In August, market volatility has increased, reflecting renewed stress in the Chinese property market, weak macroeconomic data out of China and an increase in sovereign bond yields.
Given this backdrop, global stocks sold off and the MSCI All Country World Index declined 2.8% over the month in US dollar terms. Developed markets outperformed emerging markets, with a loss of 2.3% vs. 6.1%.
Fixed income did not help diversified investors absorb equity losses, with the Bloomberg Global Aggregate falling 1.4% in August as sovereign yields rose. Yields on the 10-year US Treasury increased by 16 basis points (bps), to 4.1%.
In commodity markets, global oil prices remained relatively flat over the month as growth risks in China counterbalanced the impact of production cuts. Despite the European Union (EU) reaching its gas storage target well ahead of the 1 November deadline, European natural gas prices increased by 23% in August on the prospect of a possible strike at three liquefied natural gas (LNG) plants in Australia, which could disrupt up to 10% of the world's LNG supply.
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 August 2023.
US
At the start of August, the credit rating agency Fitch downgraded the US government’s credit rating from AAA to AA+, citing unsustainable debt and deficit trajectories and increased political dysfunction. While this decision led to heated debates in political and economic circles it had little impact on 10-year US Treasury yields, which hardly increased after Fitch’s announcement. However, yields rose later in the month on the back of better-than-expected economic data and strong issuance.
Overall, incoming economic data remained solid in the US. Labour market data pointed to a cooling but still strong jobs market in July, with payroll job gains of 187,000, slightly below consensus expectations for 200,000. Unemployment ticked down to 3.5%, while average hourly earnings were slightly stronger than expected at 4.4% year on year (y/y). Retail sales increased 0.7% month on month (m/m) in July, well above expectations of a 0.4% m/m rise.
On the inflation front, headline Consumer Price Index (CPI) increased slightly in July to 3.2% y/y due to higher food and energy prices, while core CPI decelerated slightly to 4.7% y/y from 4.8% y/y in June. The minutes of the Federal Reserve (Fed)’s July meeting nevertheless revealed that most officials remain concerned about inflation, and thus left the door open for additional rate hikes if necessary. Jerome Powell’s Jackson Hole speech, unlike last year, has been well received by financial markets. Overall, the Fed’s policy will remain data dependent with a bias to tighten if necessary.
Market pricing suggests the Fed could deliver one final hike before year-end, followed by four or five rate cuts in 2024. The August purchasing managers’ indices (PMIs) certainly supported this dovish outlook, as the manufacturing and services PMIs fell to 47 and 51, respectively.
Despite the relative strength of the US economy, the S&P 500 fell 1.6% in August as yields rose. Higher rates and volatility supported the US dollar, which gained 1.7% on a trade-weighted basis.
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 August 2023.
Europe
Eurostat’s flash GDP estimate showed that euro area GDP grew by 0.3% quarter on quarter (q/q) in Q2 2023. While this pace was relatively modest, euro area labour markets remain very tight, with the unemployment rate dropping to 6.4% in June, its lowest level on record. However, the economic outlook remains uncertain, as the August composite PMI fell to 47, its lowest level (ex-Covid) since 2012.
Eurozone headline inflation defied expectations and remained flat in August at 5.3 y/y. Core inflation, however, did fall modestly from 5.5%y/y in July to 5.3%y/y in August. While improving, inflation nevertheless remains well above the European Central Bank (ECB)’s target and markets continue to price further ECB rate increases before the end of the year.
The MSCI Europe ex-UK index dropped by 2.2% in August, dragged down by the banking sector after the Italian government announced a tax on banks’ “excess” profits. European bond yields remained broadly stable in August and the Bloomberg Euro Aggregate rose 0.3% over the month.
In the UK, the Bank of England (BoE) hiked its policy rate by 25bps at the start of August, bringing Bank Rate to 5.25%. The BoE highlighted its intention to hold rates at restrictive levels for some time. Despite this tighter monetary policy, the UK economy surprised to the upside during the second quarter of 2023, as GDP rose by 0.2% q/q vs. a consensus expectation of 0.0% q/q.
UK headline CPI eased in line with expectations to 6.8% y/y in July, down from 7.9% y/y in June. Labour market data showed growth in regular pay (excluding bonuses) was 7.8% y/y in the period April to June 2023, the highest rate since comparable records began in 2001. In this context, markets continue to expect further rate increases from the BoE this year. Against this backdrop, the 10-year Gilt yield rose 5 bps to 4.4% in August, while the FTSE All-share underperformed its developed market peers, declining 2.5% over the month.
Exhibit 3: 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 August 2023.
Asia
In China, activity data was much weaker than expected. On the inflation front, CPI turned negative in July at -0.3% y/y, while producer price index (PPI) deflation continued for the 10th month in a row. Retail sales missed expectations by a wide margin, growing 2.5% y/y against expectations of 4.5% y/y. A rebound in the coming months seems unlikely as household confidence also remained weak.
Chinese investment data also highlighted low business confidence as private investment decreased 2.3% y/y in July. Real estate was the weakest sector, with an 8.5% fall in investment between January and July compared to the same period last year. The difficulties of Country Garden and Evergrande, two of China’s largest property developers, also highlighted real estate weakness in August.
To address these difficulties as well as deflationary risks, the People’s Bank of China (PBoC) lowered its interest rate twice in August, but so far credit demand remains weak. At the end of the month, Bejing also took several initiatives to support financial markets, such as halving the stamp duty on stock trading. Despite these measures the Renminbi lost 1.6% against the US dollar over the month, while the CSI 300 index dropped 6.2%.
In Japan, the economy expanded by 6.0% q/q in the second quarter of 2023 on the back of a strong contribution from net trade. Activity indicators such as the Tankan index point to a continuation of this strong momentum in coming months. Japan also seems to be turning the page on its deflationary period, with core CPI up 10 bps to 4.3% y/y in July and spring (Shunto) wage negotiations leading to the biggest wage increases in 30 years. Compared to other markets, Japanese equities proved relatively resilient in August as the Topix posted a modest gain of 0.41%.
Exhibit 4: 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 August 2023.
Conclusion
As discussed in our mid-year outlook, market expectations for a “Goldilocks” scenario that supported global markets until the end of July were probably too good to be true. To some extent, August’s volatility highlighted that a growing number of investors seem to share the same concern.
China’s difficulties will inevitably weigh on the global economy in the coming months, given the country contributes almost a third of global growth. At the same time, even though inflation pressures are receding, risks have not entirely disappeared and central banks will likely have to maintain restrictive policies beyond 2023.
In this context, we continue to believe that investors should remain well diversified with a focus on quality.
Exhibit 5: Index returns for August 2023
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 August 2023.
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