Market Bulletin - Summer showers
After a tough three months, markets are hopeful of entering a new phase.
As investors bid farewell to a volatile third quarter, now is a good moment to put some of the recent fearmongering into context. The data was never going to look rosy; and, sure enough, when the figures came in, they reflected the impact of fears that have hounded markets in recent months: China’s slowdown, uncertainty over the timing and impact of the Federal Reserve rate rise, poor corporate earnings and, most recently, the crisis at Volkswagen, were perhaps the most important.
The S&P 500 dipped 8.7% over the quarter. Global stocks generally saw their biggest drop since the same quarter in 2011. Taken together, activity in mergers & acquisitions, debt and equity markets, and syndicated lending generated fees of $16.5 billion – the lowest quarterly total since 2011. The Bloomberg Commodity Index was down 14.8%, its biggest quarterly drop since 2008.
Meanwhile, in a report released last week, the IMF warned of an increase in corporate failures in emerging markets if the US – and its retinue of developed-world central banks – chooses to raise rates. It pointed in particular to a surge in dollar-denominated debt in emerging markets, which it identified as the common prequel to a downturn in emerging markets. Emerging market borrowing costs have spiked to those levels experienced during the 2013 Taper Tantrum.
Some signs were good, however. September’s manufacturing PMI suggested that the global economy continued to expand moderately in the third quarter, while mergers & acquisitions activity showed an upward trend in both August and September. The US economy continued to grow (as did China’s, of course) and US unemployment continued to fall, having reached its best figure for seven years in August. Economic sentiment in Europe (before the VW news, at any rate) reached a four-year high and an array of leading indicators suggested the UK economy is in good health.
Given market affection for rounded numbers and neat timespans, the simple fact of stepping out of the third quarter seems likely to lift spirits. Volatility is not likely to disappear quite yet, not least because the fears afflicting markets have not gone away, and October has a history of wide trading margins. Volatility is particularly dangerous for the purer forms of tracker funds – by following market movements they not only miss out on bargains, but actually increase volatility. For a long-term active investor, on the other hand, the short-term pricing anomalies created by volatility can provide buying opportunities.
The S&P 500, FTSE 100, FTSEurofirst 300 and Nikkei 225 all enjoyed an end-of-quarter relief bounce on the final day of September. After a volatile week on markets, marked by uncertainty over the global economy, the most important news came late in the week: US non-farm payrolls rose by 142,000, 29% lower than the expected figure of 200,000. Gold and Treasury bonds saw inflows as a result and stocks initially dipped on the news, but recovery arrived fast – by the end of the week the S&P 500 and FTSE 100 were up by 1.14% and 2.87% respectively.
But what of those big fears already mentioned? As we have said before, the coming Fed rate rise is not to be feared, and neither does a slower growth trajectory in China mean that a crisis is on the cards. (Official Chinese data has never been fully trusted by analysts, so the recent questions are nothing new.) Nevertheless, even official Chinese figures continued to disappoint, and Asian currencies more broadly ended the quarter at a six-year low. Manufacturing activity in the People’s Republic contracted for the second consecutive month in September. The government cut a sales tax on small cars as the sector looks set to contract in 2015 for the first time since the 1990s. Investors remain nervous.
Yet the Shanghai Composite didn’t fall drastically over the course of the week (foreshortened as it was by a national holiday) and its trading range in September was, of course, far tighter than in August – around 240 points against August’s 1,050-plus. (It remained above its August low throughout September.)
Moreover, the more general downturn in capital markets in emerging economies – investors pulled around $40 billion out of emerging markets in the third quarter – has brought prices to a point where some investors are ready to head back in. Chris Iggo, CIO of global fixed income at AXA Investment Managers, is mildly optimistic. “We’ve been reducing our EM exposure in both credit and sovereign bonds over the past five to six months,” says Iggo. “Over the next few months, though, buying opportunities will start to increase.”
In Europe, despite the ongoing crisis at Volkswagen, there were a number of positive signs last week. After a rough quarter, the FTSEurofirst 300 experienced a choppy week, dropping early as the Volkswagen effect continued to play out, before rising again, only to be hit by US payroll news. It ended the week down 0.14%, with Friday’s post-payrolls recovery looking set to continue. Fears over Volkswagen now appear to be priced in – some believe by too much. “VW’s provision of $6.5 billion to cover crisis fallout is pretty chunky but the market cap has fallen by almost $30 billion,” says Stuart Mitchell, manager of the Greater European fund at S. W. Mitchell Capital. “Sales might be slightly hit too, but it’s hard to see how the impact on the brand could be what the market implies.”
Business sentiment was much improved in September, and a number of the countries worst-hit by Europe’s debt crisis are now showing strong signs of post-crisis turnaround. Spreads on 10-year Italian government debt continued to tighten last week, and a revised forecast published last week said the Irish economy is set to grow 6.5% this year. S&P raised its nominal GDP growth forecast for Spain to 4% and raised Spain’s credit rating one notch to BBB+. Spanish regional elections saw pro-independence Catalan parties gain a majority of seats in the regional parliament, raising the likelihood of an independence referendum for Catalonia, which accounts for a fifth of the Spanish economy. “It’s definitely worth thinking about,” says Stuart Mitchell. “There’s heated rhetoric about independence, but it’s a while off and less than 50% of the vote went with pro-independence parties – and it wasn’t even an independence referendum.”
In the UK, new data published last week showed second-quarter productivity rising 0.9%, its highest rate for four years. UK stocks were helped by an energy and commodities rally late last week – Shell rose over the week despite its decision to cease drilling in the Arctic. Proposals aired at the Labour Party conference (from higher taxes to Bank of England reform) were largely ignored on markets.
Disappointment over the payrolls data announcement took 10-year Treasury yields down six basis points on Friday to 1.98%. The news made Janet Yellen’s rate rise deferral look all the wiser – emerging market stocks were buoyed by the news. Markets are particularly sensitive to monthly data at the moment, given recent volatility, but US figures more broadly give cause for optimism. Indeed, amid the headline news of China and Volkswagen, it can be hard to remember how important steady US growth is for the global economy and for capital markets.
Data released in late September indicated the US economy grew 3.9% in the second quarter, which was above expectations. Some third-quarter blues are expected, and markets are priced accordingly; but the broader trend remains positive, and some fund managers expect to pick up on summer stock discounts before price rises return. Markets are not yet entering calm waters; but as the quarter ended, the storms of the summer were continuing to subside – despite the ongoing doom-mongering.
AXA Investment Managers and S. W. Mitchell Capital are fund managers for St. James’s Place.
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