After rallying in July, global equities consolidated briefly in early August before falling until mid-month. Markets then shifted direction amid slightly more encouraging news on the trade conflict between China and the US and Turkey’s steps to stem the drop in its currency. While neither of these developments was truly decisive, investors interpreted them as steps in the right direction despite a number of outstanding issues. This impression was bolstered further by the trade agreement reached between Mexico and the US late in the month.
Stocks supported by strong second-quarter earnings
Economic data, meanwhile, improved slightly overall, lessening the possibility of a marked shift in global growth. Quarterly corporate results were once again solid, in particular in the US, where the tax cut boosted profits, while solid economic growth led to 9% revenue growth for S&P 500-listed companies. According to US national accounts, pre-tax profits continued to increase in the second quarter (by 7.7% year-on-year) to their highest point in this cycle.
Underperformance of emerging equities continues in August
In this rather favourable macro- and microeconomic environment, and as political issues appeared to receed somewhat, the MSCI AC World (in dollars) began a rally that led it late in the month to levels not seen since mid-March. A pull-back on the last trading session of August, however, reduced its monthly gain to 0.6%. The MSCI Emerging (in dollars) continued to underperform, falling by 2.9% in August and by 8.9% year-to-date, while the MSCI AC World has risen by 1.9% in the first eight months of 2018.
Problems in Turkey, and, to a lesser extent, Argentina, weighed on emerging equities and sent some currencies into a steep dive. This exacerbated the decline in dollar-denominated indices. Emerging Europe and Latin America, for example, fell sharply. Asian equity markets were less affected as support from the Chinese authorities and central bank easing measures managed to stem the drop in Chinese equities.
Exhibit 1: Emerging equities continued to underperform
Source: Bloomberg, BNP Paribas Asset Management, as at 31/08/2018
Monthly performances of developed market equities
In major developed markets, US equities outperformed by far, with the flagship indices (S&P 500 and the Nasdaq) setting records at the close of the month, driven by solid corporate earnings and economic indicators that are pointing to further solid growth in the third quarter after a 4.2% increase in GDP in the second quarter. The S&P 500 rose by 3.0% in August, led by tech stocks and consumer cyclicals.
Falls in eurozone indices (-3.8% for the EuroStoxx 50) reflected, on the one hand, concerns in the financial sector about contagion from the Turkish crisis, and, on the other, the Italian market’s poor performance amid upward pressure on bond yields due to budget negotiations within the government. In addition to banking stocks, interest-rate-sensitive stocks such as telecoms and utilities underperformed.
In Tokyo, the Nikkei 225 rallied by 1.4% after erratic shifts, while the broader Topix index fell by 1%. Although the Bank of Japan indicated late in July that it wanted to give preference to Topix ETF purchases under its asset-purchase policy, investors feared that it would buy less than originally planned. Japanese markets initially suffered from a slight uptick in the yen, whose safe haven status sent the USD/JPY exchange rate back to 110 by mid-month. Subsequently, Japanese equities joined the global equity rally. Sectors exposed to domestic demand tended to underperform in August.
Exhibit 2: New surge in US equities
Source: Bloomberg, BNP Paribas Asset Management, as at 03/09/2018
Currency sell-off in Turkey and Argentina spills over into other EM currencies
Forex market participants in August looked askance at the sudden falls in several emerging currencies, mainly the Turkish lira and the Argentine peso, both of which lost 25% against the dollar over the month.
In Argentina, despite aggressive measures by the central bank and assistance granted by the IMF in May, poorly worded government statements revived concerns late in the month. In Turkey, the lira fell sharply in early August on US sanctions and President Erdogan’s actions since his re-election (e.g., undermining the central bank’s independence, and appointing his son-in-law as finance minister) have done nothing to inspire the confidence of international investors. Against this backdrop, news of the departure of a central bank vice-governor triggered a new bout of weakness in the lira very late in the month after initially appearing to bottom out on 13 August.
Market participants’ nervousness spread beyond Argentina and Turkey, as seen in a return of volatility in emerging currencies to the highest levels since early 2016. This nervousness led to the traditional retreat into developed country currencies that are considered safe havens (the yen, the Swiss franc, and, to a lesser extent, the US dollar). As a result the Swiss franc gained 2.9% against the euro and 2.1% against the dollar.
Exhibit 3: Higher volatility in emerging currencies
Source: JPMorgan, Bloomberg, BNP Paribas Asset Management, as at 04/09/2018
Summary – a robust macro and microeconomic environment, but disconcerting political events
In August, investors once again kept a close eye on international trade news and, more generally, the latest on the US diplomatic front. These moves are hard to interpret or predict. The trade agreement between the US and Mexico, which opens the door to a new version of NAFTA, was regarded as a step forward, while the first trading sessions of August had been marked by concerns over Turkey, fed by statements by the US president, which exacerbated the drop in the Turkish lira.
In the economic arena, investor concerns over the strength of global growth receded somewhat as indicators remained solid in the US and began to improve in the eurozone and emerging economies. Central bank guidance remained accommodative, boosting assumptions of a very gradual normalisation in monetary policies despite some signs of an acceleration in inflation, particularly in the US. And measures by the People’s Bank of China (PBoC) to stem the depreciation in the yuan appeared to be an additional factor in stabilising global markets.
However, considerable uncertainties remain around the Sino-US trade conflict after the 23 August imposition of reciprocal tariffs as well as the political situation in Europe. The UK government began to consider a scenario of a Brexit without an agreement by 29 March 2019 and released several technical notes on the topic. In Italy, budget decisions, which involved raucous discussions within the government during the summer, should be presented in September and will be reviewed in October by the European Commission.
Finally, US mid-term elections are approaching. The outcome of the 6 November voting is likely to be a close run thing, but if the Democrats were to regain control of the House of Representatives, it would revive questions over the president’s future after constant controversies this summer involving close collaborators.
On one hand, a robust macroeconomic and microeconomic environment, and, on the other, disconcerting political events have focused investors’ minds in recent months and triggered erratic shifts in the financial markets. With summer holidays now over, there could be a return to fundamentals, at least for a while.
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