Equity markets in September: Italy stole, in extremis, the headline from Trump

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Please note that this article may contain technical language. For this reason, it is not recommended to readers without professional investment experience.

Global equities could have fared worse in September, judging by the first week, when the MSCI AC World index (in US dollars) fell by 1.9%, or better, considering the rally that lasted until 25 September (+2.6%).

These shifts were due mainly to how news on the “trade front” was interpreted. After fearing the worst in early September, investors were somewhat reassured by the White House statement on 17 September, in which President Trump announced an increase from 10% to 25% in tariffs on USD 200 billion of products imported from China, effective 1 January 2019, and threatened to target another USD 267 billion in goods in the event of reprisals. Investors mostly shrugged off these statements, no doubt taking them to be Trump’s normal “negotiation” tactics.

Central bank measures, particularly in Turkey, were deemed constructive in creating a respite for emerging currencies. Further reassurance came from rather encouraging economic figures and G7 central bank guidance that pointed to a slow and cautious normalisation in monetary policies rather than a sudden tightening.

At the very end of the month, the Italian government cast a pall over the markets when it submitted a “budget of change”. While short on details, it did take up some of the campaign promises, which should mean a widening in the fiscal deficit to 2.4% of GDP in 2019, 2020 and 2021.

Heavy upward pressure on Italian bond yields and the sharp drop in the Milan equity market weighed on stocks as a whole and weakened the euro. Against this backdrop, the MSCI AC World ended the month up by just 0.3%. Interestingly, after rising slightly in the first week of the month, equity volatility rather quickly receded to about 12% for the VIX (S&P 500) and 13% for the VSTOXX (EuroSTOXX 50).

The MSCI Emerging index (in US dollars) fell by 0.8%, due mainly to the poor showing by Asian markets amid the trade conflict rhetoric. In contrast, emerging European and Latin American markets were driven up by higher oil prices with WTI rising by 4.8% to more than USD 73/bbl.

This level had not been seen since July. OPEC refused to state clearly whether an increase in output was being considered, given that supply of crude will be dented by the sanctions on the Iranian energy sector that are scheduled to kick in at the start of November.

Exhibit 1: Rise in oil prices since mid-August

Source: Bloomberg, BNP Paribas Asset Management, as at 28/09/2018

New closing records for US equities

European equities ended the month almost level (+0.2% by the EuroSTOXX 50) after falling by 1.5% on 28 September. In Milan, the MIB lost 3.7% on that day, but its monthly gain is still considerable, considering that investors were expecting a more favourable budget from the Italian government prior to the actual announcement.

Among major developed markets, US equities did well, with the S&P 500 and Dow Jones setting new closing records in September, driven higher by corporate earnings and very solid economic indicators pointing to continued robust growth in the third quarter. The S&P 500 gained 0.4% on the month despite declines in basic materials, financials, utilities and techs.

In Tokyo, equities began the month by falling sharply on global trade concerns and the natural disasters that have hit Japan. They promptly rallied, driven by a weaker Japanese yen (-2.3% vs. the US dollar), solid economic data and Shinzo Abe’s re-election as leader of the Liberal Democratic Party, allowing him to remain prime minister and to pursue to the government’s expansionary economic policy. The Nikkei 225 gained 5.5% in September, touching a 27-year intraday high.

Exhibit 2: Rally of Japanese bonds in September

Source: Bloomberg, BNP Paribas Asset Management, as at 28/09/2018

Emerging economies under watch

In emerging economies, the sharp increase in the Turkish central bank’s base rate (+625bp to 24%) helped the lira rally. More broadly, currencies that had been mauled manhandled in August tended to recover, as investors cheered geopolitical progress, headway (including a trade agreement between the US and Mexico) or shrugged off poor economic performances.

The South African rand fell in early September over due to an unexpected contraction in GDP in during the second quarter (-0.7% after -2.6%), before rallying on news the announcement of an economic stimulus plan. Amid the With widespread rejection of the proposed austerity drive plan and despite a sweetened IMF assistance plan, the Argentine peso continued to dropped further against the a backdrop of an acceleration in inflation and the resignation of the central bank governor.

In Brazil, with the presidential campaign set to unfold over the next few weeks (with the first round of voting is on 7 October and the final result is on 28 October), the real hit an all-time low againstvs. the US dollar due to the many economic policy uncertainties, while in the economic policy whereas the fiscal deficit has already widened considerably.

Exhibit 3: Some emerging market currencies remain fragile

 

Source: Bloomberg, BNP Paribas Asset Management, as at 28/09/2018

A shifting environment

After being hit by several “anxiety fits” during the summer, related to emerging currencies, Italian bond yields, and the latest global trade developments, tentativeness in early September quickly gave way to more constructive trends despite a market environment that remains somewhat tense.

The stabilisation of the Turkish lira, the pullback in Italian bond yields, a weakening US dollar, and new closing records for the S&P 500 might give the impression that calm has been restored. But the last, volatile trading session of September showed that this was not so. Instead, the more positive trends prior to that last trading day in our view reflect investor pragmatism.

Given the many issues (the repercussions of US trade policy, the Italian government’s fiscal policies, and the Brexit negotiations) that do not look ready to be resolved, it makes sense to focus on favourable fundamentals, but without giving in to exuberance. Solid economic indicators, appropriate reactions from central banks in Turkey and Argentina to slow the declines in their currencies, and the cautious normalisation of G7 monetary policies can all be considered supportive factors.

A shift is occurring in the landscape that we had grown used to, and a new equilibrium will probably take time to become established. There is no point in being timid during this phase of instability, especially as many safeguards are in place to avoid the worst on the trade front. Nor is there any point in playing daredevil in this shifting landscape. Clear responsiveness and strong discipline should, more than ever, govern asset allocations.


To read more content by Nathalie Benatia, click here.

Nathalie Benatia

Macroeconomic Content Manager

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