Markets & Economy

Global Markets Weekly Update

October 13, 2017

Review the performance of global stock and bond markets over the past week, along with relevant insights from T. Rowe Price economists and investment professionals.

U.S.

Stocks continue advance

Stocks continued their advance into record territory, marking the fifth consecutive weekly gain for the large-cap Dow Jones Industrial Average and S&P 500 Index. The small-cap Russell 2000 Index lagged and recorded a modest loss for the week. The week brought the first releases of major third-quarter earnings reports, with JPMorgan Chase and Citigroup falling Thursday after reporting lower fixed income trading revenues and higher set-asides for credit card losses. Wells Fargo reported an earnings decline on Friday, further weighing on the broader financials sector. Consumer staples stocks performed well, boosted by a surge in Wal-Mart shares after the retail giant announced a massive share repurchase program and predicted a strong rise in online sales.

Political concerns continue into earnings season…

Even with the onset of earnings season, the tumultuous political environment continued to play a large role in driving sentiment. Health care services stocks stumbled early in the week as rumors surfaced that President Donald Trump was preparing to loosen regulations to allow less comprehensive and cheaper insurance plans. Stocks of hospitals and other health care providers fell when President Trump signed an executive order allowing such plans on Thursday, and shares fell further on Friday following news that the administration would also stop providing subsidies to insurers in order to reduce premiums for low-income enrollees in state insurance exchanges.

T. Rowe Price traders noted that the president’s ongoing feud with the powerful Republican chair of the Senate Foreign Relations Committee, Bob Corker, also seemed to weigh on sentiment by imperiling congressional action on tax reform. Finally, investors also seemed to worry about a potential pullout by the U.S. from NAFTA (see below), as well as the possibility of another North Korean missile launch.

…but economic data boost sentiment

A series of positive economic reports may have helped compensate for the disruption in Washington. Initial jobless claims during the previous week fell sharply, as the impact of Hurricanes Harvey, Irma, and Maria on the labor market appeared to be dissipating. Retail sales also jumped in September, reflecting further resilience in the face of the natural disasters. In fact, consumers entered October feeling better about the economy than they had in 13 years, according to the University of Michigan’s gauge of consumer sentiment, released Friday.

The hurricanes did have a large impact on September headline inflation data, which jumped in response to a temporary surge in gas prices following the shutdown of Gulf Coast refineries. However, T. Rowe Price Chief U.S. Economist Alan Levenson notes that increases in core (excluding food and energy) prices moderated in September, while core goods prices fell somewhat. Recent weakness in monthly core inflation data has drifted further away from the Federal Reserve’s annual inflation target of 2%, but Levenson believes the Fed is likely to continue on its path of gradual interest rate increases, with the next rate hike likely to be in December. Policymakers remain concerned that the current level of interest rates is too low and is driving elevated asset valuations.

Bonds: yields decrease as demand remains strong

The tame inflation data fed into a decrease in long-term Treasury yields (bond prices and yields move in opposite directions). Municipal bonds outperformed Treasuries, helped by another moderate new issuance calendar that was again absorbed by strong demand. The secondary market also remained active, as high demand left dealers with light inventories. Despite recent fluctuations in prices of municipal Puerto Rico debt, the volatility appeared to have very little influence on market demand for the wider municipal market.

The investment-grade corporate bond market was focused on new issuance, according to T. Rowe Price analysts. Most deals were met with strong demand, and secondary market trading increased as some portfolios made room for the new bonds. The technology/media and telecommunications (TMT) sector underperformed amid increased selling of recent new issues and more volatile bonds. At the end of the week, many portfolios seemed poised to reduce risk ahead of potential new supply from the banking sector following earnings releases and due to the weakness across the TMT segment.

The high yield market saw limited secondary trading due to the focus on the primary market. The appetite for new issuance continued to outstrip supply as below investment-grade funds reported inflows for the week and a number of deals were scaled larger. In issuer-specific news, Rite Aid bonds came under pressure following headlines saying that Amazon.com will soon decide whether to begin selling prescription drugs online.

U.S. Stocks1

 

Index

Friday’s Close

Week’s Change

% Change YTD

DJIA

22,871.72

 98.05

15.73%

S&P 500

 2,553.17

  3.84

14.04%

Nasdaq Composite

 6,605.80

 15.62

22.71%

S&P MidCap 400

 1,818.55

  1.89

 9.62%

Russell 2000

 1,502.45

 -6.19

10.85%

This chart is for illustrative purposes only and does not represent the performance of any specific security. Past performance cannot guarantee future results.

Source of data: Reuters, obtained through Yahoo! Finance and Bloomberg. Closing data as of 4 p.m. ET. The Dow Jones Industrial Average, the Standard & Poor’s 500 Stock Index of blue chip stocks, the Standard & Poor’s MidCap 400 Index, and the Russell 2000 Index are unmanaged indexes representing various segments of the U.S. equity markets by market capitalization. The Nasdaq Composite is an unmanaged index representing the companies traded on the Nasdaq stock exchange and the National Market System. Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark of Russell Investment Group.

Europe

European stocks ended the week higher, with two key benchmark indexes, Britain’s FTSE 100 and Germany’s DAX 30, reaching record highs. A slide in the pound boosted investor confidence in the multinational companies that dominate the FTSE 100 and generate sales in foreign currencies. Mining stocks were strong, buoyed by solid import demand from China. The pan-European benchmark Stoxx 600 ended the week marginally higher. European equity funds posted solid weekly inflows overall, according to EPFR Global data.

Standoff in Spain de-escalates

Spanish government bonds rallied as political concerns eased slightly after Catalan leader Carles Puigdemont symbolically declared independence but stopped short of making a formal declaration. Earlier in the month, Catalonia held a referendum on independence that Madrid ruled illegal and invalid. The yield on 10-year Spanish government bonds had fallen to 1.61% by Thursday’s close, well below the peak of over 1.78% it reached on October 4. Spanish stocks also rallied midweek, but Spanish equity funds suffered their second-largest outflows on record.

Lower for longer

European Central Bank President Mario Draghi said that interest rates would remain "lower for longer," and announced that the European Central Bank (ECB) planned to cut its monthly bond purchases to €30bn from €60bn. Quantitative easing would extend out to September 2018, he said. T. Rowe Price traders noted that the moves helped to push bonds higher and yields lower.

T. Rowe Price Chief International Economist Nikolaj Schmidt believes that a tapering of quantitative easing is very likely to occur more gradually than many investors expect, and its effects may not begin to be felt for some time to come. He argues that this would be supportive for wages, growth, and risk taking, which, on the other hand, could prompt central banks to hike rates more aggressively than is currently priced in by the markets—a hidden risk for many investors

Japan

Japanese stocks powered higher in the holiday-shortened trading week (the Japanese market was closed on Monday for Health and Sports Day). The widely watched Nikkei 225 Stock Average surpassed its 1996 peak, but the market still traded at about half of the all-time high it set nearly three decades ago. For the week, the Nikkei gained 539 points (2.6%) and closed at 21,230.00. For the year to date, the Nikkei is up 11.2%, the broad-based, large-cap TOPIX Index is ahead 12.5%, and TOPIX Small Index has gained 21.0%. The yen strengthened and closed near ¥112 per U.S. dollar, which is about 4.1% stronger than ¥117/dollar at the end of 2016.

Japan’s economy—a sweet spot

Recent improvement in the Japanese economy—recording six consecutive quarters of growth through the second quarter—has again raised hopes that, together with an improving global economy and Bank of Japan stimulus, this could be the catalyst for the long-awaited Japanese growth and inflation cycle. In recent years, Prime Minister Shinzo Abe’s government has made reform one of its primary objectives. He has targeted improved standards of corporate governance, including the mandatory hiring of external directors and other measures.

Pockets of inflation

There are long-awaited signs that pockets of price inflation may be emerging, according to Tokyo-based equity manager Archie Ciganer. With Japan’s unemployment rate falling to a 23-year low of 2.8% in June, and with the ratio of jobs to applicants reaching its highest level since 1974, worker shortages are becoming real. While broad-based wage increases remain modest, workers are moving for higher-paid positions, especially in the part-time employee segments of the economy. At some point, as labor constraints persist against a backdrop of global economic strength and domestic corporate profits, this may well begin to feed through to a gentle rise in inflation.

China

China trade data signal resilient Asian trade; forex reserves rise for eighth straight month

China’s exports grew strongly in September and the country’s foreign exchange reserves rose for the eighth straight month, two reassuring pieces of data for policymakers heading into a pivotal leadership transition later in the month.

China’s exports rose 8.1% in September, exceeding August’s gain but slightly missing forecasts. Imports grew a stronger-than-expected 18.7%, reflecting buoyant domestic demand and higher commodity prices. China’s trade surplus fell to roughly $28.5 billion in September from $42 billion in August, while its trade surplus with the U.S. surged to a record monthly high of $28 billion. The latest trade data follow other indicators pointing to strong global demand and an uptick in Asian trade. But it also risks worsening tensions with the Trump administration, which opened a probe into China’s trade practices in August.

Earlier in the week, China reported that its foreign currency reserves rose in September to a higher-than-expected $3.1 trillion. Analysts pay attention to China’s reserves because they show how much Beijing is dipping into its cash stockpile, the world’s biggest, to support its currency. A string of monthly declines in China’s reserves in 2015 and 2016 raised fears that the country was burning through its war chest to stabilize a weakening yuan. But stricter capital controls and strong economic growth this year have largely stabilized China’s reserve position.

The latest data come as Beijing heads into a twice-a-decade Communist Party congress set to begin October 18, during which a new slate of leaders will be unveiled. Analysts are particularly interested in the makeup of the Politburo Standing Committee, a seven-member group that effectively controls China, notes Hong Kong-based portfolio manager Eric Moffett. Additionally, any pronouncements regarding economic reforms and China’s strategic direction over the next five years will also be of interest, Moffett added.

Other Key Markets

NAFTA negotiators take up contentious areas of the pact

The fourth round of NAFTA negotiations began during the week, with the U.S pushing for changes that would weaken the pact and that have drawn backlash from Canada, Mexico, and business groups and sparked concern about the success of the talks. T. Rowe Price analyst Marta Yago believes that investors should not rule out the possibility that the U.S. could walk away from NAFTA and that negotiations are likely to cause a good deal of volatility over the next couple of months. This round focused on some of the more contentious issues up for negotiation, including content rules, which include higher levels of content for U.S. manufactured goods; a lower trade deficit with Mexico; and change to the dispute resolution process. The U.S. has proposed a sunset clause, which would force NAFTA’s expiration in five years unless all three parties act to renew it.

According to Bloomberg News, on Thursday night, the U.S. proposed raising the automotive “rules of origin” to 85% from the current 62.5%. These rules govern what share of a product must be sourced within NAFTA to receive the pact’s benefits. The U.S. Chamber of Commerce Senior Vice President for International Policy John Murphy said higher requirements for North American content would incentivize manufacturers to cease trading under the agreement and instead pay the low U.S. most favored nation tariff, which is 2.5%. The auto sector has also warned that changing the rules of origin could disrupt supply chains and be expensive for the industry. T. Rowe Price sovereign analyst Richard Hall believes that the main risk continues to be President Trump’s ability to swallow a NAFTA deal that makes relatively modest changes. Hall believes the initial U.S. negotiating position is well beyond the bounds of anything that Mexico and Canada would ever concede to, but he expects that pressure from U.S. business and agricultural community might be enough to keep the U.S. from exiting the agreement.

South Africa rally potential increases as ANC candidate gains in polls

The South African rand rallied against the U.S. dollar amid stronger-than-expected manufacturing and mining data and dollar weakness. While the domestic economy remains weak, T. Rowe Price sovereign analyst Roy Adkins believes that a potentially significant, politically driven rally across all assets is becoming more of a possibility. The potential for a rally is increasing as African National Congress (ANC) presidential candidate Cyril Ramaphosa gains popularity. Adkins notes that politics have been a significant drag on sentiment, and this could reverse dramatically with a Ramaphosa victory. The business community is a supporter and financial backer of Ramaphosa. Low levels of business confidence, in large part driven by a poor political environment, have meant very weak investment and weak overall growth. Foreign direct investment has been negative for the last three years, and T. Rowe Price equity analysts report that cash on corporate balance sheets is 40% of gross domestic product, all-time highs. A revival of sentiment could stanch the outflow of investment and put money to work, Adkins believes.

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