Global equities edged up again in May; oil prices fell on OPEC disappointment; 10-year Treasuries gained
Global equities rose for a seventh straight month in May, supported by continuing robust economic data releases and generally upbeat earnings reports. The MSCI AC World index finished 1.3 per cent higher over the month. In the US, the S&P 500 rose 1.2 per cent with volatility driven by political turmoil in Washington that raised doubts about the administration’s ability to implement pro-growth policies. This boosted 10-year US Treasuries (yields fell). In Europe, the Euro Stoxx 50 was roughly flat over the month, whilst the UK’s FTSE 100 outperformed (+4.4 per cent). The MSCI EM also rose (+2.3 per cent), although the MSCI Russia and Brazil both fell sharply. The decline in Russian equities came as oil prices retreated in the wake of OPEC’s meeting on 25 May which disappointed investors who had hoped for deeper or longer cuts to production. Meanwhile, volatility in Brazilian asset prices was predominantly driven by a political scandal engulfing reformist President Michel Temer. Finally, eurozone peripheral government bond spreads narrowed amid receding political risks in the region (all data above as of close of 31 May in local currency, price return, month-to-date terms).
US Q1 GDP print revised upwards with Fed signalling another rate hike in June
US data releases in May remained broadly upbeat. Positively, the second estimate of Q1 GDP was revised upwards, to +1.2 per cent qoq annualised, on the back of a better than expected gain in personal consumption. With the Q1 GDP print likely depressed by temporary factors and seasonal adjustment issues, a rebound is likely in Q2. Crucially, the labour market remains strong, with the April employment report seeing a 211,000 rise in nonfarm payrolls, slightly above expectations, and the unemployment rate declining to 4.4 per cent. However, wage pressures remain subdued, perhaps going some way in explaining recent soft inflation prints. Nevertheless, the May FOMC meeting minutes suggested the Fed is confident enough to raise interest rates again in June – assuming the data holds up – whilst also signalling a gradual unwinding of its balance sheet later this year. A fiscal stimulus package remains the largest upside risk to the economy, although the precise timing and size of this remain uncertain.
Eurozone activity data remains strong; Macron victory paves the way for reduction in ECB purchases in 2018
In the eurozone, Q1 GDP expanded by a solid 0.5 per cent qoq in the second estimate. Confidence surveys remain high going into Q2, pointing to the potential for an acceleration in growth during the quarter. Importantly, household spending is likely to stay upbeat this year as employment gains remain positive (although higher inflation will weigh on real income growth). Elsewhere, net trade should find a boost from strong global demand conditions. Meanwhile, political uncertainty eased this month with the victory of market-friendly Emmanuel Macron in the French presidential elections, which should support confidence in the region. Combined with the strength of recent data, this also paves the way for the European Central Bank (ECB) to further reduce its asset purchases in 2018. However, interest rate increases remain a long way off given the lack of underlying inflationary pressures in the region.
Chinese growth moderates amid regulatory and credit tightening; Japan GDP accelerates in Q1
April Chinese data showed softer growth momentum following Q1’s strength. Growth is likely to moderate further this year due to the lagged impact of liquidity and credit tightening, stricter enforcement of financial regulations, and intensified property tightening measures. However, we believe the government will proceed with financial de-leveraging and regulatory tightening at a measured and calibrated pace to avoid triggering a sharp economic slowdown or financial system instability. Japan’s real GDP expanded by 2.2 per cent qoq annualised (seasonally adjusted) in Q1, up from 1.4 per cent in Q4. This marked the fifth consecutive quarter of positive growth, driven by both external and domestic demand, with firm consumer spending and housing investment. Looking ahead, a weaker yen and uptick in global trade should support exports, and fiscal policy will be supportive. Also, weak inflationary pressures (amid subdued wage growth) should see the Bank of Japan (BoJ) maintain its ultra-loose policy stance.
Economic performance is improving in many major EM countries; Brazilian politics remains volatile
In terms of economic developments during the month, Brazilian data releases continued to point towards a gradual recovery. However, a political scandal engulfing reformist President Michel Temer significantly raises downside risks to much needed reforms being implemented. More positively, however, easing inflationary pressures should allow the Central Bank of Brazil to remain on its easing path. In Mexico, the final release of Q1 GDP came in at 0.7 per cent qoq seasonally adjusted, pushing the annual growth rate to 2.8 per cent yoy (its highest since Q3 2015). Amid peso and fuel price-induced inflationary pressures, the Bank of Mexico remains on a tightening path, raising the overnight rate by another 25bps at its May meeting. In India, a growth recovery post-demonetisation remains on track, led by a revival in consumption, solid external demand, and better infrastructure sector output growth. Following recent downside surprises to inflation, the Reserve Bank of India (RBI) is expected to keep policy on hold at its June meeting.
A mix of synchronised growth and subdued inflation implies a market regime where equities continue to outperform bonds
The macro environment remains supportive for global equities, with the implied equity risk premium on offer still consistent with a neutral positioning. However, we move to a positive bias on this stance, as we have upgraded our US and UK equity view to neutral amid recent gains in US Treasuries and UK gilts which we think has increased the relative attractiveness of bearing equity risk in these two countries. We also maintain a relative preference for Japan and Europe where profits and valuations look relatively attractive. Elsewhere, our market-implied measure of the credit risk premium is still not particularly substantial. However, a mix of positive growth and low inflation should sustain low default and downgrade rates, therefore we remain neutral overall (with a negative bias for the riskier high-yield category). We remain underweight in DM government bonds which we continue to view as being overvalued. Upbeat global activity amid the prospect of fiscal easing and gradual Fed and ECB tightening should see higher yields over time. Nevertheless, Treasuries still have the scope to rally should bad news on growth or deflation materialise.
For emerging markets (EM) equities, strong performance this year has resulted in aggregate EM equity valuations that no longer look anomalously cheap. Therefore, the investment case has changed to be more about economic and price momentum, alongside the upside offered by cheap currencies. From the perspective of a dollar based investor, we think unhedged prospective returns look attractive across much of Asia and parts of EMEA. EM local-currency debt has not rallied as strongly as equities this year, and aggregate yields remain high, particularly relative to developed markets.