Equity markets in March: another tumbleAfter the sudden swoon in equities in early February and their rocky climb back up in the following weeks, investors have taken a wait-and-see attitude, wondering about which scenario to adopt and about the impact of US trade policies. Trade-related concerns kept resurfacing during the month – from President Trump’s initial announcements and his 8 March signing of the law instituting tariffs on steel (25%) and aluminium (10%) imports (with exemptions for several countries) to his 22 March threats against China. The lack of visibility surrounding both the decisions and their consequences has kept investors on edge. Ultimately, it was the fear of a trade war (which Trump says would be “easy to win”) that took hold in investors’ minds.
Despite a rally in major equity indices during the last week of the month on reports that left hope for negotiations between China and the US rather than a rapid escalation in trade tensions, the MSCI AC World index fell by 2.4% in March, leaving it down by 1.4% on the year to date.
Emerging equities held up better (-2.0% for the MSCI Emerging in US dollar terms), giving them a modest first-quarter gain (+1.1%).
Equity volatility rose, with the VIX (based on S&P 500 options) surging to above 24 from below 20 in late February.
Given an economic environment that has remained quite robust, with the notable exception of the dip in eurozone business surveys, and with no real sign of inflation, there has been little real contagion of other risky assets.
Equity markets in March: higher volatility than in 2017Equity volatility on S&P 500 and Eurostoxx 50
Equity markets in March: specific issues
Equity markets were also hit by issues that are specific to major US tech companies, such as reputational problems in user-data confidentiality, and fears of stepped-up regulation and taxation in the US and Europe. Investor nervousness over these issues hit sector leaders after their solid performance until then, before spilling over into the rest of the market, spreading in particular to cyclical stocks and boosting defensive sectors.
In local currency terms, declines on the major developed markets were of the same order of magnitude, at -2.7% for the S&P 500, -2.8% for the Nikkei 225 and -2.3% for the EuroSTOXX 50.
US markets were hit by fears of an escalation of trade tensions that could dent US exports. Investors may have been unnerved further by yet more departures of top-level Trump administration officials. And, of course, tech company losses were exacerbated by the heavy weightings of the sector in the indices.
European indices were held back by economic data that were not as solid as expected, the euro posting further gains in March (+0.9% vs. dollar) and, to a lesser extent, uncertainty over the general elections in Italy early in the month.
Japanese equities suffered from the USD/JPY’s foray to below 105, a high for the yen vs. the US dollar since November 2016. Political scandal made a difference – because of the role allegedly played by his wife, Prime Minister Abe was undermined by a case of influence-peddling involving the minister of finances. The decline in his popularity has cast doubt on his chances of being re-elected as head of the Liberal Democratic Party in September and, thus remain prime minister.Equity markets in March Note: Index 100 = 01/01/2017. Source: Bloomberg, BNP Paribas Asset Management, as of 30/03/2018
Careful monetary policy normalisation
In the wake of the 20-21 March FOMC meeting, the US fed funds target rate was raised by 25bp to a range of 1.50% to 1.75%. This change had been fully priced in on the back of solid economic data and comments from US Federal Reserve officials. The strength of growth, and of the job market in particular, with fiscal policy likely to lend support to consumption and investment, points to a steady increase in key rates ahead.
US inflation figures soothed the fears of a sudden acceleration borne of the sharp uptick in wages in January. The PCE deflator came in at 1.8% year-on-year in February after 1.7% in January and the core figure was 1.6%. The Fed expects this inflation measure, which it keeps a special eye on, to slightly exceed the 2% target in 2019 and 2020. It has raised the level of key rates that it would deem “appropriate” for 2019 and 2020, but not for 2018. For this year, it forecasts only two additional rate rises.
The 8 March meeting of the ECB’s governing council kept key rates on hold at the levels of March 2016 (0% for the main refinancing rate, 0.25% for the marginal lending facility and -0.40% for the deposit facility) and should stay there “well past the horizon of the net asset purchases”. These purchases are set to continue at the monthly pace of EUR 30 billion until the end of September 2018 or beyond if necessary and the proceeds of maturing securities will continue to be reinvested.
The only change the council made is the elimination of the easing bias in favour of prolonging or expanding asset purchases if the adjustment in inflation looked like it could not be sustained. This is a minor change.
Meanwhile, the eurozone is enjoying “strong and broad-based growth”, which was not affected by the shift in March confidence and business surveys. The flash PMI composite, which reflects the views of purchasing managers in manufacturing and services, came in at 55.3 for March, the lowest since early 2017, but the average of this index in the first quarter still points to solid growth.
Against this backdrop, the ECB is having to look for arguments for sticking to its accommodative monetary policy. One argument is that inflation has slipped from 1.5% YoY in November 2017 to 1.1% in February. According to ECB president Mario Draghi, core inflation (at 1% in January and February) is not yet firmly ensconced in an upward trend.
Core inflation remains under controlCore inflation (CPI) year-on-year % change Source: Bloomberg, BNP Paribas Asset Management, as of 04/04/2018
The economy: generally robust as spring begins
The OECD now forecasts global growth of 3.9% in 2018 and 2019 (after 3.7% in 2017). This upward revision reflects the solid growth seen in late 2017, but, above all, the brighter outlook for 2019 for business investment and employment against a backdrop of expansionary fiscal policy in the US and, possibly, Germany.
The OECD nonetheless said “that an escalation in trade tensions would undermine growth and employment”, focusing on aspects that investors had zeroed in on in March and are likely to continue to do so.
Investors were kept on edge by the lack of clarity on the possible impact of the US president’s decision to impose tariffs on aluminium and steel imports and launch special trade sanctions against China. Europe brought its share of political uncertainties to the fore, with the Italian elections failing to produce a majority, thus opening the door to long negotiations between the main parties to form the next government.
Despite this cloudier environment, market concerns in March focused on protectionism, with investors able to cling once again to rather soothing messages from central banks, while inflation has shown no signs of an uncontrolled acceleration.
Even when, as the Fed currently, they are on the way to policy normalisation, many monetary officials appear to want to avoid disrupting the financial markets. Barring a highly unfavourable turn in events, leading to a trade war and a sudden acceleration in inflation, which would undermine central bank actions, equities are likely to be driven by robust macroeconomic and corporate fundamentals.
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