September Wrap Up - Liquidity and a bold stimulus package

Two major announcements boosted global liquidity in September pushing share markets higher. The US Federal Reserve began a much-anticipated easing cycle cutting overnight interest rates by a more than expected 0.5%. US shares as illustrated by the S&P 500 ended the month up 2.1%. This was followed by China's most aggressive financial stimulus package since the pandemic; the central bank cut interest rates, introduced a swap facility to support equity markets and hinted a future policy largesse. This was a major positive surprise. Chinese share prices exploded upwards, rising 17.4% for the month (SSE Composite Index).

We have talked in previous monthlies about the change in tone for the global economy.  The battle against the post covid inflation spike is receding and central banks have switched focus towards the risks of slowing economic growth. It is a delicate balancing act. Fight the inflation fight too long and risk damaging the economy, leading to recession. Ease policy too quickly and risk reigniting inflation.

The US Federal Reserve seem, at least for now, to have the mix right. In September they cut official interest rates for the first time since 2020. While broadly expected by the market the Fed had an ace up its sleeve cutting rates by 0.5%, more than the 0.25% expected by the market.

History suggests that rate cut cycles are typically good for share prices, as long as the economy doesn't slump into a recession. Thus far the market is betting that this doesn't happen. For September US share prices were strong, rising 2.1% (S&P 500). This adds to what has been a very strong start to the year, with US shares up the most year to date since 1997.

We always look a little deeper than the headline. What is interesting in this rally is that market performance has broadened away from the magnificent 7 that dominated proceedings early in the year.

One measure of this is the performance of the S&P 500 equal weight index. This equal weight index differs from the S&P 500 index we normally quote in that, as the name suggests, each company's performance is weighted as 1/500 of the index rather than weighted by the market value of that company. The even weighted index beat the market value index by the most this quarter since the four quarter of 2022. The "average" company is back and performing well. A broadening market, with more companies performing well is a healthy sign. 

The story of the Chinese economy has been vastly different. While the rest of the world was grappling with a post covid inflation headache China has been battling with property price deflation and bloated private sector debt levels.

This is a scary combination. High levels of borrowing against property which is falling in value has nasty economic consequences. We have seen this game before, most notably in Japan in the 1990s. It did not go well, resulting in decades of weak economic growth, price deflation, zombie banks and poor equity market returns.

China does not want to follow a similar path. The first step in addressing this was what has been dubbed by some as a monetary policy "bazooka." Several initiatives were announced including interest cuts, relaxation of bank reserve ratio requirements, support for local governments to buy unsold homes, expanded financial programs for business and most directly impacting share markets, a RMB500bn swap facility for liquidity in the A-share market, with potential for further increases.

These measures had a huge impact on sentiment, at least in the short term. The Chinese share market rallied strongly for the month, up 17.4%.

While a real boost to the share market these measures don't amount to a decisive "bazooka" solving all of China's economic challenges in our view. But it is a step in the right direction and will help boost China's weak domestic demand and the still struggling property sector. More is needed.

Investors are waiting to see whether we will have similar moves from the fiscal side in coming days, as large fiscal expansion will be more meaningful in tackling China's economic challenges. It is possible that the supplementary budget is approved at the NPC standing committee meeting in late October.

In BlackRock's view if any fiscal package announced over the next 1-2 months is more than 2trn RMB, they would consider this significant and could provide a backdrop for Chinese A-shares to continue to perform.

We have talked in previous reports about our strategy to broaden exposure in portfolios; lengthening the average maturity of fixed income assets, increasing allocations to Emerging Market and Australasian shares and adding listed infrastructure. The increased liquidity injected into the global economy over the past month has been supportive of this strategy and gives us increased comfort we are on the right track.

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