Market Review and Outlook
Review of October 2018
October lived up to its reputation as a difficult month for investors, as rising U.S interest rates and bond yields combined with geopolitical fears to create a sell-off in risk assets.
The MSCI World index of developed stock markets fell 5.4% in sterling terms in October, and was down 7.3% in U.S dollar terms and 6.8% in local currency terms.
Of the larger stock markets, Hong Kong were particularly weak – down 10% in local currency terms- after China reported weaker than expected growth figures, and investors continued to worry over the impact on the region of a U.S /China trade war. Japan was down 9%, despite the Bank of Japan making its largest-ever monthly purchase of ETFs in order to steady the market.
U.S stocks were down 7%, led by a sharp pull-back in tech stocks. The U.K fell 5%. However, from its August peak to October low, the FTSE100 recorded a fall of over 10%, making it formal market correction.
The hawkishness of Fed statements surprised many, given that U.S inflation has been coming down in recent months by most measures.
However, third quarter GDP data came in stronger than had been expected and the labour market continues to tighten.
Furthermore, President Trump’s criticism of the Fed for raising interest rates in September has perhaps made it hard for the central bank to do anything other than press on with planned rate hikes. Otherwise it will risk looking captured by the White House.
The Italian government upped its challenge to the euro zone’s fiscal austerity dogma, when it published a draft budget that will substantially increase the budget deficit above previously agreed limits. Italian government bond yield rose sharply as investors priced in a default risk, and Italian banks -large holders of government debt- saw their share prices fall sharply.
Wanton Italian fiscal laxity is considered by many to be a bigger challenge to the E.U than Brexit, given its ability to break the euro zone. Yet it comes at a time when Angela Merkel is losing authority within Germany. Investors are nervous that a Greek-like crisis is coming with Italy.
The Barclays Global Aggregate index of investment-grade bonds fell 1.2% in dollar terms over the month.
The MSCI Emerging Markets index fell 6.8% in sterling terms, 8.7% in dollars and 7.8% in local currency terms. China fell 10% in local terms. Easily the best performer was Brazil, up 10% and one of only two countries to show positive returns in October (the other being Qatar). Brazil benefited from investor optimism after Jair Bolsonaro, a right-wing populist, did well in the first round of the presidential elections (which he went on to win in the second round in November).
Average U.K house price inflation in October fell to 1.3% over the previous 12 months, the lowest rate of increase since 2013, according to the Nationwide monthly house price survey. Prices were flat month-on- month. The number of transactions remains relatively subdued.
The post-correction rally of early November is probably over. It is unlikely that we are entering a bear market, though risk assets will remain skittish. All eyes are on the Fed and U.S/ China trade talks.
The global financial system is sound, with western banks now able to absorb far greater losses than they were in 2008. Meanwhile, the global economy is growing at a good pace, even if the IMF and OECD have both recently downgraded estimates for 2018 and next year. But 3.7% is not to be sneered at, and will manifest itself in improved corporate earnings.
Outside of the U.S it is hard to claim that stock markets are over-valued, while inside the U.S there are many sectors on attractive valuations.
However, the economic headwinds for the U.S are undoubtedly going to get stronger over the coming months and into 2019. The year-on-year boost to personal incomes, and corporate profits, from Trump’s tax cuts last December will not be replicated. Meanwhile the Fed is slowly raising the cost of borrowing, which will dampen investment and consumption.
Investors will also be watching how Beijing responds to weakness in the Chinese economy. With more borrowing by households, companies and municipalities (which risks leading to a debt crisis)? Meanwhile the renminbi appears to struggle to keep to its dollar peg, threatening to fall below the psychologically important USD 7 level.
Investors will remember the last significant renminbi devaluation, in the summer of 2015, with a shudder.
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