Asia Pacific
The MSCI Pacific Index returned 0.7% in the week to 18 July, as markets proved resilient to heightened geopolitical risks.
Japan’s TOPIX was up 0.6%. The Japanese government raised its assessment of the economy for the first time in six months, stating that personal spending was showing signs of recovery following April’s sales tax increase.
The Japanese government’s announcement followed the Bank of Japan’s (BoJ’s) two-day monetary policy meeting, in which the central bank decided to maintain its accommodative monetary policy framework, with governor Haruhiko Kuroda predicting inflation to accelerate in the second half of this year. However, the BoJ cut its economic growth forecast for this fiscal year to 1% from 1.1%, due to ongoing weakness in exports.
Hong Kong’s Hang Seng was up 1.0%, lifted by better-than-expected economic growth data out of China. Property stocks traded higher on expectations that China will loosen its housing market policy after home prices fell in June.
Australia’s All Ordinaries rose 0.8%, while Singapore’s Straits Times was up 0.5%. Singapore’s exports fell in June from a year ago, due to weakness in electronics shipments—a key element of the country’s exports.
United States
Wall Street overcame a spike in geopolitical-induced volatility to end the week of 12-18 July higher. The Dow Jones was up 0.9%, the S&P 500 rose 0.5% and the NASDAQ gained 0.4%.
The S&P 500 suffered its biggest single-day loss since April on Thursday following reports that a Malaysia Airlines passenger jet had been shot down in eastern Ukraine. Uncertainty over the geopolitical consequences of the tragedy caused a sharp drop in share prices and a broad move into the safety of government bonds.
Nevertheless, Wall Street’s return to calm at the end of the week suggests investors believe geopolitical risk—although currently elevated—remains contained. Therefore, despite the potential for events in Ukraine, or in the Middle East (last week saw an escalation of Israeli operations in Gaza), to cause bouts of market volatility, share prices continue to be buoyed by positive news on the outlook for economic growth and corporate profits.
On the economic front, the main event of the week was Janet Yellen’s half-yearly testimony to Congress. The Federal Reserve chairwoman indicated that US interest rates could rise sooner than the market expects if the labour market continues to recover at its current rate. The latest jobless claims data pointed to an ongoing improvement, with the number of Americans registering for unemployment benefit for the first time falling by 3,000 to 302,000 in the week ending 12 July.
Other data releases in the week also pointed to a modest strengthening in the economic backdrop. The latest monthly survey by the National Association of Home Builders suggested that the improving labour market was leading to greater demand for new housing, with optimism among house builders at its highest level since January. Meanwhile, surveys of manufacturing activity in the Philadelphia and New York areas both recorded strong increases for July.
The second-quarter corporate earnings season has also got off to a strong start, providing a further boost to market sentiment. At the end of the week, with 82 out of the 500 companies listed on the S&P 500 Index having reported profits for the three-month period between April and July, 77% of these reports were better than expected according to Bloomberg.
Importantly, the growth in earnings is being supported by stronger sales, as well as by cost controls and price rises. Company managements have also been relatively sanguine on the outlook for future profitability. Share prices have started to look more expensive compared to corporate earnings following strong gains since 2013, so evidence of a pickup in sales is welcome and—if sustained—should be positive for the market going forward.
Europe
Eurozone stock markets stabilised in the week ending 18 July, with the MSCI Europe Index returning 0.7%. Among the major markets, Sweden’s OMX Stockholm 30 climbed 1.8% and the UK’s FTSE 100 was up 0.9%, while Germany’s DAX, Italy’s FTSE MIB and Switzerland’s SPI each gained 0.6%. The French CAC 40 rose 0.4%, but Spain’s IBEX 35 lagged slightly, down 0.1% for the week.
Positive returns came despite investor sentiment towards Europe souring somewhat in recent weeks, thanks to a number of headwinds, including eurozone bank stress tests, a missed debt payment from Portuguese banking group Banco Espirito Santo, disappointing growth data and renewed geopolitical concerns in Ukraine, following the shooting down of a Malaysia Airlines passenger jet in eastern Ukraine.
Eurozone banks will have just two weeks this autumn to come up with plans to plug any holes in their balance sheets, according to the latest guidance published by the European Central Bank (ECB). The ECB plans to carry out stress tests on 128 of the largest banks across the eurozone before it takes over lender supervision in November. Banks will be given the results of the stress tests in October, along with constructive feedback on an “asset quality review” that will look to identify inconsistencies in the way they evaluate their riskiest assets.
Economic data remained weak. Eurozone industrial production dropped sharply in May, with output falling 1.1% following a rise of 0.7% in April. However, analysts suggested the severity of the fall may have been worsened by the timing of public holidays, some of which were used as “bridging days” to extend long weekends.
In the UK, the latest monthly consumer price index (CPI) published by the Office for National Statistics (ONS) revealed that inflation rose by 1.9% in the year to June, compared to a rise of 1.5% in May. Inflation is now very close to the Bank of England’s (BoE’s) 2.0% target, which could strengthen the case for a rise in UK interest rates. However, the increase in the CPI was attributed largely to rising prices for clothing, footwear, food and non-alcoholic drinks—all seasonal factors that could reverse in coming months.
The strength of the labour market will also have a strong bearing on the timing of UK rate increases. Unemployment fell by 121,000 to 2.12 million in the three months to May, the lowest level in almost six years, according to the ONS, while the unemployment rate fell to 6.5%. However, the BoE is not yet under pressure to raise rates to temper wage inflation—average weekly wages increased just 0.8% in the year to May.
While the outlook in Europe may not look as attractive as earlier in the year, given weaker economic data and rising geopolitical risks, sentiment continues to be supported by the potential for ECB policy action. Also, if the outcome of banking sector stress tests in October is positive, it would remove one overhanging concern and reaffirm that the healing process in the financial sector is continuing.
Global Emerging Markets
The MSCI Emerging Markets Index was up 0.8% in the week ending 18 July, as signs of economic recovery in several markets helped overcome sharp falls in Russian stocks on the back of rising geopolitical risks.
Brazil’s BOVESPA made strong gains, up 4.1% on the week amid further signs of falling poll ratings for president Dilma Rousseff ahead of elections later this year. Rousseff’s economic policies and interference in state-run companies have been blamed for Brazil’s sluggish growth.
Emerging Asian markets also rose, with India’s SENSEX up 2.5% and the MSCI China up 1.2%. Indian stocks benefited from hopes for a boost to infrastructure spending as the Reserve Bank of India provided regulatory incentives to infrastructure developers looking to raise money via the bond markets.
In China, sentiment improved as the latest GDP data showed that the Chinese economy had grown 7.5% in the second quarter compared to a year earlier, up from 7.3% in the first three months of the year. Reports of a strong rise in industrial production in June, and a sharp increase in retail sales, suggest economic activity is picking up as we move into the second half of the year.
South Korea’s KOSPI gained 1.5%, boosted by hopes for stronger earnings in the technology sector following strong earnings from US technology companies. However, Taiwan’s TAIEX fell 1.0% amid weakness for the market’s largest company, semiconductor maker TSMC, on concern over possible order losses.
In emerging Europe, Turkey’s ISE 100 rose 3.7% amid further signs of improvement in the country’s current account deficit, while Poland’s WIG rose 0.5%.
Russia’s RTS fell sharply, down 7.7%. Investors sold Russian stocks on fears that the scope and severity of western sanctions against Russian economic interests would be significantly expanded as the shooting down of a Malaysia Airlines jet over eastern Ukraine was linked to Moscow-backed Russian separatists.
Bonds & Currency
US, eurozone and UK bond yields fell in the week as rising geopolitical tensions sparked a flight to quality. 10-year yields fell by 3bps-7bps while yield curves bull-flattened as long-term rates outperformed.
Credit spreads widened, both investment grade and high yield, in reaction to higher geopolitical risk and to concerns expressed by Federal Reserve chairwoman Janet Yellen regarding credit and leverage loan valuations.
*Source: J.P. Morgan Asset Management
