- The MSCI AC World index gained 2.6% (in USD terms) and is up by 17.3% year-to-date.
- Emerging market equities outperformed (+4.1% for the MSCI Emerging index in USD), driven by the strength of markets in Russia and Asia, and the rebound of many emerging market currencies against the US dollar.
- Renewed risk appetite clearly contributed to weaker government bonds despite the cut in the US federal fund rates; German Bunds underperformed their US T-note peers.
A month that began with anxiety ends with a relief rally
Equity markets fell sharply in response to disappointing economic indicators. Surveys of purchasing managers showed a downturn in activity in September, in both the manufacturing and services sectors. In the US in particular, the ISM non-manufacturing index lost 3.8 points at 52.6, its lowest since August 2016. This undermines the assumption that the services sector could resist the slowdown in manufacturing. However, subsequent data suggests domestic demand has remained strong. Investor attention quickly shifted to political factors.
Firstly, the prospect of a partial trade agreement (‘phase 1’) between the US and China was seen as reassuring. Markets welcomed the announcement that tariff increases due to enter into force on 15 October would be suspended. Negotiators indicated that progress has been made in three important areas: Greater opening-up of the Chinese market to US financial services firms, the removal of the practice of forced transfer of technology, and the protection of intellectual property. Details were not yet available, but the tone adopted by both sides appeared to be quite conciliatory, raising hopes that an agreement could be signed in mid-November.
At the same time, exchanges between the UK and the EU took a more constructive turn as the 31 October Brexit deadline approached. Although the situation remains confused, the EU agreed to postpone the deadline to 31 January 2020 to allow the British parliament to pass the proposed withdrawal agreement. Meanwhile, Premier Boris Johnson’s push for a general election in December received parliamentary approval. Even if nothing is settled, the probability of a no-deal Brexit has, for now, receded.
Exhibit 1: Equities rose in October (MSCI indices)
European Central Bank: Ciao Mario
For market observers, the main point of interest was that the ECB monetary policy meeting in October was the last chaired by Mario Draghi. At the press conference, he was asked about dissent within the governing council over the resumption of the asset purchase programmes (APP). Several governors (notably from France, Germany and the Netherlands) had indicated that they were not in favour of resuming purchases. On 4 October, six former central bankers issued a memorandum saying Draghi was pursuing an overly lax policy that weakened the financial sector. His response remained evasive (‘we have discussions, everyone has discussions’), but he emphasised that ‘the general assessment [within the council] of negative rates is positive overall.’
This statement is significant as debates about the effects of negative interest rates are becoming more frequent and the ECB's room for manoeuvre in lowering rates further seems limited. The economic analysis remained cautious: the ECB stressed the persistence of downside risks related to uncertainties linked to geopolitical factors and the rise of protectionism.
The continued labour market improvement, with the unemployment rate at 7.5% in September, its lowest since July 2008, is consistent with the ECB's expected ‘moderate, but positive’ growth in the second half of the year. At the same time, persistently low inflation (0.7% YoY in October; 1.1% YoY excluding food and energy) has allowed the ECB to maintain its accommodative monetary policy. Draghi again urged fiscal policy to take up the baton. In her first interviews, his successor Christine Lagarde echoed this call.
Exhibit 2: Eurozone GDP growth: weak, but better-than-expected
A little puzzlement does not prevent a rise in equities
Global equities rose significantly and the S&P 500 index set a record high at the close of trading on 30 October. Yet investors still seemed reluctant to take large equity positions, and overall sentiment remained cautious.
The sharp decline in equities in the fourth quarter of 2018, as well as their steep fall this May and, to a lesser extent, in August, have left their mark. Moreover, after each fall, the upturn was not based on objective indicators (economic data, company results), but on hopes that the main sources of concern (trade tensions, Brexit) would dissipate.
Such behaviour is not unusual in stock markets, but we believe it has been pushed to the limit in recent times. As a result, the rise in equities looks fragile.
In the short term, the rally could continue, supported by the recent easing of monetary policy. Investors may doubt the effectiveness of the latest measures, but financial conditions are undeniably much more favourable than they were at the end of 2018 when major central banks were contemplating a halt to unconventional monetary policies and an end to ultra-low policy rates. Equity valuations relative to bonds have improved slightly, with long-term bond yields much lower than at the start of the year.
Finally, as highlighted above, investors' exposure to equities has remained cautious, so any sell-off may provide them with an opportunity to reposition themselves.
Given that we believe recession can be ruled out, even if the risks have increased, the equity rally could continue in the short term. There will doubtless be jitters, so we are maintaining a highly tactical approach to asset allocation.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.