Markets ended flat or down over the week as, after a very a strong equity rally in October, investors started to focus on the possibility of a December US interest rate rise. The S&P 500 ended the week up 0.22%. The MSCI Europe ex UK was down 0.39% with weaker performance from the MSCI United Kingdom and the MSCI Emerging Markets which were down 1.28% and 2.38% respectively.
The month of October was a particularly strong month for equities; the MSCI Europe ex UK had its strongest showing for six years with the index rising 8.24%. Elsewhere, the S&P 500 rose 8.44%, and the Nikkei 225 climbed 9.76%. October was also a strong month for emerging markets and commodity related equities as investors’ fears over China subsided; the MSCI Emerging Markets index closed up 7.14%, and both the Oil & Gas and Basic Materials sectors outperformed the world index returning 9.77% and 9.34% respectively.
The US Federal Reserve left rates on hold at 0.25% as widely expected, however, in their statement they dropped previous concerns over the weakness in the global economy. This reconfirmed the potential for a December interest rate rise despite the initial estimates of US third quarter GDP growth coming in at an annualised rate of 1.5% well below expectations and sharply below the 3.9% annualised pace witnessed for the second quarter.
Markets were largely unmoved as the weakness had been well flagged due to far smaller accumulation of inventories when compared to the second quarter. Similarly, the UK’s third quarter GDP growth came in at 0.5%, down from 0.7% for the preceding quarter and reinforcing the Bank of England’s lack of urgency in raising rates. Japanese retail sales for the month of September rose 0.7%, less than consensus expectations, increasing the likelihood that the Bank of Japan (BoJ) will miss its inflation target of 2% by quite a wide margin with core inflation expected to remain close to zero. Nonetheless, for the moment the BoJ has kept its monetary policy on hold, increasing market expectations for further easing sometime in 2016.
Despite relatively disappointing inflation and growth data, progress is nonetheless being made against a back drop of a weakening Chinese economy and global deflationary pressures, particularly in respect of the oil price both of which are outside of the BoJ’s control. To date the largest beneficiary of QE in Japan has been company profits which have rocketed in line with the fall in the Yen.
There are now signs of wage increases coming through and if the deflationary mind set can be broken, the domestic Japanese economy should increasingly benefit. Having increased our equity exposure at the end of September and benefitted from the strong rally in equity markets, we are now inclined to keep our powder dry whilst a potential US interest rate rise remains on the horizon coupled with further weak data out of China adding further uncertainty.
These factors are a headwind for emerging markets and commodity stocks despite their strong rally in the month of October. If markets experience a further leg down in valuations, perhaps triggered by the first US interest rate rise since 2006, along with continued central banks stimulus, this may give us the confidence to further increase our exposure to risk assets.
On Thursday the Bank of England releases its latest interest rate decision along with the minutes of the meeting and the final inflation report for the year. No change is expected with the base rate remaining at 0.5% whilst growth in the economy is slowing together with few signs of inflationary pressures and continued uncertainty over the health of the global economy.
On Friday US labour data is released, with non-farm payrolls having fallen from gains of 213,000 in the second quarter to 167,000 for the third. For the month of October they are expected to rebound to 180,000 from 142,000 in September but any weakness in this number will lower expectations for a December US interest rate hike.
US unemployment is expected to remain unchanged at 5.1%. US manufacturing data has been weak in recent months, suffering from the impact of a contracting oil industry and the ISM due out today is expected to show further weakness with the index falling to 50 from 50.2, indicating that the sector is neither contracting nor expanding. Similarly, the non-manufacturing ISM due out on Wednesday is expected to weaken falling to 56.5, but nonetheless still indicating healthy expansion.
Flash purchasing managers’ indices are due out for the Eurozone today with the sector remaining expansionary with a reading of 52. German industrial production data due out on Friday is expected to show a slippage in the annual growth rate to 1.3% falling from 2.3% in August. The central banks of Australia and Norway are also due to announce their latest interest rate decisions this week.