In focus - Economics
Monthly markets review - May 2019
A look back at markets in May when stocks fell as trade tensions ratcheted up.
6 June 2019
- Global stock markets fell in May across all major regions. Investor nervousness over the outlook for global growth grew as US-China trade tensions ratcheted up. Government bond yields fell markedly (i.e. prices rose) amid a move towards perceived safe havens.
- US equities were significantly weaker. Concerns that the trade disputes will damage global demand weighed on the energy sector, with the tech sector also weaker.
- Eurozone equities declined. Industries sensitive to the trade environment such as autos and semiconductors fell sharply. Economic data generally remained lacklustre.
- UK equities also performed poorly over the month, with sectors such as financials, industrials and mining lagging. Sterling was weaker amid heightened Brexit uncertainty following the resignation of Prime Minister May.
- Japanese stocks fell on the global trade worries. The yen strengthened against other major currencies, reflecting its perceived safe haven status, which tended to add to downward pressure on share prices.
- The worsening US-China trade dispute triggered a slump in Asia ex Japan equities. Chinese stocks fared worst amid the deepening trade conflict and weaker-than-expected economic data.
- Emerging market equities also fell amid worries over trade and supply chain disruption. Russia, Brazil and India outperformed. The Indian general elections saw victory for Prime Minister Modi and his party.
- Global government bonds benefited as investors turned towards safe havens, with yields falling (i.e. prices rising). The US 10-year Treasury yield finished the month close to 2.1%, levels not seen since late-2017.
Please note any past performance mentioned is not a guide to future performance and may not be repeated. The sectors, securities, regions and countries shown are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
US equities were significantly weaker in May after US-China trade talks broke down. The US government increased the tariff rate on $200 billion of Chinese goods to 25% from 10% and China responded by hiking the tariffs on $60 billion of imports from the US. The Federal Reserve (Fed) maintained the dovish stance it has held since the start of the year.
Economic data released during the month was mixed with total nonfarm payroll employment increasing by 263,000 in April, sending the overall unemployment rate to 3.6%, from 3.8% a month earlier. Wage growth remained steady at 3.2% compared with a year earlier. The US manufacturing purchasing managers’ index (PMI) fell two points to 50.6, while the new orders component declined to below 50, indicating that the sector is contracting. However, US consumer confidence remains robust, with a reading of 134.1 in May, compared with 129.2 a month earlier.
The US administration blacklisted Chinese tech giant Huawei on security fears and said it will impose a new tariff of 5% on all Mexican imports in a bid to force Mexico’s government to stem the flow of migrants entering the US across its southern border. The technology, energy and industrial sectors were among the weakest performers in May as investors became nervous about the prospects for global growth. Utilities, healthcare and consumer staples, whilst also lower, proved to be more resilient. The real estate sector outperformed.
Eurozone equities experienced declines in May with the MSCI EMU index returning -6.4%. The outlook for global trade remained a primary concern as tensions between the US and China escalated and US President Trump threatened to apply 5% tariffs on goods from Mexico. This led to a “risk off” environment that saw investors favour lower risk assets such as government bonds rather than equities.
In the eurozone the materials and financials sectors saw the steepest declines while perceived safe havens such as utilities and consumer staples fared better. Those industries most sensitive to global trade, such as autos and semiconductors, fell sharply. Data from Germany showed that the country avoided recession, with a GDP growth rate of 0.4% in Q1. However, forward-looking data remained somewhat lacklustre. The Ifo business climate index fell to 97.9 points, indicating a worsening mood among German businesses.
Italy’s fiscal position was in focus after the European Commission (EC) cut its forecast for 2019 Italian GDP growth to 0.1% from 0.2%. This would mean the budget deficit would exceed the level previously agreed between Italy and the EC. The elections to the European Parliament were another focus with centrist parties losing ground in many countries while Green parties made gains and anti-EU populists made only a limited advance.
UK equities performed poorly over the month as economically-sensitive sectors, including financials, industrials and mining, lagged. Sterling retreated sharply amid renewed Brexit uncertainty, and fears of a disorderly exit from the EU were not soothed after Prime Minister Theresa May announced her resignation following a revolt within her own party.
Despite the political uncertainties, the preliminary Q1 GDP release from the Office for National Statistics revealed the economy expanded 0.5%, in line with expectations. In its latest quarterly inflation report the Bank of England upwardly revised its 2019 growth forecast, from 1.2% to 1.5%. This reversed part of the forecast downgrade made at the time of the previous inflation report in February, when the bank cut 2019 growth from 1.7% to 1.2%.
Evidence emerged that the surge in manufacturing activity seen before the initial 31 March Brexit deadline has begun to unwind. Markit’s UK manufacturing purchasing managers’ index (PMI) slipped two points to 53.1 in April, supporting fears that the pick-up had been driven by stockpiling, to guard against a disorderly EU departure. On a more positive note, services activity stabilised, with Markit revealing that its services PMI picked up to 50.4 in April, bouncing back from the sub-50 level in March.
The Japanese equity market fell sharply at the beginning of the month and ended May with a total return of -6.5%. Global macroeconomic and political factors were again dominant. The yen strengthened against other major currencies, reflecting its perceived safe haven status, which tended to add to downward pressure on equity prices.
The principal development was the escalation of trade issues. Any remaining hopes for an early resolution to the US-China dispute were dashed by the sudden announcement of sharp increases in US tariffs on imports from China. These higher levels will inevitably have a much greater volume impact, with repercussions throughout global supply chains. In addition, the US campaign against Huawei in particular is already having a marked impact on Japanese electronic component suppliers. These negative factors have exacerbated the reaction to a cyclical slowdown in earnings growth, which was evident in the recently announced corporate results for the final quarter of the fiscal year.
The announcement of new US tariffs on Mexico will also impact many Japanese auto companies who have invested in production facilities which they previously believed would have long-term viability under the original NAFTA agreement. The direct bilateral trade talks between the US and Japan have taken a backseat and any substantive announcements will now be delayed until August, safely after G20 meeting and Japan’s July elections.
Economic data was mixed, with the largest positive surprise coming in real GDP growth for the first quarter of 2019. This showed real GDP grew at an annualised rate of 2.1% during the quarter when consensus expectations were for a decline. Although the detailed breakdown is not particularly encouraging for the domestic economy, it does mean that Japan is likely to avoid a technical recession in the short-term. Nevertheless, political commentators continue to ascribe a significant probability to a postponement of the consumption tax increase planned for October.
Asia (ex Japan)
Asia ex Japan equities slumped in May as the worsening US-China trade dispute triggered losses across global markets. The US raised tariffs on US$200 billion worth of Chinese imports to 25%, from 10%, while China announced retaliatory tariffs on US goods. Tensions between the two countries escalated after the US put Chinese telecommunications group Huawei on a trade blacklist, citing security concerns. Sentiment was further rattled by reports that more Chinese technology companies could be penalised.
Chinese stocks fared worst amid the deepening trade conflict and weaker-than-expected economic data for April. Industrial production growth fell to 5.4%, from 8.5% in March. Retail sales rose 7.2% year-on-year, the slowest pace in 16 years. Exports dropped 2.7%, down from a 14.2% jump in March. Hong Kong equities also retreated. Markets in South Korea and Taiwan slid, dragged lower by steep declines in technology heavyweights. In comparison, Indian stocks outperformed as prime minister Narendra Modi and his party won a landslide victory in national elections. The industrials and financials sectors recorded the biggest gains.
ASEAN (Association of Southeast Asian Nations) markets largely outpaced the broader region though most closed in negative territory. The Philippines was the only market to post modest gains, helped by advances in communication services and consumer staples stocks. In political developments, Philippine president Rodrigo Duterte’s allies won a resounding victory in mid-term elections. Elsewhere, president Joko Widodo was re-elected as Indonesia’s president.
Emerging market equities fell in May as US-China trade talks unexpectedly broke down, and global growth concerns increased. Separately, the US announced plans for a 5% levy on Mexican imports. The MSCI Emerging Markets Index declined and underperformed the MSCI World.
China was the weakest index market, negatively impacted by the escalation in trade tensions. The US increased tariffs on $200 billion of Chinese goods imports from 10% to 25%. It also blacklisted Chinese telecoms company Huawei and threatened to levy tariffs on the remaining $300 billion of goods imported from China. China retaliated by raising tariffs on $60 billion of US goods imports from an existing 5-10% range to a maximum of 25%. In addition, China indicated that it is compiling an unreliable entities list of foreign companies considered to have damaged the interests of Chinese companies for non-commercial reasons. Meanwhile domestic economic data for April, notably industrial production, saw some pullback after signs of improvement in March.
South Korea and Taiwan underperformed, amid expectations for supply chain disruption and a negative impact from weaker global trade. Other laggards were Colombia, where a correction in the price of crude oil weighed on sentiment, and Chile, where copper price weakness was a headwind.
By contrast, Russia posted a solid gain, benefitting from a strong rally in state controlled oil company Gazprom. Brazil and India also outperformed. India registered a small gain as Prime Minister Modi’s Bharatiya Janata Party was re-elected with a stronger mandate.
An escalation in US-China trade tensions precipitated a sharp risk-off move in markets in May following several months of strong gains. While expectations had been growing that the two sides would reach an agreement, none materialised. The US raised tariffs on $200 billion of Chinese imports to 25% from 10% with China later retaliating. The US additionally blacklisted Chinese technology company Huawei, barring US companies from selling to them, and threatened a 5% import tariff on Mexico.
Economic data was broadly underwhelming. The US composite leading indicator dropped to a three-year low with both the manufacturing and services components dipping close to contractionary levels. Data across the eurozone was mixed. German activity data continued to disappoint, particularly in manufacturing, while unemployment unexpectedly rose. However, data out of France showed some signs of improvement, with stronger-than-expected business confidence.
Global government bond yields fell markedly. The US 10-year Treasury yield was 38 basis points (bps) lower, finishing the month at close to 2.1%, levels not seen since late-2017. The difference between 10-year and three-month US Treasury yields fell below zero once more. This inversion in the yield curve (longer maturity yields are usually higher than shorter-dated) indicated bond investors’ negative view of the economic outlook.
In Europe, German Bund 10-year yields were 21bps lower, moving back below zero, while French and Spanish yields also fell. Concerns around Italian politics and debt levels resurfaced resulting in 10-year yields increasing by nearly 10bps and two-year yields by 23bps. UK economic data remained resilient, but UK 10-year gilt yields fell 30bps as Brexit uncertainty remained heightened with Prime Minister Theresa May announcing her resignation.
With investors turning to safe havens, global government bonds benefited while riskier assets underperformed. Given the deterioration in investor sentiment, high yield underperformed investment grade credit. Meanwhile, emerging market (EM) bond yields fell, both across sovereigns and corporates, in investment grade notably, but EM currencies broadly weakened.
Convertible bonds as measured by the Thomson Reuters Global Focus index shed only 3% in US dollar terms compared to -5.8% for the MSCI World. As a result of the equity market sell-off, US convertibles became more cheaply valued. Europe remains the most expensive region, while Japanese and Asian convertibles are trading below fair value.
Commodities were hit by global growth concerns and the S&P GSCI Spot Index recorded a negative return. Energy dragged on the index as both Brent crude and natural gas prices fell. Industrial metals also recorded a negative return, with copper and zinc particularly weak. By contrast, agricultural commodities gained strongly. Corn and wheat prices gained as adverse weather conditions in the US increased the risk of yield shortfalls. Precious metals also posted a positive return, underpinned by a rising gold price.
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
The purchasing managers’ index is based on survey data from companies in the manufacturing sector. A reading above 50 indicates expansion.
 Investment grade bonds are the highest quality bonds as determined by a credit ratings agency. High yield bonds are more speculative, with a credit rating below investment grade.
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