On holiday last week I began to track the Chinese stock market story and dropped Mark a note to suggest that this ‘pricing correction’ might provide fertile ground for a full blown crisis in September when everyone returns to their desks. After all, Anatole Kaletsky reminds us that August to October is the financial hurricane season. 
Being away from my desk and not having ready access to my usual information sources (it’s hard to find a FT in the mountains of Portugal), I began to think the worst. Should I sell the house, and put the equity in cash and gold?

Maybe not just yet!

Upon cooler reflection at my desk and looking through the various market comment and data, I am happier. The house is not on the market and I’m not sure where I would buy the gold anyway. I think the following chart shows aptly what is happening.  While the Dow Jones in the US (purple) might be considered fully priced, the Chinese stock market (in red) has been in bubble territory for some considerable time.

Shanghai SE Composite Index Summary
‘While the Dow Jones in the US might be considered fully priced, the Chinese stock market (in red) has been in bubble territory for some considerable time.’

Even after the extraordinary falls in the Shanghai Composite Index (SCI), mere visual inspection suggests that values are still well above long term trend.  In contrast, the Dow Jones, FTSE EuroFirst 300 and FT100 Indices, while relatively high, do not show any extraordinary surges or breaks.  In the US, certain market momentum indicators (S&P 500 14-day relative strength index) suggest that over the last few sessions that US shares have been ‘oversold’.  In normal language, this means that share prices for many companies have fallen below their real value in terms of company earnings potential, order book strength and balance sheet positions. Most large corporates still hold considerable cash reserves.

So given the initial bounce-back we’ve seen this morning with the FTSE100 back over 6000 and the FTSE Euro300 up 3.25%, not to mention a bounce-back on other Far Eastern markets, even while the share sell off looks set to continue in China, the mounting evidence suggests that for the moment, cooler heads are prevailing and we are seeing a long-overdue pricing correction on the Shanghai Index.  Bond yields have also risen in the UK, US and Germany suggesting that the flight to safe haven assets has moderated.  Gold, the ultimate safe haven, has also seen falling prices.

Property Considerations

The first obvious impact of the Chinese pricing correction is that US interest rates look very unlikely to rise in September.  In fact, for many equity investors in the US this was considered a positive result of the turmoil. 

Not everyone shares this view, as some feel that a rapid bounce-back will embolden the Fed to raise rates in September after all.  That is, the Chinese crisis merely tested the waters for the Fed.  

I disagree. Given the certainty that Chinese currency devaluation will mean that the rest of the world will be importing deflation through lower Chinese import prices in a setting of falling commodity prices, any rate hike would aggravate this trend with immediate repercussions for inflation which is already well below target. Interest rates look unlikely to move in the US and UK until early next year.  The ECB will also not raise rates as they are still undertaking quantitative easing.  

Property investment markets and low yields will remain supported by low bond rates globally for the rest of 2015. Safe haven investment will also receive another short-term boost; hence core markets offering secure income remain in the limelight.  Peripheral markets may see a pause as investors take stock and risk appetite moderates.

Occupier markets trajectories will not be affected greatly, although the Chinese share crisis will prolong what has proven to be a long period of uncertainty and slow decision making with respect to taking on new leases. Large international corporates still have large cash reserves and have not been using these funds for expansionary investment; hence it might be argues that there is no expansionary investment trend to disrupt.  Expansionary investment is a key driver of occupier markets. Increasingly though, this lack of investment is likely to be addressed by fiscal policies.  This is probably the space to watch more so than transitory volatility in world equity markets.

So should I sell the house and buy gold?

Given the evidence so far, this seem premature, although I am aware that at least one person is thinking about buying a farm in Northern Ireland suitable for growing potatoes.  I think this is an extreme position to take, but equally I might be persuaded to invest in this undertaking, not so much for the potato production opportunity, but for the peace, quiet and respite from world events that it might offer, assuming there are no mobile phone masts nearby and that internet is not available.