By | August 15, 2023
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  • Despite a remarkable rally in equity markets so far this year, concerns have grown over the potential ripple effect of a protracted slowdown in the world’s second-largest economy.
  • David Roche, president and global strategist at Independent Strategy, told CNBC’s “Squawk Box Europe” on Thursday that global equity markets failed to price in a long-term decline in the role that manufacturing plays in driving emerging economies.
  • He suggested that the market is due for a “very large” downward correction, when many simultaneous geopolitical and macroeconomic risks are correctly priced.

The glow of the sunset is seen over buildings and a Ferris wheel on May 13, 2022 in Beijing, China.

Vcg | Visual China Group | Getty Images

China’s economic model is “washed up on the beach” and “will not take off again”, which will have a big impact on global markets, said veteran investor David Roche.

Despite a remarkable rally in stock markets so far this year, concerns have grown over the potential ripple effect of a protracted slowdown in China.

Beijing has acknowledged its immediate economic headwinds and signaled more fiscal supportwhile The People’s Bank of China unexpectedly cut interest rates on Tuesday. China has experienced rapid growth that has outpaced developed countries over the past two decades, overtaking Japan as the world’s second largest economy. But many economists now see a longer structural downward trend amid declining contributions from real estate and manufacturing — the traditional pillars of China’s rapid economic expansion.

The ruling Chinese Communist Party has set a growth target of 5% for 2023 – lower than usual targets and particularly modest for a country that says the World Bank has averaged annual GDP growth of 9% since opening up its economy in 1978. Some economists now believe Beijing is falling short of even that goal.

Roche, president and global strategist at Independent Strategy, told CNBC’s “Squawk Box Europe“on Thursday that global equity markets failed to price in a long-term decline in the role that manufacturing plays in driving emerging economies.

“We buy all goods with more services in them than metal, for example, so even manufacturing is full of services,” says Roche, who correctly predicted the developments of the 1997 Asian crisis and the 2008 global financial crisis.

He added that economies that historically exported manufactured goods will struggle to generate any meaningful growth in that sector, which will cause “big disappointments in the population, more geopolitical problems and more riots in the streets.”

“The Chinese model is obviously washed up on the beach with a large number of old holes in it, and it’s not going to take off again,” Roche said. The Chinese embassy in London did not immediately respond to CNBC’s request for comment.

“They really don’t have the method to surgically get rid of bad debts and bad assets, and at the same time they won’t be able to rely on their traditional growth metrics. That’s the big problem.”

China on Tuesday delayed release of data on youth unemploymentwhich recently soared to record highs, while economic statistics from July showed a broad-based decline exacerbated by the country’s decline in the real estate market.

Roche suggested that the changing demographics of China meant that the country no longer has enough young people to warrant a full renewal of its property cycle – a market often estimated to drive between 20% and 30% of the country’s gross domestic product.

Along with the various crises enveloping developing markets, from Latin America to Russia to Niger and the Sahel region of Africa, Roche said a major downside risk that markets have not yet priced in is that profit margins will need to be squeezed in developing markets in the West to bring down inflation in a sustainable way.

He suggested that the market is due for a “very large” downward correction, once these multiple simultaneous risks are eventually factored in.

As such, Roche recommended that investors look to “slowly accumulate” US Treasuries and safe-haven assets that offer yields at their currently cheap levels.

“I think that unlike during the Great Moderation years – [when] you never got paid to hold cash or hold bonds — now you do,” he added.

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