After achieving some gains early in the month, followed by some volatility amid doubts on global growth and rising political uncertainties, equity markets rallied late to finish November ahead (with the MSCI AC World index in US dollar terms up by 1.3%). The rally was triggered by soothing language from the Fed on its monetary policy and some encouraging developments on several political and geopolitical issues.
Exhibit 1: Equities rally towards the end of November
Source: Bloomberg, BNP Paribas Asset Management, as at 30/11/2018
On the political front, investors mostly shrugged off the outcome of US mid-term elections, which left Congress divided, with the Democrats gaining a majority in the House of Representatives, while Republicans held onto the Senate. The reason for this relative indifference was likely that the markets are having a hard time assessing the impact of this new balance of power in Washington.
Although President Trump and his administration continued to blow hot and cold on the issue of trade tariffs on Chinese goods, the markets began to price in a reconciliation on the trade front in the run-up to the G20 summit and the meeting scheduled between Trump and President Xi Jinping in Buenos Aires. These expectations were borne out on Saturday, 1 December, with news of a lull in the skirmish. The US agreed to forego a January hike in tariffs from 10% to 25%, while China pledged to boost imports from the US and promised to expand talks on touchy issues such as respect for intellectual property and the opening of its domestic market.
Also on the political front, but in Europe this time, lively talks between the European Commission and Italy led Giuseppe Conte’s government to soften its position somewhat, but no definitive announcement has yet been made on the draft 2019 Italian budget. In the UK, the markets will be keeping a close eye on Parliament’s decision on whether or not to ratify the Brexit agreement negotiated by Theresa May and approved by her government and the 27 other EU member states in November.
The price of oil is falling
One issue that overlapped between the economic and political spheres was the plunge in oil prices (with WTI dropping by 22% to USD 51/bbl., a low since October 2017). This was triggered by supply-side issues more than the concerns over global growth that had been raised by a downgraded outlook and warnings of looming risks and headwinds. Since early October, when oil prices exceeded USD 75/bbl, it had become clear that US production was abundant, that the impact of the embargo on Iranian exports had so far been weaker than expected, and that OPEC members were having a hard time agreeing among themselves.
Exhibit 2: WTI oil at USD 50 a barrel
Source: Bloomberg, BNP Paribas Asset Management, as at 04/12/2018
In emerging economies, falling oil prices hit Latin American markets, while markets in emerging Asian countries that are net importers of oil outperformed. On the whole, the MSCI Emerging Markets index (in US dollar terms) gained 4.1%. Among major developed markets, Japanese and US equities finished almost in a tie in November, with the Nikkei up by 2% and the S&P 500 up by 1.8%, while European shares ended the month down (by 0.8% in the case of the EuroStoxx 50). Energy stocks underperformed on all markets.
European markets were driven down mainly by the poor showing by cyclicals amid ongoing disappointment in economic indicators. The markets were also wary of the health of the German automotive sector. In contrast, eurozone investors flocked to sectors exposed to bond yields, such as telecommunications and utilities. Globally, defensive sectors fared better, including US healthcare, which was the biggest winner by far in the S&P 500, while tech stocks ended the month down.
The Fed tweaks its proposal ahead of December’s meeting
As expected, the Federal Open Market Committee (FOMC) kept its federal funds target range on hold during its 7-8 November meeting, at 2.00% to 2.25%. There was nothing new in the rather laconic communiqué. The Fed continued to point to a solid job market and strong economic growth, but did flag the lacklustre increase in investment in the third quarter.
Economic indicators have indeed been solid in recent weeks, in particular on the job market, with unemployment standing at 3.7% in October and an acceleration in year-on-year wage gains to 3.1%. Based on the second estimate, GDP growth came in at an annualised 3.5% in the third quarter, driven by a surge in private consumption (+3.6%), an upward revision in productive investment (to +2.5%, a still rather modest level), and a heavy contribution from inventories (+2.3pp), but penalised by a negative external contribution (-1.9 percentage points). What’s more, private consumption beat forecasts in October, despite a slight dip in household confidence (which nonetheless remained high). The housing market has fared less well over the past few months.
The November monetary policy meeting was the last one without a press conference, as Jerome Powell is scheduled to hold one after the 18-19 December meeting and announced that each meeting thereafter will be followed by a press conference. So in November, to fine-tune their expectations of future interest-rate increases, Fed-watchers had to make do with speeches and comments from FOMC members.
From these, they gleaned that there has been an apparent shift towards a slightly more cautious and less clear-cut stance. Jerome Powell spoke on two occasions, first on 14 November, when he reiterated his “balanced” vision of growth but did mention some risks, a few days before the Fed vice-chairman, Richard Clarida, suggested there was a greater need for data-based assessments (the job market and inflation) in determining the appropriate pace of interest-rate increases and what the ultimate target should be.
But the highlight of the month was Powell’s 28 November speech to the New York Economic Club. Powell stated that key rates were currently “just below the neutral level”, in contrast with his early October statements that interest rates were still “a long way from neutral”. This eased fears of a series of rate hikes in 2019. While the markets have already priced in a 25bp increase in December, their expectations for the following months back-tracked. The minutes of the FOMC’s November meeting, which were released on the day after the New York speech, confirmed the more flexible approach to monetary policy that the FOMC wants to adopt, beginning next year.
Exhibit 3: Are we seeing a reversal in the US yield curve?
Source: Reuters Datastream, BNP Paribas Asset Management, as at 04/12/2018
A new world?
Financial market trends in November reflected the issues that have concerned investors for some time now and that are likely to continue to do so next year, including political and geopolitical uncertainties, doubts on how sustainable growth is, and the phasing out of accommodative monetary policies.
The political issues are obviously inscrutable – if there is one thing we’ve learned in recent years, it’s that the outcome that seems most unlikely sometimes happens. So, the markets have tended to track the latest news and, in November, Brexit developments, Italy’s run-in with the European Commission, and trade talks between China and the US seemed to be taking a somewhat favourable turn.
Economic indicators fell slightly below forecasts, feeding doubts on the health of the global economy just as the IMF and OECD were pointing to burgeoning risks and downgrading their growth forecasts slightly for 2018 and 2019. Investors were spooked by this dip in the short-term outlook, despite the fact that growth is still satisfactory in absolute terms.
Against this backdrop, central bankers have changed their tune. Now they are saying that monetary policy will continue to be normalised but that, rather than a clear-cut approach, it will have to be more data-based so as to reflect the actual situation. Once again, the Fed is on the front lines, as its policy is close to the point where it will become restrictive at a time when policies are obviously still ultra-accommodative in the other major developed economies.
In late November, the Fed used some soothing language but normalisation is happening nonetheless, and investors will have to learn, sooner or later, to live without quantitative easing (QE). In concrete terms, low volatility appears to be a thing of the past, and correlations between assets could very well reverse themselves, all of which will require considerable flexibility in asset allocation.
To read more content by Nathalie Benatia, click here.