Market Analysis Jun 2019

The second quarter saw gains in US shares, culminating in a new record high for the S&P 500, despite trade-related uncertainties causing a mid-quarter dip. The Federal Reserve's commitment to a dovish stance and signs of potential trade progress by the end of June boosted investor confidence. In May, President Trump's tariff comments regarding Mexican imports and Chinese goods triggered a sharp market decline, but June brought optimism as US-China talks showed improvement, and Mexican tariffs were suspended.

While Q1 GDP growth at 3.1% (revised from 3.2%) met expectations, economic data presented mixed signals. Favorable employment figures, including a steady 3.6% unemployment rate and a 3.1% YoY increase in average hourly earnings, contrasted with weakening consumer and business confidence indices and slowing business activity based on survey data. The Federal Reserve refrained from rate cuts at its June meeting but indicated potential easing through the "dot plot."

Cyclical sectors like financials, materials, and IT generally fared well, while healthcare faced challenges due to potential pricing legislation changes. Defensive sectors made modest gains, and energy stocks experienced declines.

Eurozone equities saw Q2 gains, with strong performances from IT, consumer discretionary, and industrials, despite a May decline. Trade tensions impacted sentiments towards trade-sensitive segments such as semiconductors and car manufacturers. A lack of further trade war escalation in June facilitated a market recovery. The real estate sector faced challenges due to Berlin's proposal for a five-year freeze on residential property rents starting in 2020.

Q1 GDP growth at 0.4% QoQ was confirmed for the eurozone, with June's annual inflation remaining stable at 1.2%. ECB President Mario Draghi indicated potential further monetary policy easing, including new bond purchases, if the eurozone's inflation outlook doesn't improve.

Forward-looking surveys presented mixed signals, with the flash composite PMI reaching a seven-month high at 52.1 in June, signaling better conditions. However, the manufacturing component indicated contraction.

Political developments included Spain's general elections in April, resulting in the incumbent Socialist Party emerging as the largest. Italy's fiscal status garnered attention after the European Commission revised its 2019 GDP growth forecast to 0.1% from 0.2%, raising concerns about breaching agreed deficit levels.

UK equities displayed strength in Q2, led by sectors associated with stable earnings growth. Technology and large consumer goods companies drove the gains, while domestically-focused areas lagged due to renewed political and Brexit-related uncertainties.

Theresa May's resignation as prime minister and leader of the Conservative Party marked a significant development. Despite an Article 50 deadline extension to October 31, uncertainty prevails concerning the new leader's approach.

The negative effect of the original March 31 Article 50 deadline was evident, causing a 0.4% contraction in April's economy, primarily due to car production drops linked to Brexit uncertainty. Manufacturing weakness was widespread as the boost from orders ahead of the original deadline faded. The UK's May manufacturing PMI dipped below the 50 threshold for the first time since July 2016.

Q2 presented a challenging landscape for Japanese shares, resulting in a -2.4% total return with a dip in May. The yen's safe-haven status amid geopolitical risks and shifting US interest rate expectations contributed to its strength. Trade tensions, particularly the US's substantial tariff increase on Chinese imports, took center stage. Combined with sluggish corporate earnings growth and stalled US-Japan trade talks, Japanese electronic component suppliers suffered. Q1 2019 displayed an upbeat note for Japan's growth, with a 2.1% annualized real GDP increase. June's shareholder meetings revealed a growing emphasis on corporate governance and shareholder activism.

Asia ex Japan, however, saw the MSCI Asia ex Japan index underperform the global equivalent due to economic risks and trade uncertainties. ASEAN countries excelled, particularly Thailand and Singapore, while the Philippines benefitted from communication services and consumer staples. Hong Kong's financials rally and Taiwan's gains in consumer staples and industrials fueled growth. Chinese stocks experienced losses and were among Asia's weakest performers. Indian stocks slightly advanced following Prime Minister Modi's re-election and central bank interest rate cuts. South Korean stocks retreated due to lackluster corporate earnings.

Q2 proved favorable for financial markets, as both risky assets and government bonds yielded gains. Expectations of central bank accommodative policies, along with the potential for US rate cuts, underpinned this trend. The Fed and ECB's June dovish affirmations signaled flexibility for further measures if necessary.

Government bond prices surged, driving yields down. The 10-year US Treasury yield dropped over 40 basis points (bps), and the 10-year German Bund yield fell over 25bps to -0.33%. Spanish 10-year yields slid 65bps, while UK 10-year yields underperformed with a 17bps decrease.

Corporate bond markets outperformed government bonds, enjoying positive total returns. Credit benefited from falling yields, with investment grade bonds exhibiting superior returns to high yield bonds. Emerging market bonds experienced a positive quarter, especially local currency-denominated EM debt due to a weakening US dollar. Within US dollar-denominated and corporate EM bonds, investment grade yields exceeded high yield yields.

Convertible bonds gained by 1.1% in US dollar terms per the Thomson Reuters Global Focus index, compared to the MSCI World index's 4.0% advance. Convertible bond valuation remained mostly balanced, with Europe topping the price scale and Japanese and Asian convertibles trading below fair value.