Two elements behind China's economic slowdown

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben discussed the latest Brexit developments, the slowdown in the Chinese economy and the outlook for third-quarter earnings season in the U.S.

Johnson, EU reach agreement on Brexit

UK Prime Minister Boris Johnson successfully negotiated a draft divorce agreement with the European Union (EU) on 17 October, setting up a critical vote in Parliament on 19 October. The agreement with the EU effectively allows UK member Northern Ireland to stay in a common customs union, and prevents a hard border with the Republic of Ireland, an EU member.

"This is the deal that I think most people wanted, but unfortunately, it doesn’t seem to be the deal that the Democratic Unionist Party (DUP) of Northern Ireland wanted," Ristuben said. He explained that the DUP, which has come out against the deal, has 10 members of parliament (MPs) - and that those 10 members are why Johnson was elected prime minster in the first place, as his Conservative party lacks a majority. In order for Johnson to make up for these lost votes, he’ll need to attract the support of 19 Labour Party MPs to get his deal approved, Ristuben added.

How it all shakes out is anyone’s guess, he said, but one thing appears clear: After three years, the broader marketplace is likely experiencing some Brexit fatigue. As evidence, Ristuben noted that when the deal was announced on 17 Ocober, global equity markets had little to no reaction.

What’s behind the growth slowdown in China?

Switching to China, Ristuben said that the country logged a 6% GDP (gross domestic product) growth rate during the third quarter - at the low end of the Chinese government’s targeted growth rate of 6.0% to 6.5%, and also the lowest growth rate reported since 1992. The report, released 19 October by China’s National Bureau of Statistics, is a recognition by the government that economic growth is slowing, Ristuben observed.

There are two elements to the slowdown, he said: Investment and consumption. "While state-owned and state-run businesses in China are continuing to invest, it’s very clear that non-Chinese foreign firms are beginning to divest from China," Ristuben remarked. Consumer spending - particularly in relation to automobile purchases - has also softened recently, he noted, due to a weakness in the country’s housing market. Overall, this slowdown is probably creating some motivation for Chinese President Xi Jinping to strike a trade deal with U.S. President Donald Trump, Ristuben said.

Outlook for Q3 earnings season

Turning to earnings season, Ristuben said that third-quarter earnings for S&P 500 companies are projected to decline -4.6% on a year-over-year basis. However, he noted that earnings from the first two quarters of the year beat consensus expectations. "If the third quarter follows suit, growth will likely end up better than expected: either flat or slightly negative," Ristuben stated. If growth does end up negative, it would make for the third consecutive quarter of declining earnings, he added.

With the season still in its early stages, Ristuben said there’s been mixed results among the banks that have reported, with some beating expectations. He noted this is likely due in part to a reduction in interest rates during the third quarter, which spurred a rebound in the U.S. housing market. Overall, however, the general tone emerging from the banking sector is less optimistic than at the start of the year, Ristuben stated.

"It’s important to understand that this doesn’t mean banks have turned pessimistic," he explained. "Rather, I think banks are recognising the detrimental impacts that trade tensions are having on the manufacturing sector - and are therefore beginning to become more concerned about these impacts potentially spreading to the consumer spending market," Ristuben concluded.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.