Global Weekly: No X-mas presents yet

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Equity markets were again up for a volatile ride this week, mostly on the back of continuing geopolitical unrest. The kick-off on Monday was negative, as concerns around the trade war between the US and China deepened again following the arrest of Huawei’s CFO in Canada.

In the following days, investors shifted their attention to Trump’s threat about a potential government shutdown. Next to that, the market was digesting the outcome of the OPEC+ meeting (‘OPEC+’ refers to OPEC and its partners). Although the agreed production cuts were a touch stronger than anticipated, the recovery in the oil price was only short-lived. Lastly, the Brexit saga continued with Theresa May postponing the parliament vote, surviving a vote of confidence and trying to gain support from the EU get the deal through. Although Brexit volatility on financial markets is mainly reflected in pound sterling price movements, it does not particularly add positively to investor sentiment in equity markets.

From a sector perspective, US tech companies were among the hardest hit as it came under serious selling pressure on Monday. Throughout the week, however, the tech sector recovered, with trade tensions easing again. Meanwhile, at a company level, we regularly see the effects of the European slowdown coming through. This week, it was BASF that downwardly adjusted its outlook for the fourth quarter. Although BASF’s challenges are partly company specific, industry dynamics have clearly been negatively impacted by hesitant end-user demand. As mentioned last week, earnings expectations are currently being adjusted to new macro projections for next year. Although at present, average analyst expectations could still be on the optimistic side, we believe that if and when this trend stabilizes, equity markets have room to bottom out. Certainly if accompanied by some relief on the geopolitical side, the market environment could potentially look more friendly early next year.

Bonds: growing uncertainty

Uncertainty keeps spreading in financial markets and global politics. Italy, Brexit and ‘yellow vests’ in France remain a source of concern in Europe, while the recent G20 summit provided no lasting relief to investors worried about trade conflicts further escalating into 2019. Growing uncertainty is more and more weighing on economic confidence, as US indicators are the only ones still holding up. Fed chairman Powell already struck a dovish tone in recent speeches, raising market expectations for a considerable shift in Fed communication after next week’s meeting.

Although a rate hike at this meeting still is very likely, markets have come close to pricing out any further hikes in 2019. The ECB decided to end its asset purchase programme (quantitative easing) by the end of this year, as was widely expected. At the same time, however, the central bank emphasized its intentions to keep rates low for very long, as growth and inflation forecasts were lowered. We do not expect the ECB to hike rates before 2020, implying an increasing risk that rates will remain at rock-bottom levels throughout this whole economic cycle. With yields low for longer, core European government bonds become less unattractive.

The first sign of inversion somewhere on the US Treasury yield curve seems to have further sparked anxiety that a recession could be around the corner, perhaps already in 2019. While US Treasury and German Bund yields are now falling in tandem, corporate spreads have widened sharply over the last few months, into territory that does not fit the still constructive low growth, low inflation environment we are expecting and economic indicators are pointing at. BBB corporate spreads moved from a five-year low early this year to touch a five-year high recently, the same levels at which the ECB started buying corporate bonds in 2016.

In relative terms, global investment-grade spreads have now widened considerably more than global high-yield spreads. If recession risks would be higher than we currently expect, high-yield spreads look most vulnerable from here. If economic data continue to be more resilient than market turmoil suggests, corporate bonds are starting to look relatively more attractive.