It's been a turbulent couple of weeks for global equity markets. A rout in Chinese stocks quickly spread to the West, with US, UK and European equities selling off. Several stock indices around the world fell more than 10% from their last peaks.
Worst-hit was the Shanghai Composite index. It closed last Tuesday at an eight-month low, down 42% from its peak in June.
The sell-off provoked some pretty alarming newspaper headlines and much talk of Beijing's "Black Monday". China has replaced Grexit on the market's worry list.
We'd take this with a bit of a pinch of salt.
Equities, especially in China, are skittish and prone to big moves. The relationship between equities and economic activity is mixed. The old chestnut is that the equity market has predicted ten of the last six recessions. Nobody forecast an economic boom in China when the Shanghai equity index doubled in value between June 2014 and June 2015.
China's market may have tanked, but anyone who put money into the Shanghai composite a year ago would have seen their investment rise by 40%. Moreover, equities play a lesser role in China than in the West and their capacity to derail growth is correspondingly lower. The Chinese market is far smaller relative to the size of the Chinese economy than Western markets are to Western economies. Chinese consumers have less than a fifth of their assets in the Chinese equity market. Lower equity prices have less effect on Chinese consumers than in the US where households are more exposed, through savings, to equities.
Last week's crash in Chinese equities has, however, focussed attention on the challenges to China's economy. After almost two decades, the era of blazing-fast Chinese growth is coming to an end. Abnormally high levels of outstanding debt, at 282% of GDP, and a housing bubble, are major risks. Markets worry such imbalances may require a drastic slowdown in growth or a recession to get back to reality.
So far the slowdown looks manageable. Chinese growth averaged at 9.2% in the five years after the financial crisis. The IMF expects that to slow to a still respectable 6.5% over the next five years. If things get worse the Chinese authorities have plenty of leeway to cut interest rates, devalue their currency and ease restrictions on bank lending to bolster growth.
A key reason behind this resilience is that consumer demand remains strong. Amid last week's stock market turmoil, Apple's CEO, Tim Cook, revealed to a CNBC journalist that Apple continued to experience strong growth in China over July and August – a statement that helped Apple regain $66bn in market capitalisation.
China's economic slowdown is part of a wider story of weakness in emerging markets. Commodity intensive economies, such as Russia and Brazil, have suffered from falling commodity prices. The prospect of higher interest rates in the US has tempted globally mobile capital away from emerging market economies, further dampening growth.
Western central bankers, who gathered for the annual monetary policy jamboree in Jackson Hole last week, seem outwardly insouciant in the face of the equity sell-off. Their confidence was no doubt bolstered by recent economic data.
Second-quarter GDP estimates for the US and UK, showed a good rebound in activity and strong growth in business investment and inventories. In Europe, Germany's Ifo business climate index hit a 3-month high.
We see two big positives for Western growth.
First, falling commodity prices are a boon for Western consumers. Commodity prices have fallen by a third since last year's peak, pushing down inflation and giving consumer spending power a timely boost. In the UK and US, a stronger dollar and sterling have made imports cheaper and have further boosted spending power. In the UK consumer confidence hit a 15-year high in August. In the US and Germany retail sales showed strong growth through July.
Second, money is cheap and increasingly available in the US, the UK and the euro area. While the US Federal Reserve and the Bank of England have indicated that they are contemplating raising interest rates, both stress that rises are likely to be gradual. In the euro area the ECB's quantitative easing programme has pushed private sector demand for credit to the highest level in ten years. And in response to last week's rout, several central bankers indicated that they would consider delaying rate rises in order to avoid similar market jitters.
So China's Black Monday is not enough to change the big picture for growth in the West. We continue to look for decent growth in the US and UK over the next year and an unspectacular euro area recovery.
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