0.40 percent at the start of 2022.
Many people thought rates and bond yields would come back down relatively quickly, but that school of thought is changing, reported Michael Mackenzie and Liz Capo McCormick of Bloomberg.
“All around the world, bond traders are finally coming to the realization that the rock-bottom yields of recent history might be gone for good…The surprisingly resilient US economy, ballooning debt and deficits, and escalating concerns that the Federal Reserve will hold interest rates high are driving yields on the longest-dated Treasuries back to the highest levels in over a decade. That’s prompted a rethink of what ‘normal’ in the Treasury market will look like…strategists are warning investors to brace for the return of the ‘5% world’ that prevailed before the global financial crisis.”
Higher bond yields may be good news for income-oriented investors who turned to dividend-paying stocks for income when bond yields were low. Now, those investors may be able to earn attractive yields with lower-risk Treasuries, reported Al Root of Barron’s.
It’s not such great news for stock markets, though. “…rising Treasury yields are a problem for stocks because investors will rotate out of riskier equities and into less-risky bonds because the additional return in stocks isn’t worth the volatility,” stated a source cited by Teresa Rivas of Barron’s.
Last week, major U.S. stock indices finished lower, while yields on longer-term U.S. Treasuries moved higher.
Consumer sentiment is a lagging indicator. It’s also a contrarian indicator.
After rising sharply in June and July, consumer sentiment leveled off this month. The preliminary August reading for the University of Michigan Consumer Sentiment Index was 71.2. That’s slightly below July’s reading, although it’s up 22.3 percent year-over-year, and up 42 percent from its all-time low of 50 (June 2022). The historic average for the Index is 86.
“In general, consumers perceived few material differences in the economic environment from last month, but they saw substantial improvements relative to just three months ago. Year-ahead inflation expectations edged down from 3.4% last month to 3.3% this month, showing remarkable stability for three consecutive months,” wrote Surveys of Consumers Director Joanne Hsu.
The University of Michigan Consumer Sentiment survey provides information related to:
Consumer sentiment is a lagging indicator because it can take several months for changes in economic activity to be felt by consumers. This type of sentiment also is considered a contrarian indicator. John Rekenthaler of Morningstar explained, “When people are deeply unhappy, stocks are likely to thrive, because the economic damage that bothers them has already occurred. A contented populace, on the other hand, is the investment equivalent of red sky at morning. Equity shareholders, take warning.”
Mixed inflation data caused markets to stumble last week. The Standard & Poor’s 500 and Nasdaq Composite indices finished lower, while the Dow Jones Industrial Average moved slightly higher, reported Barron’s. Yields on U.S. Treasury notes and bonds rose.
An unwelcome surprise.
Last week, Fitch Ratings startled markets by lowering the credit rating of United States Treasuries from AAA to AA+. It was the second rating agency to downgrade U.S. Treasuries; Standard & Poor’s cut its rating to AA+ in 2011, reported Benjamin Purvis and Simon Kennedy of Bloomberg.
The decision to lower the rating was not a comment on the strength of the U.S. economy, which expanded faster than expected in the second quarter on the strength of business investment in equipment, particularly transportation equipment, reported Erik Lundh of The Conference Board.
While many were baffled by the decision, as well as its timing, Fitch had warned it was considering a rating downgrade in May when lawmakers were haggling over the debt ceiling while the possibility of default loomed, reported of Bloomberg.
Last week, Fitch Senior Director Richard Francis told Davide Barbuscia of Reuters, “Fitch downgraded the U.S. credit rating due to fiscal concerns, a deterioration in U.S governance, as well as political polarization reflected partly by the Jan. 6 insurrection.”
There are now 10 countries with government bonds that are rated AAA by at least two rating agencies: Germany, Denmark, Netherlands, Sweden, Norway, Switzerland, Luxembourg, Singapore, Australia, and Canada, reported Tania Chen of Bloomberg.
Markets did not take the downgrade well. Stocks sold off and Treasury rates rose mid-week. Jacob Sonenshine of Barron’s reported:
“Of course, the [stock] market always needs a reason to fall, and this past week it found one in surging Treasury yields. It’s hard to tell exactly what made them pop. Though some blamed Fitch’s downgrade of the U.S. credit rating to AA+ from AAA, it’s more likely a combination of massive issuance—the Treasury said it plans to issue more debt than had been expected—and solid economic data that forced market participants to reconsider their growth targets. Higher yields make stocks worth less, all else being equal.”
Markets briefly reversed course later in the week when the U.S. employment report showed jobs growth easing. Overall, employment data supported the idea that a recession may be avoided. The number of new jobs created remained above the pre-pandemic monthly average, and average hourly earnings were up 4.4 percent year-over-year, according to Barron’s Megan Leonhardt.
At the end of the week, major U.S. stock indices were lower, reported Barron’s. Yields on longer U.S. Treasuries rose more than yields on most shorter Treasuries, steepening the yield curve.