As in recent months, geopolitical events dominated market moves over the course of November. The outcome of the US midterm elections was broadly as markets expected. The Democrats took control of the House of Representatives and the Republicans increased their majority in the Senate. As a result it seems less likely that the Republicans will be able to extend fiscal stimulus in a bid to tempt voters in the run up to the 2020 Presidential elections. US growth looks set to slow through the course of 2019.
The US administration’s more hostile approach to global trade played a significant role in the risk off sentiment that prevailed through much of November. Markets are increasingly concerned about the impact on growth outside of the US, but also the ramifications for growth in the US as tariffs raise cost pressure for households and firms. The meeting between President Xi and President Trump at the G20 at the end of the month showed some inclination to de-escalate the tensions, but significant areas remain where it will be difficult to find common ground.
There were plenty of other political events for investors to digest in November. Some progress was achieved on Brexit as a withdrawal agreement was agreed between the UK and the European Union (EU). The deal was underwritten by the leaders of the 27 EU member countries, and will be submitted to the UK parliament in December. The deal presented is the only clear solution to the Irish border question, but the need to align to EU rules is not palatable to all within the Conservative Party. There remains considerable scepticism amongst investors about the ability of the Prime Minister Theresa May to pass the deal through the House of Commons.
Our base case scenario is that final approval is still likely. Aside from a “no deal” scenario, which has little parliamentary support, the possible alternative outcomes of a new referendum or general election both carry the risk of no Brexit at all. We think that a majority of UK MPs will ultimately find all of these alternatives less palatable than the proposed deal. But there is likely to remain considerable volatility—particularly in sterling—over the coming weeks and sterling fell 0.7% over the month.
Tensions between Brussels and Italy also persist. The European Commission rejected the Italian budget law after no significant changes were made to the first spending proposal under the new government. It is unclear whether the Italian government will alter its proposal or face an “excessive deficit procedure”. More recently, discussions seem to have become more constructive between the Italian government and the EU, which could suggest the possibility of a compromise. The spread between Italian and German 10-year government bond yields fell back below 300 basis points (bps), having peaked earlier in the month at 327bps.
With geopolitical concerns continuing to weigh on risk appetite, global stock markets were unable to bounce back after the sizeable declines registered in October.
Exhibit 1: Asset class and style returns in local currency
Source: Barclays, Bloomberg, FactSet, FTSE, MSCI, J.P. Morgan Asset Management.DM Equities: MSCI World; 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 November 2018.
The global economy continued to expand but regional divergence remains. In general, the US data still show a solid trend despite a few signs of softness, particularly in the homebuilding sector where higher US interest rates are starting to hinder demand. Consumer confidence remained at a high level, though down slightly from a peak earlier in the year.
US headline inflation increased to 2.5% year on year (y/y), in part reflecting the implications of the oil price rally that reached its peak at the beginning of October. The recent rapid decline of the oil price suggests that inflation will gradually ease in the coming months. More importantly, core inflation declined to 2.1% y/y, highlighting that there are still very few signs of a meaningful acceleration in the underlying pace of inflation.
The meeting of the Federal Reserve was uneventful in November. The central bank left rates unchanged as expected, assessing that the economy is strong and the labour market is healthy. The market attaches an 80% probability to a rate hike in December but the expectation for further hikes next year has receded following the minutes of the November meeting and a speech by the Fed Chair at the Economic Club in New York saying that rates are “just below” the neutral level.
Signs of weakness persisted in Europe. The second estimate of GDP growth for the third quarter was disappointing with a growth rate that remained at 1.7% y/y. Some of the weakness was related to Germany (-0.2% quarter on quarter), which also posted a sharp decline in industrial production in the third quarter. This was in part due to the temporary decline in vehicle production as companies tackled new emissions standards.
In Italy, third-quarter GDP contracted 0.1% on the previous quarter. The persistent political uncertainty and increasing friction with Europe have seen some tightening in financial conditions, which is likely to affect corporate activity. The manufacturing and services purchasing managers’ indices (PMIs) were both below the 50 level, which indicates a fall in the level of output.
Consumer confidence in the eurozone declined more than expected and the flash PMI indicators for November were disappointing. The composite index fell 0.7 to 52.4, services fell to 53.1 and manufacturing to 51.5. Of the composite components, future output and employment fell the most.
Slowing activity is going to make it more difficult for the European Central Bank (ECB) to lift inflation, which at 2.0% y/y on the headline rate and 1.0% y/y on the core rate, remains stubbornly low.
The ECB is still expected to end its quantitative easing programme by year end but the market is increasingly sceptical that the ECB will be able to lift interest rates in the second half of 2019 as per its current guidance.
In the UK, macro data and monetary policy expectations are highly conditional on the approval of the EU withdrawal agreement by parliament. Unemployment rose modestly to 4.1% for September, but wage growth is slowly picking up. Headline consumer price index inflation stabilised at 2.4% y/y while core inflation held at 1.9% y/y for October.
Emerging countries continue to face challenges. So far there is little to suggest tensions between the US and China will abate. In the face of hostility from Washington, China has launched a new round of fiscal stimulus to be implemented in 2019. Additional monetary stimulus is also expected, with a possible cut of the reserve requirement ratio to support regional banks and small enterprises.
In Latin America, Fitch recently downgraded the outlook for Mexico to negative due to the political uncertainty created by the current administration. The central bank unexpectedly announced a rate hike to 8.0% with the intention of stabilising the currency and reducing inflation. In Brazil, markets have looked favourably on the appointment of President Bolsonaro given his reform agenda and focus on fiscal control.
In Japan, real third-quarter GDP growth contracted by 0.3% quarter on quarter, although this decline was expected given the recent natural disasters (including typhoons and an earthquake). The government’s reconstruction programmes, which are likely to start in 2019, could help to reinforce growth dynamics.
The third-quarter earnings season was reasonably strong, especially in the US where earnings per share (EPS) grew in excess of 25% y/y. Yet strong earnings did little to buoy sentiment and markets were especially sensitive to any guidance about future earnings being constrained by margin pressure associated with higher costs. In Europe, over 50% of companies beat EPS expectations and overall EPS growth was 10% y/y, which is still strong by recent standards.
After an exceedingly difficult year, emerging market equities stabilised in November but remain down over 7% year to date.
Exhibit 2: World stock market returns in local
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 November 2018.
The US 10-year Treasury yield fell back to 3.01% as markets became more concerned about the outlook for global growth and the oil price fell. Credit continued to struggle across the board as investors fretted about the high level of corporate leverage and the prospects for slowing growth.
Exhibit 3: Fixed income sector returns in 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 November 2018.
Exhibit 4: Fixed income government bond returns in 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 November 2018.
The oil price has fallen sharply from a peak of USD 76 per barrel in early October, to USD 51. This was mainly attributed to supply side changes, such as the huge increase in US production, higher production in Saudi Arabia and the introduction of exemptions on Iran sanctions. Concerns about the outlook for global demand also served to send the oil price lower. The Organisation for Economic Co-operation and Development (OECD) revised down its 2019 global growth forecasts (from 3.7% y/y to 3.5% y/y) after citing risks from trade tensions.
In summary, in November investors were once again torn between reports of relatively solid fundamentals today and geopolitical events, which threaten corporate earnings in the future. There is little to suggest that Brexit, or China-US tensions, will be resolved imminently so risk appetite looks set to remain subdued in the very near-term.
Exhibit 5: Index returns in November 2018 (%)
Source: MSCI, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. Data as of 30 November 2018.