Q3 Global Market Overview

 October 18, 2013
 

Welcome to the first of our quarterly global market updates, covering the three months up to the end of September 2013.

Global Overview

Following on from an extremely volatile period at the end of the second quarter, global markets made a strong recovery during the third quarter. In September, the US Federal Reserve decided not to reduce the pace of asset purchases known as Quantitative Easing (QE). Instead, the Fed will keep its bond buying programme steady at US$85bn a month, amid concerns that the US economic recovery could be faltering. The surprise decision sent equity markets up sharply and provided an additional boost to emerging market equities and bonds.

In China, improving data over the past couple of months, such as strengthening industrial output, retail sales and export figures, implied that the Chinese economy has rebounded after a weak first half of the year.

There was a relatively muted reaction in the markets to Angela Merkel’s election triumph in Germany. However, it comes amid economic data in Europe, pointing to a recovery, albeit a mild one.

Major Global Stock Market Indices

Index 1 Month 3 Month YTD 2012
FTSE 100 0.9% 4.9% 12.9% 10.0%
FTSE 250 2.2% 8.7% 23.1% 26.1%
FTSE Small 3.4% 16.1% 33.8% 36.3%
FTSE All Share 1.1% 5.6% 14.6% 12.3%
Dow Jones 2.3% 2.1% 17.6% 10.2%
S&P 500 3.1% 5.3% 19.8% 16.0%
DAX 6.1% 8.0% 10.3% 29.1%
CAC 40 5.5% 8.0% 17.3% 20.4%
Hang Seng 5.7% 10.7% 4.3% 27.5%
Nikkei 225 8.0% 5.7% 39.1% 22.9%
China SE 3.6% 9.9% -4.2% 3.2%

Source: Datastream 30th September 2013

United States

With fixed interest yields already lower, US Treasuries were further boosted by the political deadlock on Capitol Hill, which held out the prospect of a possible fall in government sector spending which would hit US growth. The sheer scale of the bi-partisan divide in Washington dragged out the budget impasse for longer than many expected when this problem began.

While September is historically the weakest month of the year for US equity markets, with investors traditionally focusing on economic and political events, US equities ended the month higher. Losses suffered in August were recovered as the S&P 500 index returned 3.14% (in US$, total return terms), reaching a new all-time high.

Towards the end of the month, equity markets fell as investors turned their attention from the Fed’s stimulus measure towards federal debt and spending issues. However, the pullback was relatively sanguine given that it began from all-time high levels.

Much of the budgetary impasse surrounded the Affordable Care Act, known as ‘Obamacare’, due to come into effect at the start of the new fiscal year on 1 October. Congress ultimately failed to agree on a budget or a shorter-term continuing resolution by the 30 September deadline, leading to a partial shutdown of government, the first since 1996.

Whilst the focus was on monetary and fiscal policy, there were also some positive economic announcements. Employment data indicated that the labour market continues to improve, with unemployment benefit claims falling. The housing market remained buoyant as single family housing starts rose in August as did new and existing home sales. New home sales for August rose by 8% having contracted in July. It was also announced that personal income (in current US$) increased 0.4% in August, which was the largest gain in six months.

UK

UK economic news improved, with UK economic growth confirmed at 0.7% in the second quarter of the year. Bright spots included the construction and industrial sectors, which expanded at their fastest pace for three years. Retail sales fell by 0.9% in August, compared with market expectations of a rise of around 0.4%, as consumers reined in spending, particularly on food, compared with July. UK inflation, as measured by the consumer prices index (CPI), also fell month-on-month, down from July’s 2.8% to 2.7% in August.

Asia Pacific

Asian equity markets made solid gains in September, buoyed by the US Federal Reserve’s surprise decision to postpone QE-tapering. All equity markets generated positive returns over the month, in local currency terms, with economically sensitive sectors tending to outperform other areas of the market.

In China, the manufacturing Purchasing Managers’ Index (PMI) for September improved slightly to 51.1 from 51.0 in August, the third consecutive month of improvement. August export growth of 7.2% y-o-y saw a pick-up in exports to all major trading partners, while industrial production and retail sales data came in ahead of expectations. Meanwhile, the Shanghai Pilot Free Trade Zone was opened on 29 September, in what has been considered an important step towards China further opening its markets.

Sentiment towards the Indian equity market improved after the new central bank governor announced measures to defend the exchange rate and liberalise the banking sector, although gains were tempered by an unexpected interest rate increase in an effort to curb inflation.

Japanese equity markets made solid gains on further signs of improvement in the domestic economy, with business confidence continuing to rise. While all sectors ended the month in positive territory, utilities and financials led, with energy and healthcare lagging notably. The news that Tokyo had won the competition to host the 2020 Summer Olympics provided an additional tailwind for construction and real estate stocks in particular.

Emerging Markets

Emerging equity markets bounced back strongly in September, again boosted by the Fed’s delay to a reduction in its monetary stimulus. Most currencies in the emerging world also rallied sharply following this news.

Improved readings in forward-looking indicators, particularly in China, lifted investor confidence further. The best performing markets in September were: Turkey, Brazil, Russia and India. Although oil prices fell during the month, speculation that the dividend pay-out ratio at state-owned companies in Russia may be increased boosted local equity prices.

Industrial, financials and consumer staples were the top performing sectors in the emerging world. Over the third quarter, more economically sensitive ‘cyclical’ sectors such as consumer discretionary and materials outperformed defensives.

The outperformance of Latin American equities (compared to other emerging market regions) was led by Brazil, although all the major countries in the region had a positive return in September. The Brazilian Real appreciated by 7.6% versus the US Dollar. Economic data from Brazil was generally positive with retail sales beating market expectations as 128,000 jobs were created in August. The country’s unemployment rate fell to 5.3% in August from 5.6% in July.

The Brazilian central bank signalled it is likely to raise interest rates again in October in an effort to quell inflation. By contrast, Mexican policy makers cut the benchmark interest rate for the second time this year. Banco de Mexico reduced the overnight lending rate by 25 basis points to a record-low of 3.75%. Mexico’s headline inflation rate last month stood flat at 3.5% year-on-year (y-o-y). Core inflation, however, continues to move lower.

Fixed Interest

The past few months have seen a trend of rising bond yields, which means bond prices are falling, although this was broken in September. Developments at the Fed took a more dovish turn, easing the chief source of recent market concern. This resulted in a broad-based reduction in yields. Core government bonds were also boosted, late in the month, by political uncertainty on both sides of the Atlantic.

Unemployment is a key factor in the Fed’s thinking on Quantitative Easing. The rally continued with the news that Larry Summers would not seek appointment as the next Fed chairman – Summers being perceived as more hawkish than the other likely candidate, Fed Vice Chairwoman Janet Yellen. With yields already lower, Treasuries were further boosted by the political deadlock on Capitol Hill which held out the prospect, as the month closed, of no agreement on the federal budget, with the consequent possibility of a fall in government sector spending which would hit US growth.

In the wider economy the dataflow has continued to be fairly positive. Consumer confidence remains firm in the US, slightly lower in September than August, but still much stronger than earlier in the year. Business sentiment also remains positive, with the ISM Manufacturing Index hitting a 28 month high of 55.7 in August.

The improvement in European data continued. The Ifo survey in Germany rose again in September, suggesting an acceleration in growth in the third quarter. In the UK, unemployment fell to 7.7% in the three months to July from 7.8% in the preceding period. Having risen to 3%, the yield of the 10 year Treasury closed September at 2.61%, a fall of 17 basis points (bps) for the month. Gilts and Bunds broadly reflected the Treasury market, with yields falling on the Fed’s decision to postpone tapering. Bunds were also boosted by political instability in Italy. According to data from Merrill Lynch, Treasuries had a total return of 0.8%, compared to 0.7% for Bunds and 0.8% for Gilts (all local currency terms).

Italian government bonds underperformed other Eurozone peripherals, returning -0.1%. Corporate bonds performed approximately in line with governments, with lower credit quality categories outperforming, helped by their higher yields. Sterling investment grade corporates returned 0.9%, with BBB returning 1.1%. Financials outperformed, with subordinated bank debt amongst the strongest areas of the market. With reduced expectations for US monetary tightening, the dollar was weak, falling 4.4% against sterling and 2.3% against the Euro

 Conclusion

The term “tapering” has now entered the lexicon for investors, adding a different twist to an already uncertain world. Good economic news is now viewed as negative (it increases the likelihood that stimulus in the US will be withdrawn) and poor economic news is correspondingly greeted with excitement.

This obsession is of course understandable given the severity of the shock experienced by the financial system in 2008, however as far as the debate is concerned, two things are clear:

1)      Interest rates in both the UK and the US are unlikely to rise in the immediate future.

2)      Inflation is likely to become an increasing problem for savers.

The last time Gross Domestic Product (GDP) in the US was close to its current level, was between 1940 and 1948. During this period, the purchasing power of $1 declined 65% – an important reminder that money (cash on deposit) is primarily a medium of transfer and a poor store of wealth.

We therefore continue to believe that a sensibly constructed equity portfolio offers one of the best methods of protection and can create wealth over the longer term. In addition, current valuations are attractive. For the last 140 years the S&P 500 has traded in a range of 10 to 20 times earnings and the average has been 15.5. Therefore, the current mean of 16.5 does not look out of place, especially when you consider that we are coming out of one of the worst recessions in history and that interest rates have never been as low.

Many thanks for taking the time to read our report

 

Sources of information: Killik & Co, Invesco, Wells Fargo, Morningstar, MCM Bespoke Investment Services Ltd and Digital Look