Review of markets over March 2018 - J.P. Morgan Asset Management
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Review of markets over March 2018

Contributors Michael Bell, Global Markets Insights Strategy Team

After a strong year for equity markets in 2017, most equity markets were fast out of the blocks in January, only to stumble at the first hurdle heading into February. A brief recovery in stocks in the latter part of February was interrupted again in March by concerns over a potential trade war between the US and China.

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 31 March 2018.

February’s selloff was triggered not by weak economic data but by strong wage growth numbers from the US. Wage growth appeared to accelerate from 2.5% to 2.9% year-on-year: a substantial jump over just one month. The speed of the acceleration in wage growth caused investors to worry that US interest rates would have to rise faster than the economy could withstand. Some investors rushed for the exit.

However, the next month’s data showed that wages were only growing at 2.6% year-on-year. So it turns out that wage acceleration is proving more gradual; hence February’s panicked selloff was unjustified. In the meantime, US companies had been reporting strong earnings and analysts were busy revising up their earnings estimates for this year as companies started to communicate the effect the tax cuts would have on their earnings.

Just as it appeared that calm had returned to markets, global equities were rocked once again by fears of a global trade war. The US administration initially announced tariffs on steel and aluminium imports. This was followed by a 25% tariff on $60 billion worth of Chinese imports (with the exact goods as yet not specified). The Chinese, in response, have announced increased tariffs on $3 billion worth of US imports. The proposed tariffs on Chinese goods amount to only about 0.1% of Chinese GDP while those on US goods are even less significant for US and global growth. That is not to say that risks to the trade outlook do not exist, but it is important to contextualise the size and importance of any protectionist measures that are announced.

The start of the year certainly has not lacked headlines and volatility. However, have the fundamentals – healthy global growth and accommodative monetary policy – changed sufficiently to justify a more negative outlook for equity markets over the rest of this year? In short, we think not.

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 31 March 2018.

Forward-looking indicators of growth in the eurozone, such as the Purchasing Managers’ Index business surveys, have rolled over but if they stabilise at these levels would still be consistent with eurozone growth of over 2%. Eurozone consumer confidence, which has historically been positively correlated with eurozone equities, has remained at buoyant levels as the unemployment rate continues to decline.

The European Central Bank (ECB) also seems as though it is in no rush to raise interest rates. Over the past 18 months, the Governing Council has consistently revised down its inflation forecasts despite revising up its growth forecasts. While the removal of ECB quantitative easing (QE) by the end of this year still seems likely, we believe there will be a lengthy pause before the ECB begins to raise interest rates. So in Europe, the pace of growth is slowing only slightly and monetary policy remains accommodative.

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 EMBI+. All indices are total return in local currency. Data as of 31 March 2018.

In the UK, business surveys remain consistent with continued moderate GDP growth. Although retail sales remain weak, there is some cause for optimism about a pick-up later in the year. Wage growth edged up to 2.8% in the three months to January and inflation in February fell to 2.7% year-on-year. As a result, real wages are starting to increase. With sterling’s rally since the start of the year, UK inflation could fall quite quickly, further easing the squeeze on real wages.

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 31 March 2018.

The backdrop of improving wage growth and low unemployment, combined with the recent good news that a Brexit transition deal has been agreed, is likely to give the Bank of England (BoE) the confidence to raise rates again in May. Two members of the Monetary Policy Committee already wanted to raise rates in March but were outvoted. If a full withdrawal agreement is reached by October then the BoE may feel comfortable raising rates again in November. Thus, monetary policy is tightening in the UK but at a pretty glacial pace.

Apart from the ongoing political uncertainty, the main risk to the UK economy is now signs of weakness in the housing market and the potential impact on consumer confidence were house prices to start falling. New buyer enquiries and the number of newly-agreed sales are lower over the year, according to the Royal Institute of Chartered Surveyors (RICS) survey. However, with unemployment and interest rates low, there is limited selling pressure. This may explain why estate agents’ expectations of prices over the next three months have recently picked up. At the moment, we are monitoring rather than panicking about the housing market.

In the US, growth remains healthy and while fiscal stimulus runs the risk of eventually overheating the economy, it significantly reduces the risk of a recession this year. Key early warning indicators for the economy continue to paint a positive picture of the growth outlook. Consumer confidence is elevated, jobless claims remain low and job openings are the highest on record. House prices continue to rise and building permits for new homes are rising, though not at an obviously excessive pace. Business investment intentions are also strong.

The US Federal Reserve (Fed) appears to be increasingly confident that the US economy can withstand higher interest rates. In March, Fed members, under Jerome Powell’s new leadership, revised up their expectations of the pace at which they will increase interest rates next year. The Fed’s median expectation is now for three rate rises in 2019 and they were only one member away from shifting their median expectation to four rate rises this year.

Until recently, the market was not convinced that there would be so much monetary tightening. Indeed, the market started the year expecting the Fed to raise interest rates only twice by the end of 2019. Since then, the market has shifted to price in two more rate rises over that period, explaining the rise in US government bond yields this quarter. If the Fed does end up tightening at the pace its median member expects, the market still has some catching-up to do, suggesting bond yields could still move higher.

The key question is: what level of interest rates will start to weigh meaningfully on economic activity? Though this question is always difficult to assess in real time, we are increasingly monitoring areas of the economy that have seen an increase in leverage. We are particularly mindful of the fact that leverage in the corporate sector is high by historic standards and the corporate debt service ratio is rising. This could be the primary channel by which higher interest rates eventually pose a risk to the US economy.

Despite the shift higher in expectations for US interest rates, the dollar has weakened in the year-to-date. Markets have focused on the fact that the US will have to borrow more to finance its stimulus and could end up importing more as a result of higher spending, putting downward pressure on the dollar. Against this backdrop of a weaker dollar, it is not surprising that emerging market (EM) equities have held up relatively well compared to many other markets, supported by still-strong GDP and corporate earnings growth.

Overall, despite the volatility, the outlook for global growth continues to look positive, with the removal of monetary policy accommodation still gradual. The road ahead may well be bumpier but we do not think we have reached the end of the road just yet, even though, after a long journey, more and more people are inevitably asking, “Are we nearly there yet?”.

Exhibit 5: Index returns for March 2018 (%)

Source: MSCI, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. Data as of 31 March 2018.

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