Insight Investment’s global economic outlook for the week ahead (beginning 5 November 2018)

From

The multi -asset team at Insight Investment, a leading global investment manager, notes “This week is less busy on the data front, with politics moving into focus. The biggest event on this front is of course the US midterm elections. Both polls and betting markets indicate that the Democrats are likely to take control of the House, while the Republicans are likely to retain Senate control.

In our view, this is unlikely to change much of our fundamental view and given the lack of ‘kink’ on the volatility curve, markets expect much the same. The Federal Reserve meet on Thursday, although given the lack of expectation of policy change and no press conference, this is likely to be a non-event.

The only major data of note is the China trade and inflation data, which is unlikely to move the dial, given that we are now at the tail end of earnings in US and Europe.”

Market and economic review

Global equities rebound after a torrid October

Last week saw a much more positive tone for risk markets after what was the worst month for global equities since 2012. Global equities returned 3% this week, retracing around a third of October’s decline. Much like the selloff before it, there was no core reason for the bounce, but rather a whole range of economic data, earnings and political/trade developments for the market to digest. Rather than try and fit a market narrative around what was a very busy week, we’ve explored each of these areas below and how they impact our thinking.

Growth data: tariffs start to bite

Indicators on global growth remain the key determinant for our asset allocation. Last week saw a range of key growth data released, including PMIs in China, ISM surveys in the US and provisional GDP numbers in Europe. The Chinese PMI is of particular importance given heightened sensitivity from markets to any evidence of a slowdown in Chinese demand, either in hard data releases or via management commentary. There can be little comfort taken then from October’s data, with the official PMI showing a deceleration in both manufacturing (50.2 vs. 50.6 expected) and services (53.9 vs. 54.6 expected). While this can partly be attributed to the long holiday in October, there was an explicit acknowledgment of the external environment (read: trade concerns) becoming a drag on manufacturing. This is now four out of the past five months that the manufacturing print has declined. The new orders component showed particular weakness, falling deeper into contraction at 46.9 (versus 48.0 last month).

This softness was echoed both in the Caixin manufacturing PMI (50.1); and in a wider range of Asian PMIs, particularly those sensitive to global trade, which fell into contraction territory this week. Given this backdrop, it is no surprise that Chinese authorities continue to ease on both the fiscal and monetary fronts, further evidenced this week with a cut on the tax on autos purchases. Our view is that this policy action will ultimately have a stimulative effect on global growth; however, there may be further slowdown in the near term given the usual lags.

In the US, the ISM manufacturing fell from to 57.7 from a very elevated 59.8 in September, well below the consensus for 59. Similar to the Chinese PMI, the new orders component showed particular weakness, dropping 4.4 points. US growth has remained resilient throughout 2018, despite moderation in the rest of the world, however there is growing evidence that Trump’s trade war is starting to bite. While the ISM numbers this month remain consistent with above trend growth for the final quarter, tariffs were cited as the overwhelming concern for manufacturers, and we expect to see the impact start coming through in hard data over the coming months.

In Europe, the advance Q3 GDP print also disappointed relative to expectations. Real GDP growth was 0.2% qoq, slowing from 0.4% in Q2. The external sector has been the biggest drag on European growth this year, with the Chinese slowdown as described above a key factor. The EU emissions test had a negative impact on manufacturing this quarter, while investment in Italy also declined sharply, not surprising given the political uncertainty we discussed last week. So the trend in global growth is clear, continued moderation. For this reason, we keep our equity allocation below historical average, instead allocating risk to the Total Return Strategies component where we can take advantage of the higher-volatility environment.

Corporate earnings: guidance is key

We are now in the tail end of the Q3 earnings season in the US, and it’s been gathering a lot of headlines given October’s market moves. The headline growth for EPS remains very high at 26% (in line with Q2) with the number of companies beating estimates still above historical averages. However, the two key themes we’ve noted this season have been less positive. The first is that management forward guidance, while still positive, is significantly less so than we saw in Q1 & Q2. There was further evidence this week with Apple’s announcement on Thursday. Both earnings growth and revenues beat expectations; however, the share price fell 5% due to management reducing their guidance for next quarter. This ties in with another theme – the asymmetry of share price reaction. Firms beating on expectations have been rewarded less than historical averages, while the opposite is true for firms missing, where share price reaction has been particularly negative. So while earnings growth remains robust for now, a further deceleration in revenues or margin pressures would be a worrying sign for markets. That being said, the recent moves have seen a further rerating which should provide a valuation cushion so long as earnings growth remains positive. Earnings are holding up less well in Europe, which is not surprising given the growth pressures we outlined above. There have been more misses than beats in Europe for the first time in four years, with margin weakness and cost inflation driving this weakness. Share price reaction has been similar as that described in the US, albeit even more extreme, with the underperformance for misses the worst since 2007.

Rates: all eyes on payrolls

The monthly US labour report remains one of the key data highlights each month for rates markets, and in particular the average hourly earnings’ print. Friday’s report was strong across the board, with the headline payrolls number printing at 250,000, well above consensus expectations for 200,000. Average hourly earnings rose 0.2% m/m (as expected) and this brings the annual growth rate up to 3.1%. Although it’s hard to read too much into this particular number, given base effects from last year’s hurricane and recent weather issues, there is nothing to indicate the Fed won’t hike rates in December as is widely expected. At the time of writing, ten-year treasury yields have climbed 4bps since the release.

Other inflation releases during the week included US PCE and European inflation for March. In the US, September core PCE came at +0.2% (vs. +0.1% expected), keeping the annual inflation rate in line with consensus at 2.0%. In the Eurozone, headline inflation rose slightly to 2.2% in October from 2.1% in September and core rate increased to 1.1% from 0.9%, all in line with expectations. The net result for us is no real change in our base case, in that inflation should rise gradually; however, not at any pace that will take central banks off their current paths.

Politics: Trump-China talks provide welcome relief for EM equities

There were further developments in the US-China trade dispute this week, with a Trump tweet sparking a strong rally for emerging market equities. The President highlighted that conversations with Chinese President Xi Jingping on trade and also North Korea ahead of the G20 meeting later this month are “moving along nicely.” This was followed by reports from Reuters quoting Xi as saying that the President hopes China and the US can promote a “steady and healthy” relationship, along with Chinese state-run televisions highlighting the same. This marked a sharp turnaround from headlines at the beginning of the week, which reported the US is readying tariffs on the remainder of China imports. Emerging markets had rallied 5% at one point following Trump’s positive tweet; however, they have since given back some of this gain and are around 3% up at the time of writing.

The other big political development occurred in Europe, where German Chancellor Angela Merkel’s CDU party won a disappointing 27.2% of the vote in a regional election in Hesse, down from 38.5% of the previous vote five years ago. The party’s Grand Coalition partner, the Social Democratic Party, fared worse, with support slipping from 30.7% to 19.6%. Angela Merkel subsequently announced that she will not seek re-election as party leader at the November party conference, putting in question her future as chancellor. The two leading candidates to replace her are General Secretary Annegret Kramp-Karrenbauer (widely regarded as a ‘continuity’ candidate) and former CDU/CSU chairman Friedrich Merz, (viewed as more conservative and business-friendly). German bund yields rose by 5bp to 8bp across the curve above 5-year maturities, remaining around record wides relative to US Treasury yields.

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