Portfolio manager Jody Jonsson discusses the role of China’s decelerating GDP and overvalued currency in the latest market volatility.
Jody Jonsson: It has been the most difficult start to a calendar year in market history: down between 10% and 15%, depending on which market you’re looking at — whether that’s the U.S., Europe, Asia. And I think it’s been driven by two principal concerns: One is China and what China might do with its currency; and the other is possibly slowing growth, and that’s really represented by what’s happening with the oil price and the concern that it’s reflecting a much more dire outlook for the U.S. economy and the world economy.
That said, markets were generally a bit expensive coming into the end of last year, and it wouldn’t be all that surprising to see markets have just a normal correction to reset closer to long-term valuation averages. So that is happening already, and I think that is a healthy, cleansing thing for markets to undergo every so often. It doesn’t necessarily mean we’re going into a recession, it doesn’t mean it’s a repeat of 2008; it’s just the process that markets have to go through, every now and then, to shake out the excesses. So we’ve been trying to look for buying opportunities. We’re not predicting the end of the world or a further collapse in the market, but we do think it’s part of a normal, healthy correction process.
There are really two things going on with China: One is the slowing of the GDP growth rate and the other is what will happen with the Chinese currency, and there’s a lot of concern around that right now. On the GDP growth, China’s transitioning from a very industrialized economy to one that’s more led by consumer spending, and that’s an awkward transition. It means there’s going to be less spending on materials and commodities and construction and all the things that go around that.
And then, secondly, there’s concern that China’s currency is overvalued and that the government may be trying to engineer a devaluation. That would not only be more difficult for U.S. companies that have exposure to China but also for many other countries that compete with China — it would make them less competitive. And so there are concerns about what that might do for global trade and whether it would cause other countries to need to devalue successively.
The U.S. has more exposure to it than we did, say, 10 or 15 years ago, as does Europe — Europe exports a great deal to China. And so China’s slowing will mean slower growth for the rest of the world, no question. I don’t know that it necessarily has to mean recession for the rest of the world. Industrial companies are basically in recession already, but the consumer is not. And so for the U.S., the real question is whether this spreads into the consumer sector. We certainly are on the lookout for whether this could cause contraction in global growth, but as yet we don’t forecast that.
We’re coming into this year with the Fed having taken one rate increase already and talking about more, although the market’s not certain that will happen. We’re coming in with high valuations, and we’re coming in with high margins for most companies, so we’re not coming into the year in a position where stocks are cheap and there’s a lot of upside. But that said, we’ve just had a significant correction, and some of what I just described is already being flushed out of the market in terms of valuations.
The strong U.S. dollar is making it tough for a lot of American companies that export, and that effect is still being felt, and so I think earnings growth is not going to be spectacular this year. So we try to remain focused on companies that have very strong management teams, lots of opportunities to improve the business themselves — that are not relying on just a strong global economy to carry them.
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