Global Weekly: Divergence continues

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The divergence between the US and Europe in stock market performance continued this week, as the preliminary leading economic indicators also kept pointing in different directions for the regions. The S&P 500 Index stayed around the same level as last week, but the European Stoxx 600 lost 1.5%.

Important US preliminary manufacturing data for September was better than expected. The Purchasing Manager’s Index (PMI) came in at 51 instead of 50.4. Data above 50 indicates expansion, while below 50 signals contraction. With the US economic indicator pointing to continuing growth, data from Europe showed a clearly different picture. Eurozone PMI manufacturing data, at 45.6, continued a downward trend that began in January 2018. Germany showed the largest contraction in manufacturing, as at 41.4, it hit a new ten-year low. It was also far lower than the 44 that had been expected. Germany is particularly vulnerable to global trade, given the country’s significant dependence on exports. And even though China and the US have started trade talks again, their different political and economic interests are likely difficult to solve and will probably keep global trade under pressure. This is one of the reasons why we continue to prefer the US over Europe for stock investing.

The second occurrence occupying the equity market this week was the announcement of a formal impeachment inquiry into US President Donald Trump. In the last 50 years, we have seen two impeachment announcements: against Richard Nixon in 1974 and Bill Clinton in 1998. On both occasions, it caused some volatility on the day of the announcement. Clinton was acquitted in 1999, but when Nixon resigned later in 1974, the S&P 500 Index had dropped by 13% during the impeachment period. As the outcome of the current inquiry is highly unpredictable, it is an extra risk for markets, but far less important than the economic outlook or company earnings.

On a company level, the week started with the collapse of the 178-year old tour operator Thomas Cook. As consumers changed their travel habits, moving away from the traditional tour operator to online bookings, Thomas Cook’s pile of debt became too much. TUI AG, EasyJet Plc and Ryanair jumped on bets they could win market share from the firm’s collapse. On Tuesday, Total SA was in focus after the oil major said it will accelerate dividend growth, given its forecast for higher cash flow. On Wednesday, Nike’s stock price rose to a record-high after strong results. Nike was able to report quarterly earnings per share that topped even the most bullish Wall Street estimates. The company’s strategy to focus more on online sales, a more efficient supply chain and product innovation has paid off. Especially in China, sales were strong, with currency-adjusted growth of 27% in the quarter.

Manufacturing data hints at further slowdown

For most of September, the mood on the financial markets has been slightly positive. Actual growth numbers were not as bad as feared, economic surprise indicators turned positive and the US and China seemed to be working in a more constructive manner. Together with dovish policy actions from the European Central Bank and Federal Reserve, this environment supported credit spreads.

As the end of the month approaches, this positive mood is fading, with risks becoming more prominent in news headlines. We have seen disappointing data that hint at growth slowing further, as weak manufacturing data was released, especially in the eurozone. There is also sign of contraction in services data, reinforcing fears that the slump in manufacturing could spread. In the US, consumer confidence posted its biggest drop this year. Furthermore, we see many political risks that could make things worse. An escalation in the US/China trade war (after many constructive signs, Trump recently called China a currency manipulator and again accused China of stealing intellectual property). There is also a potential trade war between US and the EU: the World Trade Organization will authorize the US to impose tariffs on European goods following illegal state aid to Airbus; and the EU seems likely to respond with tariffs on US goods. The impeachment process against Trump and continued uncertainty concerning Brexit are also not helpful for global growth. We see this data and the political risks as confirming our expectations for the economy to slow further. We expect that the central banks will keep fighting this slowdown with further easing. As a consequence, we retain our positive view on longer duration. Long-duration (safe-haven) bonds can provide diversification from equity and credit risks in times of market turbulence.

Although a slowing economy is not positive for corporate bonds, we stick to our overweight position in investment-grade credits -- not based on fundamentals, but rather, on strong technicals. The spread on the corporate bond index slowly widened after an initially positive reaction regarding the ECB’s new quantitative easing (QE) programme. We consider this the result of a very heavy supply of new bonds, which should moderate at some point. At the same time, we expect demand for credits to remain strong, as it is only one of a few places in the investment-grade universe where investors can get positive yields. Furthermore, we expect the new QE programme to result in net purchases of approximately EUR 2.4 billion of assets per month. This assumes the approach to purchases is similar to the previous QE programme.

We think the slowing economy is a bigger risk for high-yield corporate bonds. This view is confirmed by high-yield investors continuing to steer their exposure away from lower quality high-yield bonds and towards BB bonds. This shift is not expected to change for now. Within the high-yield universe, we retain our preference for emerging-markets debt, which we expect will be supported by the Fed’s rate cuts.

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