Firming global activity helps push global equities higher; oil prices surge on OPEC deal; Treasuries dip on Fed hawkishness
Global equities rose in December, with upbeat macro data boosting risk appetite among investors at the global level. The MSCI AC World index finished 2.4 per cent higher over the month (in local currency terms). In the US, the S&P 500 gained 1.8 per cent to hit fresh record highs, whilst in Japan the Nikkei rose by 4.4 per cent, boosted by a sharp decline in the yen against a broadly stronger US dollar. Meanwhile, European stocks outperformed (the Euro Stoxx 50 rallied by 7.8 per cent) amid strong gains in financial shares. Emerging market equities significantly underperformed however (the MSCI EM index fell 0.2 per cent), with Chinese benchmarks pressured by regulatory curbs to rein in insurers' stock purchases. Elsewhere, oil prices surged as OPEC finalised a deal to cut output, along with co-operation from 11 non-OPEC countries. Finally, US 10-year Treasuries declined (yields rose) during the month, driven by the Fed’s hawkish tilt at its December meeting, whilst European equivalents gained as the ECB maintained its highly accommodative stance (all data above as of close of 31 December in local currency, price return, month-to-date terms).
Our Nowcast indicates continued US activity acceleration as the Fed hikes the fed funds rate by 25bps
As expected, December’s FOMC meeting saw a unanimous decision to raise the federal funds target rate to 0.75-0.50 per cent from 0.50-0.25 per cent. While FOMC participants raised their expectation for the number of rate hikes in 2017, from two to three, Fed Chair Janet Yellen’s post-meeting press conference saw a reaffirming of the “uber-gradual” hiking cycle ahead. The meeting statement was more upbeat on activity and inflation than in early November, reflecting a host of consensus-beating data releases over the past month. The ISM non-manufacturing index for November reached its highest level in over a year (57.2), whilst the December Conference Board Consumer Confidence release hit a 15-year high. Less positively, November’s retail sales data saw the control measure (excluding food, autos, gas and building materials) rise by only 0.1 per cent mom, however underlying momentum remains firm. Encouragingly, our US Nowcast measure of underlying activity edged up in November to its highest rate of expansion since December 2014.
European activity also accelerates at the end of the year as the ECB extends its Asset Purchase Programme
In the Eurozone, further evidence of robust growth momentum came in the form of the December PMIs which saw a large gain in the manufacturing component (to its highest level since April 2011) offset a slight deterioration in the services component, leaving the composite index unchanged (53.9). Elsewhere, unemployment fell by more than expected to 9.8 per cent in October, its lowest level since July 2009. Overall, there seems to be enough evidence to suggest that Eurozone GDP growth should accelerate in Q4, although concerns remain about mounting domestic political risks in 2017. Meanwhile, at its December meeting, the ECB extended the Asset Purchase Programme by nine months (to December 2017) at a reduced pace of EUR60 billion a month (from EUR80 billion currently), with Draghi emphasising at the press conference that the announcement does not represent a taper of the programme.
Japan’s Q3 GDP growth revised down as Bank of Japan (BoJ) stands pat; tight labour market supports 2017 growth prospects
Softer than expected Japanese private non-residential investment saw Q3 GDP surprisingly revised down to 1.3 per cent qoq annualised from 2.2 per cent in the prior release. The December BoJ meeting saw policy remain on hold, including the maintenance of the “yield curve control” framework. Policymakers still expect labour market tightening will support wages and private demand, narrow the output gap and lift inflation towards the 2 percent target. The potential for further near-term yen weakness may also help boost inflation, as well as exports.
China’s growth holds firm as government officials signal an acceleration of supply-side reforms in 2017
China’s economic activity continues along a steady growth path, buoyed by resilient domestic demand and a recovery in exports, although property activity has slowed following policy tightening. The recent improvement in industrial pricing power has been reflected in higher profits, particularly in industries with overcapacity. The annual Central Economic Work Conference highlighted that “stability” is key for 2017 economic planning, with containing financial risks a higher priority than growth targets. The conference also suggested that the government will maintain "proactive fiscal policy and prudent monetary policy” and accelerate supply-side reforms.
Emerging market assets stabilise following Trump-induced weakness; more resilient economies may outperform
Emerging market assets sold off following Trump’s election victory, although they have stabilised more recently. Looking ahead, more resilient economies may outperform, including those that are relatively shielded from a shift towards protectionism (e.g. Brazil, India, Indonesia), have a low foreign ownership of local currency government bonds (South Korea, Thailand, India), and low levels of dollar-denominated debt (China, Poland, Indonesia). Meanwhile, Brazilian activity seems to have bottomed out, and given anchored inflation expectations, the central bank may accelerate the pace of interest rate cuts in 2017, supporting growth prospects. And although India’s recent economic data deteriorated amid the government’s demonetisation programme, the Reserve Bank of India anticipates a largely transitory economic impact, reflected in their unexpected December decision to keep rates on hold. However, Mexico remains vulnerable under a Trump policy agenda. The sharp post US-election peso depreciation drove the Bank of Mexico to raise its policy rate by another 50bps in December despite evidence of cooling growth. Turkey is also facing headwinds from domestic political developments and high levels of dollar-denominated debt, with GDP contracting by 1.8 per cent yoy in Q3, weighed by weak household consumption.
Our preference for risk assets remains intact in a less bond friendly environment
With proactive fiscal and monetary policy supporting the recent acceleration of global economic activity, amid rising inflationary pressures (especially in the US), structurally we expect global developed market bond yields to move higher still. In addition, prospective returns still look low relative to competing asset classes, so we maintain an underweight position. We continue to prefer an overweight exposure to a diversified basket of risk assets, including equities (in particular Europe, Japan and selective parts of EM with resilient fundamentals) and local currency EM debt, within the context of a well-diversified multi-asset portfolio, from a strategic and long-term perspective.