Weekly Economic Update: Red October as Global Assets Show Negative Returns

By Alexander Forbes Investments on Nov 08, 2018 in Market and Economic Commentary

 

Global wrap – Red October across all major asset classes

A cocktail of bad data, downwardly revised global expectations, and continued capital flight from emerging markets, culminated in increased volatility and negative performance returns in all major asset classes. The International Monetary Fund’s downward revision of global growth, to 3.7% from 3.9%, for both 2018 and 2019, reignited concerns about the potential for a market correction or a bear market. Oil prices initially increased above US$80/bbl, before declining by 14.2%, to US$73/bbl. However, year-to-date (YTD) prices remain 8.7% higher.

The MSCI World and the MSCI ACWI indices returned -7.3% and -7.5% in October, and -1.9% and -3.5% YTD, in US dollar terms. The MSCI Emerging Market Index returned -8.7% in October, and -15.5% YTD. Bond markets also saw negative performance returns, with the Citi World Government Bond Index returning -1.1% in October, and -3.6% YTD. The JP Morgan Emerging Market Bond Index returned -1.2% in October, and -10.4% YTD.  

October’s market performance highlights a slightly worse outlook than what we have been emphasising over the past couple of months – we are in a low-return environment. The likelihood of negative performance returns for 2018, if we do not see a rebound in markets, as we move into year-end, has increased. That said, even if we see a rebound into year-end, it will most likely be temporary, given the risks of increasing interest rates, ongoing trade tensions, the beginning of sanctions on Iran’s oil exports, and the impact these will have on global growth.  

 

US – Below-expectation technology stock earnings spook markets

With a decline of 6.9% and 9.2%, respectively, October 2018 was the worst October for the S&P 500 and the NASDAQ since 2008. Due to capital flight from emerging markets into safe-haven assets, the US ten-year and two-year bond yields were up 6bp and 5bp, to 3.17% and 3.09%, respectively, which leaves the yield curve a mere 8bp from inversion. The US dollar index was up 0.6% in October, and 4.3% YTD. Technology stocks carried US equities higher in 2018, but were also the trigger for a market correction. At some point there was even debate on whether they could be a safe-haven asset, but October showed they are not – the widespread decline followed below-expectation tech stocks.

On the data side, personal income growth disappointed, while personal spending was in line with market expectations. Unit labour cost and non-farm productivity beat expectations by two- and one-tenth of a percent, growing by 1.2% and 2.2%, respectively. The change in non-farm payrolls exceeded expectations by 51 000 jobs, with 246 000 new jobs created in October, which was higher than the previous month and market expectations.

This week’s big market movers are going to be the US mid-term elections, the US Federal Reserve (the Fed) rate decision, and news flow related to a potential trade deal between the US and China. Regarding mid-term elections, a majority win for the Republican Party, in both the Senate and House of Representatives, will be positive for equity markets, while if the Democratic Party wins either house, it will likely be negative for equity markets. The Fed is expected to keep rates unchanged at 2.25% in November, and to hike rates by 25bps to 2.5% in December; the market is pricing in a probability of only 5.7% for a hike in November. However, for the December meeting, markets are pricing a 76% probability for a hike. 

 

Europe and the UK – Brexit stalls and Italy’s fiscal issues continue

European markets followed the US lower in the month, although they were up last week. The Euro Stoxx, FTSE 100, CAC 40, and the DAX declined by 4.8%, 4.1%, 5.2% and 5.6%, respectively, in October. However, they were all up by at least 3.3% last week. Bond market performance varied by country and duration. Two-year bond yields declined in Germany, Italy and the UK, over the month, but they rose last week in Germany and the UK, due to Brexit concerns.  The Bank of England (BOE) unanimously kept rates unchanged at 0.75%, in line with market expectations and interestingly, indicated that rates are likely to rise faster than expected, if Brexit negotiations conclude smoothly, and along the expected timelines.

 

Emerging markets – sell-off continues    

The MSCI Emerging Market Index recouped lost ground last week, relative to the previous week, rising 3.4%, but it was 16% lower YTD. For the month, the Brazil MSCI was up 15%, following the election of the far-right Jair Bolsonaro as President, with a 55% majority vote. Elsewhere in emerging markets, equities were down across the board, due to capital flight to safe-haven assets. However, markets ended last week on a positive note, due to expectations of a potential trade deal between the US and China.  

 

South Africa – Weak data underscores poor growth recovery

Money supply beat expectations, growing by 7.0% year-on-year in September. However, private sector credit moderated to 6.2% year-on-year, which was also below expectations. The trade balance turned into a deficit of R3.0bn, from a surplus of R8.8bn in the previous month. The Absa PMI index, a gauge of the health of the manufacturing sector, declined to 42.4 points, from 44 points, which implies that just under 60% of manufacturing purchasing managers are dissatisfied with prevailing business conditions. This doesn’t bode well for next week’s manufacturing and mining production data. Perhaps the more concerning data was the unemployment rate, which increased to 27.5% in Q3 2018, from 27.2%, which is in line with an economy still in a technical recession. This is not positive for retail sales, and presents a risk for our business. However, not all is gloomy. A coordinated communication strategy seems to be on the cards between the South African Reserve Bank and National Treasury, with the governor highlighting that the policy debate is being won by the orthodox and rational side, while the Finance Minister categorically said South African Airways needs to be closed, because it is loss making.

Local asset class returns were in the red, except the tradable property index and cash, which returned 0.1% and 0.6% in rand terms, respectively. The JSE All Share returned -5.8%, while the Top 40 returned 6.7%. The Capped SWIX was slightly better, but still in negative territory, with -4.6%. Industrials were the biggest losers, with -8.0%, followed by resources (-4.0%) and financials (-3.2%). This October recorded the second worst performance returns in 23 years. The stage looks set for a relief rally in local equities: outflows have been significant, technicals are supportive, valuations are cheap, and the policy measures in China, indirectly support South Africa, via the resource sector, and China-exposed stocks. Indeed, the 10 largest active fund managers have reduced their global holdings by 3.9%, rotating into local equities, cash and bonds. That said, 2019 still looks to be a challenge for South African assets, as global growth slows and monetary policy tightens.

This week: Iran sanctions, US mid-term elections and US Fed meeting

This week will be a big week in markets. First, US sanctions on Iran’s oil exports kicked in on 5 November. Iran’s oil production has already declined by some 10%, but so far this has been offset by increased production from other OPEC producers. Market expectations are that oil prices will likely rise once sanctions take effect. Second, the Fed is expected to hike rates by 25bp to 2.25%, when it meets, taking the likelihood of a US yield curve inversion even closer. An inversion of the US yield curve has preceded seven of the past seven US recessions, four to five quarters later. More importantly, the US mid-term elections are likely to have a significant impact on markets, depending on whether there are changes in who leads the House and Senate, which are both currently lead by the Republican Party. 

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Alexander Forbes Investments

Alexander Forbes Investments

Alexander Forbes Investments was established in 1997. We are a forward-thinking and trusted global investment provider, with roots in Africa. In pursuit of certainty we set out to understand our retail and institutional clients’ circumstances and risk tolerance to set clear goals. Our adaptive investment approach, called Living*Investing allows us to maximise opportunity and minimise risk at every stage of the investment cycle.

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