Insight Weekly Multi-Asset update – week beginning 28 October, 2019

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Market and economic review

Last week was a positive one for equities, with price reaction to earnings generally positive across the board (see below). In contrast, global government bond yields were relatively quiet. Within FX, emerging market currencies performed well, in particular the Brazilian real which was helped by the passing of new pension reforms.

US earnings produced an interesting price reaction: positive despite negative company guidance

It was another busy week for US earnings with 169 companies reported so far (~40% of S&P market cap.). The headline growth rate currently stands at -3% which is just above pre-season expectations for -3.8%. Revenue growth remains positive at +2.8% and thus we are seeing clear evidence that margin compression is hurting bottom line profits. This is something we are monitoring closely as falling margins can play an important role at turning points in the business cycle.

There were a number of important cyclical bellwethers reporting in both the industrial and technology sectors. Caterpillar, whose profits are closely linked to global manufacturing output, missed on analyst expectations and reduced guidance for Q4. Management commentary around this reduction highlighted that demand was being hampered by uncertainty over the economic outlook rather than financial difficulty. There was similar commentary from Texas Instruments, who produce semi-conductors for a wide range of industries, with the CFO stating that “most markets weakened further” due to a “far more cautious” customer base. This is clear bottom-up confirmation of the detrimental impact that trade uncertainty is having on corporate decision making. Despite this negative guidance, share price reaction has been positive in aggregate which would suggest a lot of the slowdown has already been priced in.

It is early days in the European reporting season, but we have seen similar themes thus far of cyclical names posting negative earnings but share price reaction remaining muted.

PMIs suggesting a degree of stabilisation

Provisional Purchasing Manager Index (PMI) numbers were released on Thursday morning, giving the first insight into whether September prints will offer a degree of stabilisation, or a continuation of the recently seen deterioration, especially within the manufacturing component. As a reminder, something we have been looking for is contagion from the poor manufacturing releases into the services component, ultimately dragging overall composite numbers down. 

Within Europe, France was first up, releasing a composite of 52.6 which beat expectations of 51.0. European equities started on the front foot, however this was short lived as numbers from Germany quickly followed. As a reminder, the August print saw German manufacturing fall to 41.7, the lowest it has been for some time, and considerably below 50 (the point at which the surveys suggest economic contraction vs. economic expansion). The September print showed signs of stabilisation at 41.9 (vs. an expected 42.0), however it is stabilisation at a very low level. These numbers contributed to a eurozone composite of 50.2, vs. an expected 50.3, where the underlying components saw a slight miss for both manufacturing (45.7 vs. an expected 46.0) and services (51.8 vs. an expected 51.9).

Away from Europe, Japan also saw a reduction at a composite level to 49.8 from a previous 51.5, however given the usual stability of this series, this may be a result of damage from the recent typhoon. If that is the case, a recovery could be expected in subsequent releases. It will be worth looking at industrial production numbers next week to see whether they support this reading.

On a more constructive tone, the US numbers helped improve market sentiment. Services printed in line with expectations at 51.0, up 0.1 from last month, and manufacturing surprised at 51.5, vs. an expected 50.9 and an increase of 0.4 from last month. This resulted in the overall composite of 51.2 vs. an expected 50.0.

Potentially one step closer to Brexit

Last week UK Prime Minister Boris Johnson managed to achieve something that ex-Prime Minister Theresa May failed to do over multiple attempts – receive Parliament’s backing on a deal agreed with the EU. Shortly after however, Parliament did vote down PM Johnson’s proposed timetable for implementing the exit from the Union. This meant that PM Johnson had to request an extension to the 31 October deadline, which the EU is currently considering. Whilst awaiting a response from the EU, PM Johnson has announced his intent to bring a vote on a General Election to take place on 12 December. Under the Fixed Term Parliaments Act, the PM will need to secure 2/3s of the votes, however Labour and the Liberal Democrats are keen to see the chance of a no-deal Brexit being completely removed before supporting this move.

President Draghi’s tenure comes to an end

There were no surprises in Mario Draghi’s last meeting as president of the European Central Bank (ECB). There were no changes to monetary policy, with the deposit rate remaining at -0.50. In line with President Draghi’s messaging in recent months, there was further mention of fiscal policy, with a statement that those countries with ‘fiscal space’ should use it. Christine Lagarde takes over as the institution’s President, and will hold the next ECB meeting on 12 December. Whilst there is no expectation of easier monetary policy by way of a cut to the deposit rate in this meeting, the market is pricing a probability of at least one further cut during the first half of 2020.

Outlook

The Federal Reserve will meet this week to make a decision on whether to change the target Federal funds rate range, currently 1.75-2%. Market pricing suggests a 90% chance of a cut, with further cuts to follow throughout 2020. The Bank of Japan also has their meeting, on Thursday.

On the data front, manufacturing PMIs from around the world, US jobs reports and Q3 GDP numbers for both the US and the Euro Area will be the main areas of concentration. However, various other prints such as industrial profits and retail sales data may also be of interest.

Earnings releases will continue with 162 companies reporting, representing 30% of US market cap, including important names such as Alphabet and Apple.  This number of companies takes us significantly past the halfway mark so we should have a good grasp on how the overall earnings season has performed.

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