Insight Investment’s global economic outlook for the week ahead (week beginning 29 October 2018)
The multi asset team at Insight Investment notes “ This week we see a raft of top tier macro data released, with PMIs and labour market data the main focus.
As the earnings season gathers pace, 25% of market cap is due to report next week including major companies Apple, Facebook, Chevron and Exxon, and, given the market reaction this week, sensitivity to management guidance will be key.
Italian budget discussions and S&P’s credit rating review should continue to dominate sentiment in Europe early in the week. Although, with the main macro data from Wednesday, the market will be hoping stabilisation in Europe can been maintained.”
Market and economic review
Volatility returns to equity markets
Another bout of volatility last week as risk aversion came to the fore. The downturn in equities accelerated, and the sector rotation from cyclicals to defensive stocks continued. US markets were not immune, with the tech-heavy Nasdaq posting its largest one-day fall since 2011. Thursday saw a marked reversal, but this was short lived, with sharp share price reactions to mixed earnings numbers. The markets appear keen to punish any sign of weakness either in reported results or forward guidance.
We’re now over halfway through the US earnings season and while headline growth remains strong, there are a number of trends making market participants nervous: explicit commentary on tariff impacts (Caterpillar, 3M, Ford); revenue disappointment (Amazon, Alphabet) so that the beat rate on sales this quarter is now at 44% vs. 58% in Q2; and large share price reactions (in both directions) with the net impact now negative. European earnings are showing a similar trend, with only 43% beating estimates (the lowest in five years). Raw material costs appear to be the main headwind.
Most recently, big misses in tech earnings from Alphabet and Amazon sent Nasdaq futures tumbling, 3.5% off Thursday’s high. This and follow-on reduction around the globe takes many equity markets into correction territory. Month to date, Japan is now off -11.8%, Europe -6.8%, emerging markets -9.4% and the US -7.1%.
Other risk assets joined the free fall, with European dividend futures particularly hard hit as banks sought to offload exposures from structured products. Wednesday was one of, if not the, highest volume days ever seen in the dividend futures market. The extent of these moves provides attractive entry points, so that after an extended period of holding a low level of exposure in our portfolios, we took advantage of attractive valuations to make a small addition of an option based dividend position.
Having fallen 10% from their 4-year peak in early October, oil prices followed a similar pattern to stocks, retreating sharply early in the week. From a multi-asset perspective, this hasn’t helped. The reaction of yields has been more constructive. We have talked in previous updates of our view that the rate of change of yields is more important than the absolute level, and the rapid increase in early October was a partial driver of equity market falls. This week, with focus turning more to growth dynamics and potential slowdown concerns, duration exposure has at least provided some benefit. As we write, the US 10-year yield is back to 3.07% from its high earlier in October of 3.25%. Similarly, German bund yields have fallen to 0.35% from 0.57%.
Italian budget – tensions continue, pressure mounts
Last week started with Moody’s Investors Service downgrade of Italy’s sovereign credit rating to ‘Baa3’ from ‘Baa2’ and assigned a stable outlook. Against fears for a potential negative outlook, this removed an element of concern for markets. As expected though, the European Commission officially rejected Italy’s proposed budget and asked for it to be revised, which is the first time such demands have been made of a member state. Despite a small rise in Italian yields to 3.60%, they ended the week at 3.48%.
Economic releases – Moderation in growth outlook continues
With a number of advance PMI releases in Europe, it was clear the pace of economic growth slipped lower in October, which sets the scene for a disappointing end to the year. Against a background of trade and tariff tensions we have discussed in previous weekly updates, it is unsurprising the slowdown is being led by a drop in exports.
Focusing on Germany, its composite PMI fell to 52.7 in October from 55.0 in September, below the consensus, 54.8. The IFO business climate index extended its decline (-0.9 pts, falling to 102.8, consensus forecast of 103.20), and importantly the business expectations index moved lower. In our view, the slowdown in the manufacturing sector indicates a high level of uncertainty about the prospects of export-focused industries in Germany, which are highly exposed to US-China trade tensions and weakening growth in China.
The growth outlook continues to moderate in the US, with new home sales data falling 5.5% to 553,000, well below the consensus, 625,000. Despite being a volatile series, and likely affected by the recent hurricane, to us this still reflects pressure from rising rates and the start of tightening lending standards.
US trade data continued the negative tone from last month, with the advance goods deficit rising to a record $76.0bn in September, from $75.5bn in August. The trend in the deficit is rising, reflecting fiscal-fuelled domestic demand growth sucking in imports.
Central banks – ‘nothing to see here’
The European Central Bank message last week was ‘nothing to see here’. Its main re-financing and deposit rates remained unchanged at 0.00% and -0.4%, respectively, in line with the consensus. The central bank also maintained its marginal lending facility, at 0.25%, in line with the consensus too. Rounding off with no change to the forward guidance language, or the withdrawal of stimulus, it confirmed the pace of quantitative easing has now been reduced to €15bn per month, and that it expects to end purchases after December, all as previously stated.
We also heard from new Federal Reserve Vice-Chair Richard Clarida in his first public speech since taking office. Of interest to us was his take on wage gains not necessarily being inflationary, and that recent productivity growth could persist. These are aspects we will continue to monitor in our assessment of likely reaction function to data outturns.
