Overview of what happened in equity markets in August 2017

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Geopolitics came into play in August

Financial markets clearly tracked the deterioration in the geopolitical and political climate in August. Investors were spooked by the tragic terrorist attacks in Spain but the main reason for nervousness in the equity markets came from Washington.

The war of words between Pyongyang and Washington, after the North Korean missile tests in late July, was a source of concern for investors up to mid-August. Subsequently, domestic developments in Washington heightened doubts on the Trump administration ability to enact stimulus measures.

Against this troubled backdrop, equity markets initially fell as the dispute between the US and North Korea escalated. Over the full month the MSCI AC World index rose slightly (+0.2% in US dollar terms), thanks to a month-end rally sparked by favourable economic indicators, while the MSCI Emerging Markets index outperformed significantly (returning 2% in USD terms over the month).

Exhibit 1: Emerging markets equities extended their run of outperformance relative to developed market equities in August 2017

market

Source: Bloomberg, BNP Paribas Asset Management, as of 31/08/2017

A month-end rally

While geopolitical concerns weighed on equity markets globally (and Asian indices in particular), developments in Washington at first mainly affected US markets. US small caps reacted particularly as they are more exposed to domestic demand. The Russell 2000 index fell by 1.4% over the month.

The S&P 500 rallied in the closing days of August to end the month basically flat (+0.1%). Solid performances by the IT and utilities sectors offset poor performance in the energy sector (due to falling oil prices), telecommunications and financial stocks.

Exhibit 2: US Small cap stocks were particularly penalised by political developments in August

marketSource: Bloomberg, BNP Paribas Asset Management, as of 31/08/2017

The EURO STOXX 50 index, which had held up better in the first three weeks of the month, was hit by the resumption in the euro’s rally on 23 August and ended the month down by 0.8%. Interest-rate-sensitive sectors (utilities and real estate) were the month’s biggest gainers.

The EUR/USD exchange rate settled at around 1.18 for the first three weeks of August. The release of better-than-expected economic activity surveys triggered a  strengthening of the euro on 23 August. The fact that Mario Draghi made no mention of the stronger euro in his Jackson Hole speech and the statements of other central bank Governors on this subject convinced market participants that there were no impediments on the euro’s upward trajectory. After a brief foray above the 1.20 level on 29 August (the highest level since early 2015), prompted by concerns over new North Korean missile launches, the EUR/USD ended the month at 1.1876, up 0.6% vs. end-July. Solid US economic figures helped the dollar recover somewhat at the very end of the month.

Exhibit 3 : The euro’s upward trend versus the US dollar seems to be running out of steam

marketSource: Bloomberg, BNP Paribas Asset Management, as of 31/08/2017

In Tokyo, the Nikkei 225 index declined by 1.4% but the broader TOPIX index managed to hold firm (-0.1%). Export-driven sectors fared well, unlike the financials sector and those that are at an early stage in the production process. In early August, the Japanese prime minister undertook a minor reshuffling of his government, with plans to set up new structural reforms in the combat against deflation.

Exhibit 4 : The US equity market rallied at the end of August

market

Source: Bloomberg, BNP Paribas Asset Management, as of 31/08/2017

In the first eight month of 2017 global equities have risen by 13.4%, what happens next ?

Conditions in equity markets were a little more chaotic in August than in previous weeks. This was reflected in the upturn in volatility during the month, with the VIX rising back to its highest levels this year, last seen during the second quarter.

Late in August, it fell back to 10.5%, near its average level in July (10.3%). Nonetheless, the fact that the equity markets held up relatively well against a backdrop of negative geopolitical and US domestic politics over the summer can be considered a good sign.

Despite some tentativeness in August, the MSCI AC World index (in US dollar terms) rose by 2.9% vs. end-July. That takes it to up 13.4%  year-to-date. What’s more, the positioning of both professional and retail investors does not seem to suggest excessive exuberance among them with regard to equity markets.

Overall the economic environment has been favourable, particularly in the eurozone. With inflation still lacklustre, central bankers have flagged their intent to proceed very cautiously with the normalisation of their monetary policy. They also clearly do not want to provoke any tantrums among investors that could lead to a  knee-jerk reaction in bond markets at a time of very low interest rates. This will be a tricky exercise, to say the least – equity market valuations are stretched and may find adapting to adjustments in monetary policies a challenge. On the microeconomic front, after a solid reporting season, earnings expectations look demanding, in our view.

Exhibit 5: S&P 500 – performance of sectors (monthly performance for August 2017, %)

marketSource: Reuters Datastream, BNP Paribas Asset Management, as of 31/08/2017

Exhibit 6: MSCI EMU – performance of sectors (monthly performance for August 2017, %)

marketSource: Reuters Datastream, BNP Paribas Asset Management, as of 31/08/2017


Written on 31/08/2017

Nathalie Benatia

Strategist

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