With a 0.7% fall in the MSCI AC World index in US dollar terms, the performance of global equities was disappointing in June.
This fall was mainly due to the latest developments in trade negotiations between the US and its main partners as the exemption on US steel and aluminium tariffs expired on 31 May. Investors worried about the reprisals announced on a number of US products by Mexico, Canada and the EU, in response to which President Trump refused to sign the communiqué of the 8-9 June G7 summit.
The US announcement on 15 June that heavy tariffs would become effective on 6 July on hundreds of Chinese products revived fears of an escalation, which were exacerbated by Beijing’s promise of reprisals against acts of “extreme pressure and blackmail”. Late in the month, Trump seemed to take a slightly less aggressive approach to controlling foreign investments in US companies and ensuring protection of the technologies sector. The initial plan, backed by an International Emergency Economic Powers Act, targeted China directly.
Emerging equities neglected by investors
The lack of visibility on these issues and the constant turnabouts by the US administration kept the markets on edge, with a particularly harmful impact on the performance of emerging equity markets. The 4.6% drop in the MSCI Emerging Markets index (in US dollar terms) was exacerbated by broad shifts in the currency markets. The US dollar gained 2.6% in June versus a basket of 10 emerging currencies, but far more against the Argentine peso and the Brazilian real.
A surge in crude oil prices (+10.6% by WTI to USD 74/bbl) served as a parachute for emerging markets in Europe and Latin America, while emerging Asian equities were dragged down by Chinese equities which, in turn, suffered from the global trade uncertainties. Against this backdrop, the markets mostly ignored the relaxation in geopolitical tensions after the 12 June summit between Donald Trump and his North Korean counterpart.
Exhibit 1: Net decline in emerging equities (equity indices in USD)
Source: Bloomberg, BNP Paribas Asset Management, as of 29/06/2018
The absence of clear convictions among investors was also apparent in the monthly performance of the major developed country equity markets. Performance of equities in these was somewhat muted and did not significantly shift the hierarchy established so far in 2018, which we might term the “America First” year!
In June, the major indices turned down in the second half of the month following the new developments on the trade front. Despite a slight upturn in economic indicators in the eurozone and the ECB’s highly cautious tone, the EuroSTOXX 50 ended the month down by 0.3%, driven in particular by automakers’ difficulties after Donald Trump’s renewed threats to imports of German vehicles.
Japanese indices diverged, with the Nikkei 225 up by 0.5% and the Topix down by almost 1%, despite receding concerns over the fate of Prime Minister Abe and a central bank saying it was willing to stick to its ultra-accommodative monetary policy for a long time to come. The energy sector was boosted by the spike in oil prices after OPEC’s decisions proved to be less clear-cut than they could have been. Oil prices rose on heavy speculative positions and doubts over the ability of certain oil-producing countries to ramp up output.
In the US, the S&P 500 ended up 0.5%, while the NASDAQ, after reaching an all-time high in mid-month, ended up 0.9%. The markets were led by consumer cyclicals and non-cyclicals, followed by telecoms and utilities, which, from mid-June on, were boosted by receding long bond yields. By contrast, financials took a hit from the flattening of the yield curve.Exhibit 2: Rebound in crude oil prices (in USD per barrel) Source: Bloomberg, BNP Paribas Asset Management, as of 29/06/2018
The US dollar's pause for breath
After falling appreciably from mid-April to the end of May, the EUR/USD rate was mostly directionless in June between 1.16 and 1.18, ending the month almost unchanged at 1.1667, without breaking through an important technical support level.
The US dollar’s pause for breath reflects adjustments in speculative positions. With the growth gap between the US and the eurozone already fully priced in, it took only a slight uptick in European economic data to stem the fall in the EUR/USD.
Meanwhile, despite the 13 June key rate increase, doubt was cast on the scenario of a more hawkish Fed by the reassuring tone of Jerome Powell, who reiterated that even 2%-plus inflation would be tolerated temporarily. All of the above helped the euro return to USD 1.18 on the eve of the ECB meeting, up from 1.1660 at the end of May. The monetary policy decisions and Mario Draghi’s comments sent the euro sharply lower to under USD 1.16 and it hovered at around this level until the end of the month.
The euro rallied on the European Council’s agreement on migrant policy at its 28 June meeting, no doubt because it meets, albeit modestly, Italian demands and thus lessens the risk of a head-on confrontation between Italy and its European partners over other issues.
Exhibit 3: Changes in the EUR/USD exchange rate (USD per euro) January 2016 - 29 June 2018
Source: Bloomberg, BNP Paribas Asset Management, as of 29/06/2018
Can we expect clearer skies this summer?
The scenario of a solid expansion in economic activity with moderate inflation has been undermined somewhat in recent months by the apparent slowdown in growth. And yet, the US economy looked strong in the second quarter. We do not think the shift in indicators in Europe, Japan and emerging markets points to any downturn in the global cycle. Moreover, economic data have seldom been the cause of decisive shifts in the market in June.
Investors were more concerned about the resurgence in tensions between the US and China on the trade front. Although the announcement that tariffs would become effective on 6 July on 818 Chinese products is the normal playing-out of the procedure set in place in March by the Trump administration, the subsequent war of words moved the trade conflict story back into the spotlight. Nervousness was stoked by political developments in Europe (Italy, Germany and the UK).
Investors hung on every word from central bankers, who are increasingly serving as a beacon in this shifting landscape. Meeting in Sintra on the ECB’s invitation, Jerome Powell and Mario Draghi confirmed the decisions made in June which aim to continue – or begin – to very carefully normalise monetary policies.
This commitment should ensure a smooth transition and provide support to the financial markets (both equities and bonds). In the short term, the halt to the US dollar rally, which was to be expected after a 5% increase in three months and given that current exchange rates fully price in the Fed rate rises to come, should help risky assets to recover, particularly in emerging markets.
Aside from that, investors will continue to check for any sign of a change in the solidity of the economic scenario and the political context in Europe and to balk at US trade policy, while keeping some appetite for equities.
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