Market Analysis Aug 2019

August saw a decline in US equities, although the drop was milder than in other major markets. As anticipated, the Federal Reserve (Fed) reduced interest rates at the end of July, but the central bank's comments indicated this was a corrective measure rather than the start of a broader easing cycle. This viewpoint disappointed investors concerned about economic deceleration. The annual central bankers' meeting in Jackson Hole offered limited insights into US monetary policy, while economic data trends remained largely unchanged. However, the yield on two-year US Treasuries momentarily exceeded that of the 10-year bond, often regarded as an indicator of an impending recession.

Despite signs of growth slowdown, the US economy remained robust. Q2 GDP growth was slightly revised down to 2.0% from the initial 2.1%, aligning with consensus expectations. July's non-farm payrolls indicated a healthy job market with the addition of 164,000 jobs and a 3.2% year-on-year wage growth. Retail sales reaffirmed strong US consumer conditions. President Trump announced, then postponed, tariffs on $300 billion worth of mainly consumer goods.

Market movements reflected broader concerns of a more substantial economic slowdown, amplified by the Fed's hesitance to further loosen interest rates. Investors reduced exposure to economically sensitive sectors like energy, financials, and materials, while defensive sectors including utilities, real estate, and consumer staples showed relative resilience.

August witnessed declines in Eurozone equities, with the MSCI EMU (Economic and Monetary Union) index delivering a -1.2% return. Germany's weak economic data and ongoing Brexit uncertainty weighed on the market. Financials, energy, and consumer discretionary sectors faced vulnerability, reflecting concerns about sluggish growth and trade disputes that particularly impacted banking, automotive, and IT industries. Conversely, sectors perceived as safe havens, like healthcare and consumer staples, performed better.

Germany's composite purchasing managers' index (PMI) indicated economic expansion with a reading of 51.4. However, a manufacturing PMI of 43.6, falling below the 50 threshold separating growth from contraction, sparked recession worries. This led to speculation about potential German government spending hikes to counteract a recession. Additionally, investors expected the European Central Bank to ease monetary policy in September to stimulate the economy, despite bank share declines. Persistent low-interest rates continued to challenge banks, reflected in their summer quarterly results.

August saw political uncertainty in Italy due to the split of the right-wing League and populist Five Star coalition. Hopes emerged as the Five Star party aimed to form a coalition with the Democratic Party, potentially leading to a more fiscally conservative approach and reduced disputes over EU budget rules. The month's end saw Italian assets rally on these prospects.

August experienced declines in UK equities as fears of a no-deal Brexit intensified with the government's extended prorogation of parliament. Although the pound recovered some July losses, it decreased again in the final week. Global economic uncertainties weighed on commodity and financial sectors, causing declines. On the other hand, defensive sectors like healthcare, utilities, and consumer goods demonstrated more resilience, reflecting increased investor caution.

Q2 GDP reported a 0.2% contraction, following Q1's 0.5% growth. The biggest Q2 growth drag was inventory reduction ahead of the original Brexit deadline on March 31.

Markit's UK manufacturing purchasing managers' index (PMI) remained at 48.0 in July, while services PMI rose to 51.4 from June's 50.2, surpassing the 50 threshold indicating expansion. This alleviated concerns of further momentum loss in the consumer-focused economy.

Despite downbeat economic news, labor market data remained robust, and retail sales grew again in July, defying expectations for another month-on-month decline.

August saw the Japanese market's total return at -3.4%, with an initial sharp fall followed by lateral movement, in sync with currency market shifts. The yen gained against the dollar post-July's US interest rate cut, affecting equity market sentiment. Corporate results for the fiscal year's first quarter were overshadowed by US/China trade relationship news, yielding a somewhat negative overall interpretation due to cyclical company earnings decline. Nevertheless, positive and negative surprises balanced, with potential earnings recovery anticipated in the fiscal year's second half. While domestic factors drove GDP data exceeding expectations for April to June, the impact on investors was marginal. Inflation data remained modest but stable. Several companies announced the restructuring of long-term strategic shareholdings at the corporate level.

Elsewhere in Asia, the MSCI AC Asia ex Japan index posted -4.4% in August, with Hong Kong among the weakest index markets due to ongoing protests, disappointing Q2 GDP growth at 0.5% y/y, and a 13% y/y drop in July retail sales. Singapore and South Korea also underperformed due to escalating global trade uncertainties. Taiwan's return was negative but surpassed expectations due to strong performance in real estate, communication services, and IT sectors. Despite the heightening US-China trade dispute, China slightly outperformed.

In response to growing trade and growth concerns, government bond yields decreased significantly, driving bond prices higher. President Trump's announcement of a 10% tariff on an additional $300 billion of Chinese goods, effective September 1, led to a 13 basis point (bps) US 10-year Treasury yield drop in a single day. China's retaliation with tariffs and substantial renminbi devaluation further fueled the decline. Throughout August, the US 10-year yield fell by 50 bps, reaching 1.50%, a three-year low, while the two-year yield fell by 37 bps, ending at 1.50% as well. Towards month-end, the two-year yield slightly surpassed the 10-year, signaling a yield curve inversion indicative of economic pessimism among bond investors.

European yields also fell notably, with Bund yields plunging deeper into negative territory. While regional activity data varied, the latest GDP report revealed Germany's Q2 economic contraction as predicted. The 10-year Bund yield dropped 26 bps to -0.70%. Italian 10-year yields were over 50 bps lower at 1.0%, reaching a record low due to a newly formed coalition government. Spain's 10-year yield closed at 0.11% after a 17 bps decline.

Despite the highest monthly total return in three years for US dollar investment grade bonds, corporates underperformed government bonds. Investment grade corporate bonds enjoyed positive total returns, supported by falling global yields, while high yield bonds had more modest positive returns.

Hard currency emerging market bonds achieved positive returns, while local currency bonds suffered due to Argentina's currency and bond slump.

In August, the Thomson Reuters Global Focus index signaled a -1.4% return in US dollar terms for convertible bonds, compared to the MSCI World equity index's -2.0%. Convertible market equity exposure remained low at 30%, supported by a stable BBB average credit rating, indicating resilience of these companies under challenging conditions. A strong 89% bond floor further enhanced investor confidence.