Review of markets over April 2018Contributors Maria Paola Toschi, Global Markets Insights Strategy Team
Volatility – which returned with a vengeance in the first quarter – persisted through much of April. Geopolitical headlines continued to play a significant role in unsettling investors, particularly the prospect of a “trade war” between the US and China alongside an escalation of tensions between the US and Russia over the situation in Syria.
Coupled with uncertainty over the role of Iran in the international community, oil prices rose 7% over the month. As a result, commodities were the top performing asset class (up 2.2% YTD and 2.6% in April).
Investors had to balance the potential downside of these events with an earnings season that, particularly in the US, looks to be exceeding expectations. In the end, the stronger earnings momentum was enough to push developed market equities higher over the month, but performance is still broadly flat year to date. Emerging market equities have returned 2.0% since the beginning of the year.
The perception that inflationary risks are starting to build put pressure on global bond prices and the US 10-year Treasury yield briefly touched 3% for the first time in over four years. The global aggregate bond index fell 1.6% over the month.
Exhibit 1: Asset Class and style returns (local currency)
Source: Barclays, Bloomberg, FactSet, FTSE, MSCI, J.P. Morgan Asset Management. REITs: FTSE NAREIT All REITs; Cmdty: Bloomberg UBS 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 local currency. Data as of 30 April.
The global synchronised recovery – which proved so fertile for asset markets in 2017 – has appeared to falter in recent months as survey data has pointed to a slowdown in many parts of Europe.
However, temporary factors, such as bad weather and the spike in the euro at the start of the year, likely played a role in depressing sentiment. There are already signs of stabilisation in the April data. The April flash Purchasing Managers’ Index (PMI) for the eurozone, at 55.2, is still consistent with a 2018 GDP growth rate of 2.5%.
The recovery continues to be underpinned by the improvement in the labour market. The eurozone unemployment rate fell to 8.5% thanks to significant declines in several countries, including Italy, France and Spain. A stronger labour market is supporting consumer confidence, with retail sales growing at a healthy 1.8% rate, year-on-year (y/y). The first-quarter European Central Bank (ECB) lending survey was strong, suggesting that accommodative monetary policy is still providing a significant tailwind to growth.
Concerns about global trade and a currency that has risen since the start of the year also played a role in depressing sentiment in Japan. These factors were cited by the firms surveyed in the Reuters Tankan Index which fell sharply in March. Again these concerns appear to be easing and the manufacturing PMI for April improved slightly to 53.8.
There is much less concern about a slowdown in the US, where data across the board continues to look strong. The April flash manufacturing PMI increased by more than expected, rising to 56.5. Consumer confidence also came in ahead of consensus, while first-quarter annualised GDP growth of 2.3% was robust.
Many investors remain cautious that this pace of growth will at some point lead to an acceleration in inflation, and in turn much tighter monetary policy from the US Federal Reserve (the Fed). Inflation is nudging up, but gradually. With the base effects of weak telecoms prices this time last year falling out of the annual comparison, headline inflation rose to 2.4%. Core inflation is now 2.1%. Wage growth – which many central banks including the Fed have focused on as an indicator of underlying inflationary pressure – nudged up to 2.7% in March. The unemployment rate stayed at 4.1% for the sixth month in a row.
Chinese growth also remained robust. Annual growth was 6.8% in the first quarter of the year. There is also increasing evidence that China is managing to successfully transition from export- and investment-led growth to an economy that is driven by consumption. Domestic consumption accounted for 78% of the economy’s growth in the first quarter vs. 31% for investment. Net exports subtracted 9%.
A divergence in the outlook for inflation between the US and the eurozone suggests that monetary policy will also continue to diverge. Inflation is slowly picking up in the US but there is little sign of such an imminent increase in the outlook for prices in the eurozone, where the headline consumer price index (CPI) rose 1.3% y/y in March and core CPI remained stuck at 1.0%.
The Fed is expected to announce two more 25 basis point interest rate increases over the remainder of 2018, according to market prices at the end of April. The latest press conference from the ECB suggests that it will continue its accommodative policy throughout the year with ECB president Mario Draghi once again emphasising a need for “patience and persistence”. The ECB’s current guidance remains that it will continue with its asset purchase programme until September, if not beyond, and interest rates will rise at some point well beyond that.
The UK data releases were mixed in April. The labour market looks solid, with unemployment falling to 4.2% in the three months to February, and wage growth accelerating slightly to 2.8% over the same period. UK headline and core inflation fell by more than expected (to 2.5% and 2.3% respectively). Rising wages and falling inflation will ease the pressure on the UK consumer. However, first-quarter GDP growth of just 0.1% quarter on quarter was very weak. Market expectations for a May interest rate increase from the Bank of England fell from near 100% at the end of March to 20% by the end of April.
The People’s Bank of China eased monetary conditions by cutting the reserve ratio requirement (RRR) for a wide range of banks with the intention to release liquidity for financing small and micro enterprises.
Exhibit 2: World stock market returns (local currency)
Source: FactSet, FTSE, MSCI, Standard & Poor's, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency. Data as of 30 April.
With 32% of the S&P 500 Index by market cap having reported, the US first-quarter earnings season is showing strong momentum, with earnings-per-share growth of 23%. Of those S&P companies that have reported so far, more than three quarters have exceeded expectations. Our analysis suggests that around one third of the increase in earnings can be attributed to the tax cut, with one third from higher domestic earnings and one third from international earnings. Despite the strong earnings reports, the S&P 500 price index ended the month up only 0.3%.
The earnings season is much less advanced in Europe but so far looks solid. The 1.8% decline in the euro against the dollar over the month has also eased concerns about the prospects for the region’s exporters. The MSCI Europe (ex UK) Index delivered a total return of 4.5% for the month.
In the UK, the 1.8% decline in sterling against the dollar over the month boosted the value of international earnings and helped the FTSE 100 top the table of returns, with a 6.8% monthly gain.
Exhibit 3: Fixed Income sector returns (local currency)
Source: Barclays, BofA/Merrill Lynch, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. IL: Barclays Global Inflation-Linked; Euro Treas: Barclays Euro Aggregate Government - Treasury; 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. Data as of 30 April.
The US 10-year Treasury yield hit 3% for the first time since 2014 after the increase in inflation, which has increased expectations for the number of Fed rate hikes this year.
The Italian 10-year yield continued to fall after the March elections and the 10-year spread over German Bund yields declined to 123 basis points, helped by the rise in the 10-year Bund yield to 0.56%.
The EURUSD exchange rate cooled to 1.20 as a result of the decelerating economic momentum in the eurozone and the expectation of tighter US monetary policy.
The oil price rallied. The International Energy Agency announced that the excess oil inventories that had kept prices low have now disappeared thanks to the production cuts put in place by the Organization of the Petroleum Exporting Countries (OPEC) and the strength of global oil demand. According to consensus estimates the oil price could rise further, also boosted by the prospect of sanctions on Iran.
Exhibit 4: Fixed Income government bond returns (local currency)
Source: FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. All indices are J.P. Morgan GBIs (Government Bond Indices). All indices are total return in local currency. Data as of 30 April.
Despite some risks related to trade restrictions, geopolitical noise and expectations of tighter monetary policy, markets remain on track thanks to signs that the global economy continues to expand, inflation is only rising gradually and earnings growth is healthy.
Exhibit 5: Index returns in April (%)
Source: MSCI, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. Data as of 30 April.
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