Global Market Snapshot

Size: px

Start display at page:

Download "Global Market Snapshot"

Kellie Bradford
5 years ago
Views:

1 December 2018 INVESTMENT STRATEGY Global Market Sapshot Key Market/Ecoomic Observatios Uited States Earigs Growth ad Iterest Rates Reach New Highs; Markets Tur Focus to Future Growth ad Federal Reserve (Fed) Rate Path Large-cap equities remaied below their 200 day movig average for the secod cosecutive moth as ivestors reacted to a cofluece of headlie risks ad lower earigs revisios for the fourth quarter. Iterest rates moved higher early i November, with the 10-year Treasury reachig its highest yield sice 2011, oly to declie early 25 basis poits (bps) over the last three weeks of the moth. While the yield curve cotiues to flatte, ucertaity over the path of moetary policy remais a poit of cotetio betwee Fed policy makers ad ivestors. Despite third-quarter earigs growth of early 26%, the highest level sice 2010, dollar stregth, risig iput costs, ad missed sales estimates from some mega cap mometum stocks overshadowed strog bottom lie results. The much-aticipated G-20 meetig took place the last weeked of November. Markets reacted favorably after it was aouced Presidet Doald Trump ad Chiese Presidet Xi Jipig made positive progress o trade egotiatios. I mid-november, the S&P 500 fell ito correctio territory (defied as beig dow 10% or more from a prior peak) for the secod time this year. Not havig experieced a correctio sice 2015, the market appears to be movig out of its multiyear volatility lull. With more tha half of the S&P 500 costituets tradig below their respective 200 day movig averages, the damage doe durig this correctio has bee far greater tha what was experieced earlier i the year. Durig the Jauary/ February correctio, approximately two thirds of the S&P 500 stocks remaied above their 200-day movig averages, givig the market far more support i its recovery. Although we do believe the market is likely to rally ito year ed, it may take some time for equity prices to retur to the record high levels see i September. Third-quarter earigs seaso is early complete. The S&P 500 saw a growth rate of early 26%. This marks the fourth cosecutive quarter of acceleratig earigs growth, ad every sector geerated positive results. Uder the ew Global Idustry Classificatio Stadard format, the Commuicatio Services sector was a sigificat cotributor to both earigs ad reveue growth; however, reveue upside surprise was amog the lowest of ay sector. Highlightig the recet challeges i iteret-based stock prices, third-quarter earigs marked the first time Alphabet Ic. (GOOG), Amazo.com, Ic. (AMZN), ad Facebook, Ic. (FB) all missed sales estimates i the same quarter sice Facebook wet public i Although we believe the curret ecoomic expasio is likely to cotiue through 2019, housig data cotiue to show sigs of sluggish growth. The Natioal Associatio of Home Builders (NAHB) Housig Market Idex, the mothly homebuilder survey, missed expectatios ad fell to its lowest level i over two years, its sharpest mothly drop sice The statemet accompayig the report from the NAHB suggested that risig mortgage rates, coupled with icreasig housig prices, have egatively affected demad this year. Give its importace to ecoomic growth, we believe ogoig challeges i the housig market are a sigificat iput i the Fed s aalysis regardig the health of the overall ecoomy ad the ability to withstad future rate hikes. Fed Chair Jerome Powell gave a speech o November 28 sayig iterest rates are just below the eutral rate level. We believe market participats iterpreted the speech to suggest the Fed may softe its moetary policy tighteig. The Dow Joes Idustrial Average rallied more tha 600 poits the day of the speech, its secod largest oe-day move of the year. The speech stads i

2 stark cotrast to remarks Chair Powell gave i early October idicatig iterest rates were still a log way from the eutral rate level. S&P 500 performace betwee both speeches saw stocks declie over 8%. As midterm electios largely played out as pollig data suggested, the focus i November has bee aticipatio of the G-20 summit i Argetia. Headig ito the meetig, it was ucertai whether Presidet Trump ad Chiese Presidet Xi could reach a deal regardig trade egotiatios. By Saturday ight of the coferece, the leaders from the two largest ecoomies had reached a positive agreemet o trade, ad markets reacted favorably. Amog the details of the summit s outcome, the U.S. will refrai from raisig tariffs from 10% to 25% o Jauary 1, Istead the U.S. will place a 90 day extesio o curret policy as the two coutries ca focus discussios o specific topics such as itellectual property, ad Chia agreed to boost its purchases of agricultural goods from the U.S. Third-quarter earigs seaso highlighted the impact of higher iput costs towards operatig margis, ad we believe the market is uderpricig the probability of ogoig positive progress toward a trade deal. Developed Iteratioal Markets Developed Iteratioal Markets Face Uptick i Volatility ad Festerig Macroecoomic Cocers alog with Moetary Policy Normalizatio Developed iteratioal equity markets cotiue to move i parallel with the recet pickup i dowside volatility across U.S. markets. A host of macroecoomic issues, such as weak third-quarter ecoomic growth, the Italia budget coflict, ad the Uited Kigdom s Brexit struggles, likely cotributed. Though volatile, the MSCI EAFE, Germa DAX, ad Japaese Nikkei 225 idexes were early uchaged across the moth ad remai at two-year lows. Moreover, global equity markets remai hypersesitive to risig bod yields. Essetially, equities ad bod yields have trapped each other. We see chages i rates as the key driver behid iteratioal equity, fixed icome, ad currecy markets. Double-digit earigs growth i developed iteratioal markets reflects improved ecoomic growth over the last three years. However, as expectatios have icreased, estimates have become more difficult to exceed. Both the Stoxx Europe 600 ad Japa s Nikkei 225 idex reported the lowest level of earigs beats sice 2016, reflectig dimiished ecoomic surprises i 2018 as global growth has become less sychroized. The extet to which both ecoomic ad earigs expectatios are adjusted will be key i determiig whether the historically wide valuatio differetial ca persist i the ear term. Europea markets reacted positively to reports that the Italia govermet may be ope to lowerig the coutry s 2019 deficit target. By more closely aligig this target with Europea Uio regulatios, the Italia govermet could remove a thor i the side of the Eurozoe, which recetly took iitial steps toward fiig Italy for ocompliace. Before the reports, the Italia 10-year yield declied sharply alogside a declie i the premium ivestors demaded to purchase Italia debt (as evideced by the tighter spread betwee the Italia ad Germa 10-year yields). Sice the, Italia assets, particularly bak stocks (which ow approximately oe-fifth of the coutry s debt) have moved meaigfully higher. We cotiue to believe the Europea Cetral Bak (ECB) is ulikely to chage its moetary policy guidace uless the iflatio trajectory alters course. I our view, it will be the markets, rather tha the ECB, that will disciplie Italy s growth outlook. Though Italy s budget coflict may be seeig sigs of relief, the ogoig Brexit dilemma is ot. The Uited Kigdom has struggled to fid cosesus i decidig betwee trade idepedece ad a path of less ecoomic disruptio. The Uited Kigdom ad the Europea Uio have agreed o a draft political declaratio, but the higher hurdle to clear will be gettig approval from the Uited Kigdom s ow govermet. Recet cabiet member resigatios ad calls for a vote of o cofidece idicate that a smooth approval process is ulikely. Furthermore, a sharp drop i the poud may sigal the markets believe the chaces of a o-deal Brexit have icreased. The ucertaity 2

3 iheret i this coflict has also ecumbered busiess ivestmet, as may firms have paused their capital expediture plas util the logerterm ladscape becomes clearer. Ecoomic growth mometum cotiues to slow i developed markets. Germa ad Japaese growth actually fell i the third quarter, but we believe these particularly weak data were primarily due to temporary factors. Germa exports, which comprise 47% of GDP, were dragged dow by a strugglig auto idustry o the implemetatio of ew emissios stadards. Furthermore, Germa Chacellor Agela Merkel, a stalwart of stability i the Europea Uio, decided to retire from politics i 2021, addig additioal political ucertaity withi the Eurozoe. I Japa, earthquakes ad a typhoo weighed o ecoomic growth. We believe fourth-quarter rebouds are likely for Germa ad Japaese GDP data ad that the ECB will keep its key policy settigs o hold. ECB Presidet Mario Draghi oted that he believes the recet weakess i ecoomic data is temporary ad that he cotiues to aticipate a ed of et asset purchases by year ed. Emergig Markets Emergig Markets (EMs) Post Positive Moth; Future Path Depedet o Dollar ad Chiese Growth Despite the volatile moth across developed markets, EM equities posted a much-eeded positive moth i November. Oe moth does ot costitute a tred, however, ad we could to see further volatility withi the asset class. Still, recet performace could sigal the early stages of shiftig ivestor setimet. Additioally, relative valuatios are begiig to look attractive for patiet, log-term ivestors. Curretly, the oe-year forward price to earigs (P/E) ratio of the MSCI EM Idex sits at 11.5 times, or 6% lower tha its 20-year average. But, over the ear term we believe the bear versus bull case for EM equities rests primarily o ivestor expectatios for Chiese ecoomic growth ad the stregth of the dollar relative to EM currecies. Curretly, Chia is i the midst of its fourth moetary easig cycle i the past 10 years to combat a slowig ecoomy ad U.S. trade tariffs. The coutry s ability to spur ecoomic growth while other major ecoomies are tighteig ad trade tariffs are moutig will be somethig we cotiue to moitor. Accordig to Corerstoe Macro research, Chia has implemeted 37 differet fiscal or moetary easig moves i just the last five moths, ragig from a weaker yua/dollar to tax cuts. Ultimately, we view these measures as, at best, offsettig the slowdow effects of U.S. trade tariffs. Ecoomically, Chia has diversified away its depedece o the Uited States, which accouts for 20% of the atio s total exports ad oly 3.6% of the coutry s GDP. I fact, the strogest growth i Chiese exports has bee drive by developig ad emergig ecoomies. Whe aggregated, the category s exports are 2.4 times larger tha those of the Uited States ad grew 19.3% year over year, accordig to secod-quarter data. This is early double the rate of U.S. exports. The growig iterdepedece betwee Chia ad other emergig ecoomies has played a large part i the uderperformace of EM equities year to date. Curretly, approximately 42% of the MSCI EM idex is made up of Greater Chia domiciled stocks, however over 56% of the reveues of the MSCI EM idex holdigs come from Greater Chia. Year to date, the MSCI Chia idex is dow 14.5%, while the MSCI Emergig Markets idex is dow 11.9%. Mexica equities bega to uderperform the EM idex i late October, after ewly elected Presidet Adres Mauel Lopez Obrador aouced he was cacellig a $13 billio airport project i Mexico City that was already uder costructio. While Presidet Obrador campaiged to halt the airport project, the ivestor stadoff remais uresolved because abadoig the project could potetially be iterpreted as a declaratio of default to bod holders. From the day of the aoucemet through the ed of November, Mexica equities have uderperformed the EM idex by over 1,300 bps. Mexico has a larger weightig i the idex tha Berkshire Hathaway does i the S&P 500, ad its selloff highlights our preferece for active maagers i EMs, which we believe is a widely heterogeeous asset class. 3

4 Meawhile EM currecies look to have stabilized recetly. While the Chiese yua remais ear five-year lows due to ogoig trade tesios, other currecies are begiig to regai groud agaist the dollar. The improvemet idicates that expectatios are relatively stable after a series of weak ecoomic surprises. Give the egative correlatio betwee the dollar ad EM currecies ad equities, ay further stabilizatio would likely bode well for the asset class. Commodities Commodities ear Correctio after Crude Crash, Natural Gas Surge The broader commodities complex, as measured by the Bloomberg Commodity Idex (BCOM), declied 1.1% this moth, brigig six-moth returs to -8.5%. The idex remais above the threshold typically used to measure correctios of 10%. However 14 of the 18 commodities icluded i the idex have falle beyod the threshold, suggestig that recet weakess has bee broad-based. Year-to-date dollar stregth has likely played a cotributig role i the breadth of weakess over the past six moths, with the currecy up early 5.2% o a trade-weighted basis over the same timeframe. Typically, commodities are priced i dollars, meaig dollar stregth makes it icremetally more expesive for buyers usig foreig currecy. I quatifyig this effect, the correlatio betwee the Broad Trade Weighted Dollar Idex ad the BCOM idex has bee over the past 20 years, solidifyig our view that dollar weakess will be key for commodities to reassert stregth o a sustaied basis. I eergy commodities, crude oil ad atural gas represeted opposig extremes i November. Crude oil etered a bear market, fallig over 20% i oe moth aloe as the supply outlook improved amid margially dimiished demad expectatios ad ample ivetories. Comparatively, atural gas futures rose over 30% as tight ivetories were met with seasoally high demad due to colder-tha-expected weather across much of the Uited States. The et effect was a 4.4% declie i the eergy subcompoet of the BCOM idex. I respose to the recet weakess i crude oil, iflatio expectatios have moderated below 1.98% from 2.17% i mid-october. Lower iflatio should serve as a boo to real wage growth ad savigs as a percet of disposable icome, which remais healthy ad i lie with the historical average of 6.2%. However, the dowtur i crude is likely to have a egative impact o busiess ivestmet as drillers adjust to a moderated price eviromet. Amada E. Agati, CFA Istitutioal Chief Ivestmet Strategist Daiel J. Brady Equity Strategist Erik Casaliuovo, CFA Seior Ivestmet Strategist Matthew D. Feda Seior Ivestmet Strategist Joh W. Moore Ivestmet Strategy Aalyst 4

5 Istitutioal Advisory Solutios Asset Allocatio Playbook As of 11/30/18 Asset Class Equities U.S. Equity No-U.S. Equity Fixed Icome U.S. Fixed Icome No-U.S. Fixed Icome Sub Asset Class Large Cap Mid Cap Small Cap Public Real Estate (REITs) Itl. Large/Mid Cap Itl. Small Cap Emergig Markets Global Ifrastructure Short Fixed Icome Core Fixed Icome U.S. High Yield U.S. Leveraged Loas U.S. TIPS Global Bod Ucostraied Bod Emergig Market Bod Favorability - Neutral + Poits of View Recet market volatility highlighted our preferece to favor large cap over small cap as relative valuatios remai withi their historical rage ad vulerability to icreased market volatility favors dowside protectio from large cap. Small cap outperformace has come uder pressure, affected by risig et leverage ad decliig earigs revisios. Mid caps have lagged smaller compaies this year, providig rebalacig opportuities. We cotiue to believe headlie risks from trade will ultimately lift ad large caps resumed their market leadership amidst recet market volatility. Beig midful of the curret phase of the busiess cycle causes us to favor large ad mid-cap equities over small. As a proxy for icome geeratio, low iflatio expectatios ad arrow iterest rate spreads should cotiue to pressure profitability for REITs. Upside to earigs growth is likely to remai muted for the sector i the ear term. Valuatios remai low, both o a absolute ad relative basis. Global cetral bak moetary policy remais accommodative; however, sigs of slowig earigs growth could pressure ay ear-term recovery. While still beeficiaries of sigificat moetary policy stimulus, ear term we believe these markets are more vulerable to headlie risks from geopolitics ad trade. Although weakess has persisted throughout most of the year, recet relative outperformace (i.e., techical breakout) should be ecouragig for patiet ivestors. The shorter-term focus for EM equities rests maily o the willigess of Chiese policy makers to reivigorate growth, with a lagged effect. Year to date, EMs have sigificatly uderperformed both developed iteratioal ad U.S. markets. We observe a attractive hybrid betwee fixed icome ad equities, geeratig cosistet ad typically iflatio-liked icome, with the ability to deliver capital appreciatio with lower exposure to busiess cycle phases. The asset class has bee tested umerous times this year, but cotiues to perform as we expected i a volatile global equity market. With the likelihood of loger-term rates remaiig rage boud, we favor itermediate duratio fixed icome. At this stage i the busiess cycle, ad the potetial for a Fed pause i 2019, we remai comfortable with this allocatio as the majority of uderperformace has bee isolated to a few high-profile dowgrades i the ivestmet grade credit space. The credit cycle is agig, ad outperformace could begi to wae. Valuatios should become a icreasig headwid for most belowivestmet-grade issuers. Leveraged loas potetially provide more protectio from risig iterest rates, however spread wideig puts icreased reliace o yield. Recet commets from the Fed, iflatio expectatio surveys effectively rage-boud this year, ad breakeves i declie sice May highlight our preferece to hedge iflatio over the log term via equity exposure. Sovereig debt looks about fairly valued curretly with the primary sources of retur likely to come from coutervailig global treds i currecies ad iterest rates; hece, our eutral stace. Flexibility provides for diversificatio if rates should steadily rise (a primary risk to fixed icome i this market). Yields hit a year-to-date high i November as dollar stregth ad tighteig moetary policy from the Fed have pressured the asset class. We believe the severe dislocatio i EM debt markets over the summer was due to a crisis i cofidece rather tha a fudametal dislocatio, which creates a opportuity to rebalace active maager positios. 5

6 Asset Class Sub Asset Class Alteratives Real Assets Private Hedge Fuds Cash Commodities Private Real Estate Private Debt Private Equity Equity Log/Short Evet Drive Relative Value Global Macro Favorability - Neutral + Poits of View Metals ad agriculture remai affected by global trade headwids ad dollar stregth i the ear term. We cotiue to believe log positios i commodities do ot ear persistetly positive returs, ad the risk premium may actually accrue to the short positio. Key drivers iclude a still relatively costraied supply backdrop, modest leverage levels, ad the fact that capital flows ito the asset class are becomig icreasigly global (that is, ivestor demad is quite robust). Middle-market ledig i the corporate sector is still quite costraied, cotiuig to create opportuities for private debt ivestors. We cotiue to see ivestors rewarded with a substatial illiquidity premium for takig o urated, smaller-sized loas. There is opportuity i ew/less efficiet markets ad a more diverse ivestable opportuity set, for example, via secodaries ad coivestmet optios. We recommed allocatig capital elsewhere util the ext vitage year becomes available. A trasitio from a primarily macro-drive market eviromet to a more fudametally drive oe should be positive for these alphageeratig strategies. Cetral baks ow appear more committed to a steady ormalizatio of iterest rates tha they have i the past. However, should the market move steadily higher with little volatility, these allocatios will likely uderperform. For defiitios of idexes used i this publicatio, please refer to pc.com/idexdefiitios. The PNC Fiacial Services Group, Ic. ( PNC ) uses the marketig ame PNC Istitutioal Advisory Solutios for discretioary ivestmet maagemet, trustee, ad other related activities coducted by PNC Bak, Natioal Associatio ( PNC Bak ), which is a Member FDIC. Stadaloe custody, escrow, ad directed trustee services; FDIC-isured bakig products ad services; ad ledig of fuds are also provided through PNC Bak. These materials are furished for the use of PNC ad its cliets ad does ot costitute the provisio of ivestmet advice to ay perso. It is ot prepared with respect to the specific ivestmet objectives, fiacial situatio, or particular eeds of ay specific perso. Use of these materials is depedet upo the judgmet ad aalysis applied by duly authorized ivestmet persoel who cosider a cliet s idividual accout circumstaces. Persos readig these materials should cosult with their PNC accout represetative regardig the appropriateess of ivestig i ay securities or adoptig ay ivestmet strategies discussed or recommeded i this report ad should uderstad that statemets regardig future prospects may ot be realized. The iformatio cotaied i these materials was obtaied from sources deemed reliable. Such iformatio is ot guarateed as to its accuracy, timeliess or completeess by PNC. The iformatio cotaied i these materials ad the opiios expressed herei are subject to chage without otice. Past performace is o guaratee of future results. Neither the iformatio i these materials or ay opiio expressed herei costitutes a offer to buy or sell, or a recommedatio to buy or sell, ay security or fiacial istrumet. Accouts maaged by PNC ad its affiliates may take positios from time to time i securities recommeded ad followed by PNC affiliates. PNC does ot provide legal, tax, or accoutig advice uless, with respect to tax advice, PNC Bak has etered ito a writte tax services agreemet. PNC does ot provide services i ay jurisdictio i which it is ot authorized to coduct busiess. PNC Bak is ot registered as a muicipal advisor uder the Dodd-Frak Wall Street Reform ad Cosumer Protectio Act ( Act ). Ivestmet maagemet ad related products ad services provided to a muicipal etity or obligated perso regardig proceeds of muicipal securities (as such terms are defied i the Act) will be provided by PNC Capital Advisors, LLC. Securities are ot bak deposits, or are they backed or guarateed by PNC or ay of its affiliates, ad are ot issued by, isured by, guarateed by, or obligatios of the FDIC, the Federal Reserve Board, or ay govermet agecy. Securities ivolve ivestmet risks, icludig possible loss of pricipal. PNC Istitutioal Advisory Solutios is a registered service mark of The PNC Fiacial Services Group, Ic The PNC Fiacial Services Group, Ic. All rights reserved. 6

Global Market Snapshot

Global Market Snapshot December 2018 Global Market Sapshot INVESTMENT STRATEGY Key Market/Ecoomic Observatios Uited States Earigs Growth ad Iterest Rates Reach New Highs; Markets Tur Focus to Future Growth ad Federal Reserve