Equity market just keeps going and going
The global equity market continued rallying in October, with the MSCI AC World index posting a 2% gain in US dollar terms. This was the 12th successive month of positive performance, helped by a favourable macroeconomic environment.
After dipping in September, emerging equities rose by 3.5% despite a stronger US dollar. This outperformance was driven by the Asian equity market. The MSCI Emerging index has risen by 29.8% in USD terms since the end of 2016 compared with 17.7% for the MSCI AC World.
There has been a rise in ‘positive economic surprises’, particularly in developed economies, and indicators have remained solid in absolute terms. Based on the initial estimate, US GDP expanded by 3% on an annualised basis in the third quarter, after growing by 3.1% in the second. In the eurozone, GDP rose by 0.6% (QoQ) in the third quarter and by 2.5% on a year-on-year basis, at its fastest pace since early 2011.
Exhibit 1: Solid economic momentum around the world
Corporate earnings reports have been positive. A little more than half of S&P 500-listed companies have reported results, with 74% of them beating financial analysts’ forecasts for profits and 66% for revenues. On top of the sharp upturn in the energy sector, information technology (IT) companies made a big contribution to aggregate earnings growth.
The impact of political issues, which have been prominent in recent months, varied from one equity market to the next. The impact was very favourable in Japan and positive in the US (with one exception), but ambiguous in Europe.
Exhibit 2: Japanese equity market outperformed in October
The Tokyo equity market cheered the big victory of Shinzo Abe’s coalition in general elections on 22 October. His victory should provide greater clarity on economic policy, and monetary policy in particular, as Abe is a strong supporter of the Bank of Japan’s ultra-accommodative measures. The Nikkei 225 recorded gains in 16 consecutive trading sessions (from 2 October to 24 October) and consolidated only slightly thereafter. It broke above 22,000 points on 27 October, for the first time since July 1996, and ended the month up by 8.1% vs. end-September. The USD/JPY’s return to 114, the upper end of its trading range of the past six months, supported export-driven sectors.
ECB monetary policy remains very accommodative
In the eurozone, equities were held back by the standoff between Madrid and Barcelona since the 1 October referendum, which led Catalonia to declare independence. The move was followed by the Spanish government imposing direct rule on 27 October.
The EuroStoxx 50 gained 2.2% over the month, due mainly to its 1.3% rally on 26 October in reaction to comments by ECB President Mario Draghi. Although the central bank announced a reduction in its quantitative easing programme, its tone remained highly dovish.
- Net asset purchases will be halved from EUR 60 billion to EUR 30 billion per month beginning January 2018 and “until the end of September 2018 or beyond if necessary”.
- The ECB’s key rates “will remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases”.
- The ECB is leaving open the possibility “to increase our asset purchase programme in terms of size and/or duration”.
- Proceeds of maturing bonds will continue to be reinvested.
This is probably the least aggressive monetary policy adjustment that could be imagined, and Draghi did not try to correct this impression. The announcements were officially deemed “recalibrations”. The ECB acknowledged the improvement in the economy, and in the job market in particular, which is likely to lead to an acceleration in nominal wages, but also pointed out that this improvement was due to accommodative monetary policy and was not yet self-sustaining. The ECB president said that asset purchases would not “stop suddenly”.
In our view, weak inflation (1.4% YoY in October, based on the preliminary estimate, 0.9% ex-food and ex-energy) provides the grounds for a very gradual normalisation in monetary policy and a long status quo on key policy rates.
Exhibit 3: The pace of inflation remained feeble in the eurozone
New highs for US equitymarket
US equities were at first driven by news of Congressional headway on the budget procedure, which raised hopes of a prompt passage of proposed tax cuts, before taking a hit from the indictment of President Trump’s former campaign manager, as part of the investigation into possible Russian interference in the 2016 presidential election.
The Dow Jones 30 gained 4.3% on the month and the S&P 500 2.2%, as the main US equity indices set new records despite a slight upturn in implied volatility. The VIX index, which is based on S&P 500 options, ended the month above 10%, compared to 9.5% at the end of September. IT, utilities, basic materials and financials outperformed.
The environment should remain favourable
October’s rally continued against the backdrop of rather encouraging earnings releases and a still-robust economy. The outlook for tax cuts in the US was another catalyst, while central bank news (expectations and actual announcements of decisions, and rumours of appointments at the US Federal Reserve) suggested that monetary policies would be normalised very gradually.
So, factors shaping the investment environment took a more favourable turn in recent weeks, although political issues are still raising concerns. The situation in Spain is fraught, to say the least, after the Catalonian declaration of independence and the takeover of the region by the Spanish government, which set regional elections for 21 December.
President Trump’s attitude during the renegotiation of the North American Free Trade Agreement (NAFTA) has revived fears of a resurgence in protectionism. Brexit negotiations are continuing, but little headway has been made, while in Germany, coalition talks have entered their more difficult phases and are not over. Investors may be pricing in political risk, especially as global equities have just turned in their 12th consecutive month of gains. In light of the positive macro- and microeconomic fundamentals, any tentativeness on the equity market is likely to be temporary.
Exhibit 4: S&P 500 – sector performance (monthly performance for October 2017, in %)
Exhibit 5: MSCI EMU – sector performance (monthly performance for October 2017, in %)
Written on 08/11/2017