China Slows and the Global Market ... Glows?

The headlines were ominous. China, home to the world’s second-largest economy, reported that growth slowed in the April-June period to its weakest pace since quarterly data began in 1992. And yet the global equities market barely blinked. The MSCI All-Country World Index even managed to eke out a small gain, its fourth straight. No, markets haven’t become detached from reality.

A change in sentiment seems to be sweeping through the markets, starting last week when equities rose and global sovereign yields jumped the most since early April. Taken together, it’s hard not to come away thinking that, as the top-ranked rates strategist at BMO Capital Markets put it a report Monday, “the pendulum of economic sentiment is poised to swing back from (the) ‘sky is falling’ to ‘we might get through this.’” Consider the China data. While domestic output rose 6.2% from a year earlier, June retail sales and industrial output beat expectations, as did first-half investment. In the U.S., the first of this month’s regional Federal Reserve manufacturing gauges — the Empire State index of factory activity in New York State — rose more than forecast. Then there’s the role of central banks, which have turned dovish and are allowing the global supply of money to increase at an accelerating pace. A custom Bloomberg index measuring M2 figures for 12 major economies including the U.S., China, the euro zone and Japan shows their aggregate money supply has increased by $1.76 trillion since mid-May to $75.5 trillion. By comparison, the measure increased by just $672 billion in the first five and a half months of the year. It’s widely thought that growth of the global supply of money by central banks, looking to first combat the financial crisis and then to keep their economies from falling into recession, has been a main reason for the stellar performance in riskier assets.