Market Bulletin - Bulls and doves
Corporate earnings season in America boosted US equities, while central bankers in Europe and China offered a further boon.
Few things cheer investors more than stocks climbing ever upwards, but perhaps the next best is when central banks offer a leg-up. Last week investors were treated to both, as corporate earnings drove a rally in the S&P 500, while dovish central bank policy in Europe and China provided a tailwind.
Both developments came as a pleasant surprise. Third-quarter profit expectations had been exceeded by around two thirds of those S&P 500 companies to have reported before the weekend, albeit helped by the low horizons set by summer troubles on capital markets. As a result, shares in some of the S&P’s biggest names rose dramatically, pushing McDonald’s to a seven-year high and eBay to a three-year record. The S&P 500 climbed 1.64% over the course of the week.
In Europe, equities had struggled on Tuesday, ending down slightly after improved bank lending figures quashed hopes of a monetary stimulus from the European Central Bank. After trading flat on Wednesday, the FTSEurofirst 300 gained an impressive 2.19% on Thursday. The index ended the week up a stellar 3.84%. The DAX was up 5%.
The rise followed the meeting of the European Central Bank (ECB) in Malta. The ECB’s deposit rate was left unchanged, but what mattered most were the comments of its president Mario Draghi: “We are ready to act if needed [and] we are open to a whole menu of monetary policy instruments.” In December the ECB will formally review its stimulus policy – both an expansion of quantitative easing and an interest rate cut are now on the table.
But if Thursday’s ‘Mario bounce’ for markets reflected central bank worries over the eurozone’s economic outlook, Friday provided some unalloyed positives. Readings for the manufacturing Purchasing Managers’ Index (PMI) Composite Output Index, which tracks manufacturing activity, came in above expectations for the eurozone and for its two largest economies, France and Germany. PMI Composite Output for the eurozone was 54.0 at the October reading, a two-month high, while German and French PMI both beat expectations. (A reading of above 50.0 indicates an expansion.)
Moreover, the services sector appeared to be rising in lockstep with manufacturing, indicating a more comprehensive recovery – PMI activity hit a seven-month high in Germany and a two-month high in the eurozone more broadly.
“Our extensive conversations with European companies over the past few weeks confirm our view that the European recovery is rapidly gathering momentum, whilst the US economy appears to be slowing down somewhat,” said Stuart Mitchell of S. W. Mitchell Capital. “Sluggish China doesn’t seem to be any more difficult than we might have expected.”
Indeed, proof that China’s own central bank is concerned at the country’s economic outlook arrived on Friday in the form of an unexpected rate cut. The one-year lending rate was lowered from 4.6% to 4.35%; the bank reserve ratio requirement was also cut. The dovish move prompted the Shanghai Composite Index and Hong Kong’s Hang Seng Index to both rise 1.3% in Friday’s trading; indices in Europe and the US also responded positively.
The greatest encouragement of the week came from the United States, where the S&P 500 continued to climb its way back from the August dip; it is now close to making up for its August fall. Crucially, the recovery in US stock prices is being driven not simply by Fed inaction but also by company profits. Tech stocks were a particular highlight: Alphabet and Amazon both rose by around 10% after posting results, while Microsoft jumped 7.2%.
Politics was more obstructive – the US Treasury felt obliged to postpone a sale of US sovereign bonds on concerns that Congress may not approve the raising of the government debt limit on 3 November. What should be a perennial formality has stoked tension on markets in recent years, as relations between the White House and Congress have deteriorated.
US high-yield bonds remain a focus, as inflows tend to signal investor willingness to return to risk assets. Flows into US high-yield bonds had been on a downward trend in 2015; but more recently there have been signs of interest returning – last week saw particularly strong inflows to the sector.
“Given the backdrop of volatility across markets, concerns over global growth and uncertainty surrounding the energy and oil sector, the third quarter evidenced a pull-back in risk assets,” said Zak Summerscale, chief investment officer for European high yield at Babson Capital. “Recent market weakness has presented opportunity. Credits in our portfolio remain fundamentally strong, which allows us to re-deploy cash in existing holdings at attractive levels.”
The FTSE 100 was tracking mostly downwards over the course of the week, as commodity stocks suffered. Among a number of concerns is the fact that dividend growth among London-listed companies is likely to drop to less than half the current 6.8% growth rate in 2016.
Europe was also a focus for Bank of England governor Mark Carney, who delivered an important speech that fell broadly on the side of those opposing ‘Brexit’. Yet of more immediate importance to UK stocks were Mario Draghi’s dovish comments on Thursday – the FTSE 100’s 1.04% one-week rise was mostly achieved in Friday trading.
In the long term, what may matter more is the choice of London for the first foreign issuance of Chinese government bonds denominated in yuan (or renminbi), timed to coincide with the state visit of Chinese president Xi Jinping. As it happened, the same week saw the UK successfully issue £4 billion of 50-year government debt, wisely locking in low rates ahead of any pick-up in growth – the gilts offered a coupon of just 2.5%.
Yet it is the Chinese bond sale which is most significant for investors in the long term. The People’s Bank of China bills were issued at 3.1% with a one-year maturity and were five times oversubscribed. “Three point one per cent represents good value for short-dated bonds given that onshore 10-year Chinese sovereign bonds are yielding just 3%,” said Jim Veneau, head of fixed income for Asia at AXA Investment Managers.
The choice of London reflected the depth and internationalism of the city’s markets, and is an important win for the square mile, marking it as the leading yuan offshore centre in the West and, longer term, aiding both liquidity and diversity. It also provides UK-only bond fund managers with a home-grown way of investing in China more broadly – a number of Chinese banks have already issued bonds in London in recent weeks – but the move signals broader shifts too.
“For investors, the expectation that the yuan will become an international currency means it’s wise to be an early mover in the space,” said Aidan Yao, senior emerging market economist at AXA Investment Managers. “It also helps to internationalise the currency. We believe that the one-way appreciation of the renminbi has ended.”
In China itself, markets remained concerned at the commodities outlook earlier in the week, notably at the solvency of state-owned Sinosteel; although the official GDP growth figure came in slightly higher than expected at 6.9%. Retail sales were up slightly at 10.9%.
The broader global stock market rally was especially marked in Japan, where the Nikkei rose 2.92% over the course of the week. Japan had closed by the time China’s central bank announced its intentions.
AXA Investment Managers, Babson Capital and S. W. Mitchell Capital are fund managers for St. James’s Place.
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