Overview
Yet again, “yo-yo” bursts to our lips in describing recent events.
As the U.S. and the UK continue to post respectable performances, growth concerns in China and Europe and widespread weakness in commodity prices led to fresh investor ulcers about a global slowdown and equity-market weakness in mid-October. And yet as we write this, barely a couple of weeks later, U.S. stock prices are again at record highs and the worrying seems already dated.
U.S. earnings, even revenue growth, are robust to OK. The U.S. dollar has been rising steadily since 2011 (a surprise to many readers) and recently accelerated modestly. Although the headlines scream concern over this – as the media juggernaut defends its commercial interests while seeking the worst possible angle on new developments and worrying investors silly – this is often associated with positive developments in the economy and/or financial markets.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
U.S. growth is hinting at a pace solidly above 3%, which seemed impossible to some just a couple of quarters back.
But U.S. markets watch events globally, and concerns with growth in China and Europe and a worryingly large drop in commodity prices were, again, uniformly interpreted negatively. It was a fleeting distraction, but one that drove U.S. equity markets down materially in mid-October. As we write this in early November, stocks are again at record highs, S&P third-quarter earnings growth approached 10% vs. a year ago, and even revenue growth, near 5%, is respectable.
Meanwhile, the treasury market remains the shelter for worried investors. As inflation and wages remain at levels the market perceives as safe and a stronger U.S. dollar promises downward pressure on prices, bond yields remain very low. Too low, in our view.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
The Japanese Central Bank surprised many on October 31 when it announced that it will be increasing its already-substantial monetary stimulus program, increasing the size and maturity of the bonds it will buy, and adding exchange-traded funds and Japanese real estate investment trusts (REITs) to its balance sheet. The yen and the market both responded quickly. Given the bank’s core inflation rate target of 2% and the fact that recent run rates are suggesting that number may be in the 1.3% to 1.5% range by December, this move is logical and appears necessary for the country to beat deflation. Despite very weak levels of personal income, retail sales and spending measures suggest that the Japanese consumer is responding positively to price increases. Many corporate leading indicators like manufacturing PMI and fundamentals like earnings per share are improving rapidly. However, Prime Minister Abe-san’s so-called third arrow of reform and deregulation has yet to materialize in a meaningful way – a missing key ingredient to success.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
The European Central Bank (ECB) has maintained its key target rates at record lows, and recently reaffirmed its commitment to stimulate member economies through various measures, including growing the central bank’s balance sheet back to 2012 levels and commencing its new asset purchase program as soon as this December. Separately, the stress test results for various banks in the Eurozone were positive, with only 13 of 130 banks falling short of the capital requirement. That said, inflation continues to be anemic at 0.3% and unemployment rates at 11.5% are near record levels. ECB President Mario Draghi has signaled his willingness to inject additional stimulus into the struggling economies if necessary, and is slowly gaining Germany’s support in the matter.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The third-quarter UK economy was by no means weak. However, its growth momentum cooled as threats from the euro-area slump mounted. Growth in Q3 was 0.7%, compared with 0.9% in Q2. On an annualized basis, the economy grew at 2.8%. The manufacturing sector strengthened in October, as the UK’s industrial production maintained its stable annualized 2.5% growth path from the low point in October 2012. However, the UK service sector pulled back to its slowest in 17 months in October and construction growth also eased. On the bright side, the cooling pace coupled with low headline inflation likely takes rate hikes off the table, probably for the next few months. Equity markets typically do well in this kind of macroeconomic environment.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The outlook for emerging markets (EMs) remains mixed. Major challenges include a further slowdown in China, a strong rally in the U.S. dollar and continuing correction in commodity prices, weaker demand from Europe, and continuing geopolitical turmoil (Middle East, Ukraine and Hong Kong). Countries with strong trade links with China or heavy exposure to commodity prices face cyclical headwinds. Brazil is currently flirting with recession and Indonesia’s growth slowed to the weakest pace since the global financial crisis, albeit still near 5%.
Other countries benefited from the collapsing of commodities and continued reforms. The growth trends for India and Mexico, for example, look much more positive. In response to weak economic data in Q3, China has taken further measures to support the economy. The central bank lowered its repo rate and relaxed mortgage rules for homebuyers. In addition, authorities also announced plans to boost consumption.