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Global investor sentiment will turn ultimately on China

Two pillars — Trump and China — have supported a bounteous few months for global portfolio investors. But the hope invested in both is starting to fade, casting a bearish tinge over what nevertheless remains a largely optimistic picture.

In the case of Donald Trump, expectations that the US president would act swiftly to push though tax reforms, deregulation and bold infrastructure investments are starting to ebb as signs of administrative delays proliferate.

For China, an ebullient first quarter of GDP growth is giving way to anxieties that the world’s second-largest economy may have peaked. This belief has already depressed the prices of key commodities, upon which the fortunes of several emerging markets depend.

All this, coupled with mounting geopolitical risks in North Korea and Syria, combined this week to push down the yield on the US 10-year Treasury note — a bellwether for the world’s economic prospects — to its lowest levels since November last year. Lower Treasury yields reveal declining confidence in the US and, by extension, global growth.

“Geopolitical risks are spreading. Trump’s action in Syria and talk of North Korea consume headlines. But we believe it is the inaction of Trumponomics that has disappointed expectations most,” says Jerrod Kerr, strategist at the Commonwealth Bank of Australia.

Others see dwindling Chinese dynamism as a defining headwind. China’s GDP growth of 6.9 per cent in the first three months of the year — its fastest expansion for 18 months — helped to propel the global prices of oil, iron ore, copper, aluminium and other commodities higher.

Lately, however most metal prices have retraced their steps. The price of iron ore, an important export for countries such as Brazil, Russia, Australia and India, fell to a near six-month low this week. Copper, which is important for the economies of Chile, Peru, Zambia and Russia, has lost about 10 per cent of its value over the past month. The price of Brent crude oil has also slipped over the past two weeks.

Concern over China, which is the biggest importer of oil and base metals, is mainly that Beijing’s efforts to rein in a credit bubble will start to hobble growth, precipitating corporate defaults and squeezing investment demand. Already, nine bond defaults have occurred in the first three months, a record for a first quarter.

“Credit expansion, which was the main reason for the better performance over the past nine months, has certainly slowed recently under the influence of regulatory tightening on formal lending,” says George Magnus, an economic consultant and former chief economist at UBS, an investment bank.

“For me, this is the biggest reason to expect the economy to slow from here until either the end of the year and or whenever the government takes the foot off the credit brake again,” Mr Magnus adds.

Signs of stress have not been confined to the bond market. A sudden 90 per cent crash one day last month in the share price of Hong Kong-listed China Huishan Dairy resulted from the company’s failure to honour debts amid an environment of scarcer liquidity.

In addition, analysts say that recent strong Chinese industrial output is unlikely to be sustained. This is because some of the 14 per cent jump in the value of industrial production in the first quarter derived from inflated commodity prices and partly from a sharp build-up in inventory, mainly of steel.

Nevertheless, most analysts emphasise that a peaking in Chinese growth is unlikely to presage a meltdown, especially in a year of pivotal political importance. Xi Jinping, the president, is set to preside over a changing of the ruling Communist Party’s key personnel at a congress late this year.

“Nothing must be allowed to rock the run-up to the congress as far as Xi Jinping is concerned, so I would certainly think the ‘stability at any cost’ mantra is operative for a little while yet,” says Mr Magnus. “If there are any signs of say the fragility of private investment or slower trajectory of consumption after June, then I would fully expect the government to relax credit policies again.”

On such questions hang part of emerging markets’ outlook. The bumper aggregate returns in the first quarter for investors in bonds, stocks and currencies in the developing world have been unusual in recent history. Capital inflows hit $28.6bn in the first three months, marking the first quarterly net inflow for more than two years, according to NN Investment Partners, an investment bank.

But China is by no means the only factor. Adding resilience is a revival in growth across the emerging world, says Pierre-Yves Bareau of JPMorgan Asset Management.

“After five years of an earnings diet, earnings growth has turned around since the second half of last year,” he says. “The good news is that it is broadening out across sectors, so it is not only commodities but others such as information technology and banks.”

Similarly, economic growth is improving this year across the emerging world, from Asia, to Latin America, to sub-Saharan Africa. The International Monetary Fund expects this pattern to continue, with the gap between rates of growth in the emerging and developing worlds widening every year until 2022.

Helping to underpin such optimism has been a marked pick-up in global trade. In volume terms, stripping out the effect of price changes, global trade in goods in the three months to January was 2.4 per cent higher than in the preceding three months — with emerging markets leading the way in terms of growth.

Nevertheless, there are concerns that this trade fillip has been sired mainly by US and Chinese demand — which may now be about to ebb — rather than by strengthening consumer spending in emerging markets themselves.

Thus, says Maarten-Jan Bakkum, senior EM strategist at NN Investment Partners, much in the way of investor sentiment turns ultimately on China. “Once China starts to disappoint on the growth side the sentiment can turn very quickly,” he says.

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