2017 looks set to be a more than decent year for the equity markets, although the markets stopped for breath in November. Our expert, Johan Gallopyn, outlines the main trends on the equity, bond and currency markets of the past month.
The equity markets showed a mixed picture in November. Despite the excellent economic indicators that were published for the euro zone, the European markets lost some ground (MSCI EMU -2.0%). The stronger euro weighed on investor sentiment, whereas the political uncertainty in Germany had virtually no impact. In the United States, share prices increased again, buoyed by the progress that was made in getting the tax reform programme approved in both the House of Representatives and the Senate. The S&P500 climbed for the eighth consecutive month. Towards the end of the month, the US market lost some momentum as well due to profit taking in the technology industry following the sharp increase over the previous months, which account for a substantial part of the profit that the market as a whole had recorded this year. The profit taking in the US technology industry also spread to other parts of the world. The Emerging Markets reported a weak month
as several factors give cause for concern, such as the prospect of rising interest rates in the US. The Asian markets felt little impact from the downturn on the domestic stock market Shanghai Shenzhen, although investors are cautious of a slower growth in China. The Latin American area (MSCI Latin America -3.0% in euros) was confronted with an upsurge of risk aversion after the Venezuelan government defaulted on the coupon payment on bonds.
The bond markets remained very stable during the past month. In the euro zone, the breakdown of coalition negotiations in Germany had virtually no impact on the bond market. The spreads of the sovereign issuers in both core countries and periphery countries decreased slightly against the German reference bond, although this was a matter of a few basis points. The Irish bond yield increased against the trend, owing to an impending domestic political crisis at a time when the Brexit talks are focusing on the Ireland-Northern Ireland border. On the US bond market
in particular, a watchful eye is being kept on the persistently flattening yield curve
. The difference between the 10-year and 2-year yield is ever narrowing (60 basis points compared with 125 basis points at the beginning of this year). If this were to evolve towards an inverted yield curve, past experience has shown this to usher in a sharp economic downturn, even a recession. The market now asks itself whether this predictive value also holds good when the central banks are highly active in the bond market. There was little movement in corporate bonds too. Nevertheless, the spreads of lower-grade issuers (within investment grade) and financial issuers went down further.
Central banks and monetary policy
As was generally expected, the Bank of England increased short-term interest rates by 0.25%
for the first time in a decade. In its commentary, the central bank was very wary of raising expectations about future interest rate rises. The leading economic indicators are not very promising, and although inflation is rising (3% in October), this is the result of a lower pound sterling rather than of rising wages or other domestic price pressures. The report of the latest FOMC meeting and statements by FED Chair Yellen revealed uncertainty about the projected rise in inflation and about the extent to which temporary factors weigh on price levels. Although those statements do not call into question the generally expected interest rate increase in December, they do raise doubts about the three interest rate increases which the Federal Reserve itself expects for 2018.
The weaker euro was only a short-term phenomenon, as the currency strengthened its position against virtually all other currencies in November. The latest economic figures for the euro zone keep giving positive surprises, with indicators often reaching their highest level in a decade. The US dollar declined to 1.19 against the euro, despite the favourable economic figures that were reported in the US as well and the progress that was made with the tax reform programme. The Federal Reserve’s expectations about inflation weighed on the exchange rate. The interest rate rise by the Bank of England had little impact on the pound sterling, since it was generally expected; the cautious projections, in contrast, weakened the currency when the interest rate rise was announced. The pound sterling subsequently recovered amid optimism about progress in the Brexit talks. The Australian dollar continued its decline (-3.4% against the euro). As was expected, the central bank left interest rates unchanged, while the low wage growth and resulting inflationary expectation do not augur any interest rate rises, possibly even until 2019. The Norwegian krone lost considerable ground against the euro
(-4.1%), despite higher oil prices, and followed the trend of the Swedish krona (-2.2%), which suffered as a result of cautious statements by the central bank and a certain amount of anxiety over sharply rising property prices in Sweden.
As was expected, the OPEC and certain non-OPEC countries prolonged production restrictions until the end of 2018. Additional support for oil prices comes as Libya and Nigeria also become subject to production restrictions unlike in the current agreement. As the Brent price
had already anticipated the extension of production restrictions, the price response was fairly limited
, especially as the latest shale oil production figures in the US (September) showed the highest growth ever. This illustrates that it is difficult to support the oil price without stimulating shale oil production. How the market will respond once production restrictions are finally lifted remains an open question. Industrial metals lost some ground (GSCI Industrial Metals -3.1% in USD) after the surge of previous months. The weaker economic indicators in China contributed to profit taking. The price of gold remained fairly stable, as a higher bond yield in the US and a somewhat keener risk appetite at the end of the month forced it to surrender some of its earlier gain.
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