Contributor Ambrose Crofton
Financial markets welcomed signs of an easing in geopolitical tensions in October, with risk assets generally outperforming traditional safe havens. The US and Chinese authorities moved closer to agreeing a partial deal on trade, while the UK once again edged back from the precipice of a no-deal Brexit. Global central banks reiterated their dovish stances and the US Federal Reserve cut interest rates for the third time this year.
October was a good month for equity markets, with emerging markets returning 4.2% compared to 2.6% from developed markets. The S&P 500 gained a further 2.2% and made new all-time highs at the end of the month. The pound rallied 5.0% and 2.9% against the dollar and euro respectively, as markets perceived that the risk of a no-deal Brexit had diminished. The rally in sterling meant that the FTSE All-Share, with approximately 70% of its revenue coming from abroad, was one of the weaker performing equity markets, falling 1.4% over the month. In fixed income, credit markets outperformed government bonds, with global investment grade returning 1.2%, while global government bonds gained 0.5%.
Exhibit 1: Asset class and style returns
Source: Bloomberg Barclays, FTSE, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. DM Equities: MSCI World; REITs: FTSE NAREIT Global Real Estate Investment Trusts; Cmdty: Bloomberg Commodity Index; Global Agg: Barclays Global Aggregate; Growth: MSCI World Growth; Value: MSCI World Value; Small cap: MSCI World Small Cap. All indices are total return in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2019.
US
The US-China trade war pendulum, which has been swinging between escalating tensions and a more constructive outlook, swung back in favour of the latter in October, with the announcement of what President Trump has called a “Phase One Trade Deal”. The deal involves China committing to significantly increase purchases of US agricultural products, accelerate the opening up of its financial sector, and more transparency regarding the currency markets.
While the announcement of the first phase of a deal between China and the US is a small breakthrough, we don’t expect it to lead to a resolution of the trade war for two key reasons: first, polls suggest that US voters across political parties remain sceptical about the relative fairness of Chinese trade practices; and second, both sides harbour ambitions to be the number one player in global technology. We could well see the trade war pendulum swing back towards escalation in the coming months if President Trump decides to ramp up anti-China rhetoric to boost support ahead of the presidential election in November of next year.
While financial markets welcomed the announcement of a potential trade agreement, data out of the US continued to suggest that the US economy is losing momentum. The weakness remains most pronounced in the more trade-dependent manufacturing sector, with the Institute for Supply Management’s manufacturing purchasing managers’ index (PMI) indicating that the manufacturing side of the economy is contracting. The more concerning development of late, however, has been that the manufacturing weakness seems to be gradually seeping into the broader economy, with cracks beginning to appear in the US consumer. Consumer confidence fell 0.4 points to 125.9 in October, while the pace of job growth has also been slowing—on average, 160k jobs have been added each month this year, compared to 220k per month in 2018. Real GDP growth for the third quarter was more positive, showing that the US economy hadn’t slowed as much as had been expected and grew at an annualised pace of 1.9%.
This slowing in economic momentum led the Federal Reserve to cut interest rates by 25 basis points (bps) for a third time this year, which should help lending conditions in the economy to remain supportive. The key question now is whether easier monetary policy will be able to support the consumer and labour market from deteriorating in the same way that manufacturing already has.
The US earnings season for the third quarter of the year is well underway, with companies so far doing better than expected. Earnings per share and sales are growing at 1% and 4% year on year (y/y), respectively on the S&P 500. However, US companies continue to give lower guidance for next year’s earnings, with the trade dispute an ongoing theme.
Exhibit 2: World stock market returns
Source: FTSE, MSCI, Refinitiv Datastream, Standard & Poor's, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency, except for MSCI Asia ex-Japan and MSCI EM, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2019.
Eurozone
The trade war continues to weigh most heavily in the eurozone, particularly in Germany, due to the region’s larger dependence on international trade compared to its international counterparts. The economy looks fragile—flash PMIs for October remained at 45.7 in manufacturing and rose slightly for services to 51.2, to give an only slightly expansionary composite reading of 50.2.
The labour market and consumer are also feeling the effects of the slowdown. The employment component of the composite PMI now shows that employment is increasing at the slowest pace since December 2014. Consumer confidence also fell to -7.6 in October, the lowest reading since December last year.
October’s European Central Bank (ECB) meeting marked Mario Draghi’s final press conference as president. Christine Lagarde, former head of the International Monetary Fund, now takes the reins. Lagarde inherits an ECB tool kit that is nearing its limits, with interest rates at -0.5% and quantitative easing of EUR 20 billion per month in place until the inflation target is close to being achieved. With a seemingly depleted monetary toolkit, the challenge will be whether or not Lagarde can convince governments to loosen the fiscal purse strings to stimulate the economy.
Exhibit 3: Fixed income government bond returns
Source: Bloomberg Barclays, Refinitiv Datatsream, J.P. Morgan Asset Management. All indices are Bloomberg Barclays benchmark government indices. All indices are total return in local currency, except for global, which is in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2019.
UK
To the surprise of markets, Prime Minister Boris Johnson was able to agree a new Brexit deal with the European Union (EU). This was made possible after Johnson agreed to put a customs border in the Irish Sea and for Northern Ireland to remain more closely tied to the EU than Great Britain, thus avoiding the need for a hard border on the island of Ireland. The new deal gained more support in the House of Commons; however, members of parliament refused to approve rushing through the legislation process in order to leave the EU on the 31 October deadline. This meant an extension to the departure deadline was agreed to 31 January 2019. A general election will now be held on 12 December, as the prime minister seeks a new parliamentary majority to pass his deal.
On the data side of things, the UK labour market showed signs of weakening – employment in August fell by 56k, with the unemployment rate rising 0.1 percentage point to 3.9% and the number of vacancies continuing the steady fall that began in early 2019. Retail sales excluding fuel rose 0.2% over the previous month in September, and consumer confidence fell 2 points to -14 for October. Inflation for September remained at 1.7% y/y. The outlook for the Bank of England remains highly Brexit dependent. Should uncertainty for businesses and households be further prolonged, a rate cut could be on the cards.
Exhibit 4: Fixed income sector returns
Source: Bloomberg Barclays, BofA/Merrill Lynch, J.P. Morgan Economic Research, Refinitiv Datastream, J.P. Morgan Asset Management. Global IL: Barclays Global Inflation-Linked; Euro Gov.: Barclays Euro Aggregate Government; US Treas: Barclays US Aggregate Government - Treasury; Global IG: Barclays Global Aggregate - Corporates; US HY: BofA/Merrill Lynch US HY Constrained; Euro HY: BofA/Merrill Lynch Euro Non-Financial HY Constrained; EM Debt: J.P. Morgan EMBIG. All indices are total return in local currency, except for EM and global indices, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2019.
China
The annual pace of real GDP growth in China eased to 6.0% for the third quarter, down from 6.2% in the previous quarter. Weaker growth is slowing Chinese demand for external goods, with imports falling 8.5% y/y in September. Industrial production and retail sales data for September were more positive, rising to 5.8% and 7.8% y/y, respectively. After last month’s 50 bps cut in the reserve requirement ratio, the People’s Bank of China implemented a second 50 bps cut, with a third likely to follow, collectively releasing CNY 900 billion (approximately 1% of GDP) into the banking system. Credit data for September revealed a significant pickup in total social financing and new bank loans.
Conclusion
Amid a slowdown in the major economies and ongoing geopolitical uncertainty, we continue to advocate building more defensive properties into portfolios to cushion returns should the economic environment continue to deteriorate. Within equities, investors may wish to focus on large-cap, high quality companies (those with strong balance sheets and healthy cash flows), which have historically been more resilient in downturns. In fixed income, government bonds, particularly in the US, can still serve to add ballast to portfolios in adverse market environments. Alternative strategies, such as macro hedge funds and infrastructure, are additional options for investors to consider.
Exhibit 5: Index returns for October 2019 (%)
Source: Bloomberg Barclays, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2019.
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