23 October 2016
The US dollar has weakened recently but remains strong, in line with the consolidation trend. Photo: Bloomberg
The US dollar has weakened recently but remains strong, in line with the consolidation trend. Photo: Bloomberg

Why investors should not let their guard down

Various asset classes have shown signs of stabilizing or bottoming out going into the fourth quarter.

The market is likely to improve in the short term but whether the worst is behind us is too early to tell.

There is less chance of a US rate hike this year, boosting commodities, emerging market currencies and global equities.

In addition, various assets have been oversold in recent months amid heavy selling.

Is the financial market about to make a U-turn?

Maybe not. The underlying issues remain.

First, the US dollar is strong.

US economic recovery remains intact and the normalization of US monetary policy is set to happen.

In fact, the US dollar index has weakened somewhat recently but is still in line with the consolidation trend.

Also, the European and Japanese central banks are likely to ramp up monetary easing.

If so, the greenback may stage another rally even without a Fed liftoff.

Second, China’s economic growth remains weak.

The HKEJ-Li Keqiang Index tumbled to a new low in August, showing China’s economy is still struggling to gain momentum.

Beijing has unveiled measures to stimulate domestic consumption and more is set to come.

However, it remains unclear to what extent these policies can boost the real economy.

Meanwhile, global commodity prices, particularly base metals, will be under tremendous pressure unless China’s economic growth picks up.

Third, the commodity market continues to struggle amid a strong US dollar and weak Chinese demand.

A fall in commodity prices will exacerbate disinflation or stoke deflation pressure and in turn weigh on global economic growth.

The International Monetary Fund has cut its global growth forecast for this year to 3.1 percent from a previous estimate of 3.3 percent.

Fourth, emerging markets continue to grapple with sluggish growth and capital outflow.

Many emerging economies, particularly Latin American nations, rely heavily on exports of raw materials.

The lackluster global commodity market is a drag on their economic growth.

And capital outflow is putting their currencies under immense depreciation pressure.

The four factors previously mentioned are interrelated, exacerbating a credit crunch in the financial market.

It remains unclear how policymakers will break out of this vicious cycle, but to be sure, these issues are causing ripples in some debt-strapped raw material exploration companies.

Meanwhile, the Hang Seng Index soared nearly 700 points on Wednesday but the global market has been mired in unusual volatility since the start of the third quarter.

The Hong Kong benchmark has fallen for five straight months and the S&P 500 has had huge daily fluctuations, a level of volatility seen only during previous financial crises.

Investors should pay attention to these unresolved issues and be ready with an exit strategy.

This article appeared in the Hong Kong Economic Journal on Oct. 8.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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