China Worries. China posted a rare flurry of disappointing data, including its slowest growth in investment in nearly 18 years, suggesting the world’s second-largest economy is finally starting to lose some momentum as borrowing costs rise. Factory output and retail sales grew less than anticipated, though a rebound in property sales and construction starts is likely to keep China’s overall growth relatively robust and comfortably on target ahead of a key leadership reshuffle next month. The Chinese activity and spending data for August all came in below expectations with Urban Investment up 7.8% (expected +8.2%), Industrial Output up 6.0% (expected +6.6%) and Retail Sales up 10.1% (expected +10.5%). The main culprit was a slowdown in infrastructure investment, which also weighed on industrial output. We expect further weakness ahead, as fiscal policy becomes less supportive and the drag from slowing credit growth intensifies due to tighter monetary conditions.

On top of the weaker data, S&P Global Ratings downgraded China’s long-term sovereign credit rating, citing increasing risks from the country’s rapid build-up of credit. Their downgrade reflects “the assessment that a prolonged period of strong credit growth has increased China’s economic and financial risks.” Their downgrade follows a similar demotion by Moody’s Investors Service in May and comes as the government grapples with the challenges of containing financial risks stemming from years of credit-fuelled stimulus spurred by the need to meet official growth targets. It also comes less than a month ahead of a highly sensitive twice-a-decade Communist Party Congress which will see a key leadership reshuffle. Concerns about China’s sustained strong credit growth appear to be increasing, even as first-half economic growth beat expectations.

While we don’t want to infer that ‘the sky is falling’ in terms of financial markets, we can’t help but be aware of the risks that have been created by an extended period of excessively low global interest rates. Money has flowed to the riskiest assets and investors have become complacent about the risk that this entails, not unlike the way funds flowed excessively to the U.S. housing market from 2003-2007 and then into commodities from 2008-2011. In both cases, the markets collapsed once the funds flow started to reverse. While no one can accurately predict the timing of any such event, we have to believe that the risks are higher for stocks than they have been since the financial crisis.

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