Markets & Economy

Global Markets Weekly Update

October 12, 2018

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 see biggest drop since early February

Stocks fell sharply, with the S&P 500 Index losing more than 5% Wednesday through Thursday, its largest two-day drop since early February. The smaller-cap indexes suffered the biggest declines, pushing the S&P MidCap 400 Index into negative territory for the year to date and the small-cap Russell 2000 Index into correction territory, off more than 10% from its recent highs. The Cboe Volatility Index (VIX) spiked and hit its highest level since late March on Thursday, while trading volumes reached their highest level in over eight months. Industrials and materials stocks performed worst within the S&P 500, while utilities stocks fared best. High-valuation growth stocks underperformed slower-growing value shares for much of the week but regained ground on Friday.

Single cause of sell-off is hard to identify

Rising Treasury bond yields, the deepening U.S. trade conflict with China, signs of weakness in the global economy, and other concerns continued to weigh on sentiment during the week—but precisely why worries intensified Wednesday morning and set off a fury of selling was somewhat unclear. T. Rowe Price traders noted that the first spark may have been a relatively minor one—a report that China was cracking down on traveling citizens bringing undeclared designer handbags and other goods into the country, which led to a tumble in the shares of luxury goods makers. This was soon followed by news of a rebound in U.S. producer prices in September, which, despite being widely expected, appeared to raise fears about a jump in consumer inflation.

The firm’s traders noted that technical factors came into play later in the day Wednesday, particularly after the S&P 500 fell below its 100-day moving average and seemed to accelerate program-based selling. Selling out of stocks as an asset class as a whole rather than trading out of individual shares also appeared to play a role, with exchange-traded funds (ETFs) responsible for over one-third of trading volumes.

Linehan: Heightened level of anxiety given how far we’ve come

After some hopeful signs at the opening, selling resumed Thursday, taking the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite all below their 200-day moving averages. Once again, systematic selling appeared to be at work, and ETF trading increased to 42% of total volumes. T. Rowe Price Chief Investment Officer of Equity John Linehan told The New York Times that money exiting the market reflected “a level of anxiety about the market, especially given how far we’ve come.” Investors received good news about inflation on Thursday, but it seemed to do little to improve sentiment. Consumer price inflation unexpectedly moderated in September, reaching its lowest year-over-year rate (2.3%) since February.

Bond yields decrease for the week as investors flee equities

The sell-off in equities seemed to push some investors into the bond market, and longer-term bond yields decreased for the week. (Bond prices and yields move in opposite directions.) Municipal bonds underperformed Treasuries early in the week despite a lighter new issuance calendar. Munis rebounded on Thursday, however, as weakness in the equity market and stability in Treasury yields helped draw investors back to the asset class. Fixed income markets were closed Monday in observance of the Columbus Day holiday.

Corporate yield spreads widen

The investment-grade corporate bond market experienced some weakness, partly due to equity market declines weighing on sentiment. The primary calendar was active, but volumes were light and well below expectations. Credit spreads—or the additional yield offered over Treasuries with similar maturities—widened across most sectors, but investors seemed to jump in to take advantage of the more attractive valuations, continuing a trend that had emerged over the past few weeks.

The high yield bond market was very quiet. Below investment-grade portfolios reported negative flows, including a sizable outflow from ETFs. T. Rowe Price traders observed that equity market weakness seemed to keep many investors on the sidelines, and the primary calendar was dormant. Bonds from energy sector issuers traded lower as oil prices gave back some recent gains.

U.S. Stocks

 

Index

Friday’s Close

Week’s Change

% Change YTD

DJIA

25,339.99

-1107.06

2.51%

S&P 500

2,767.13

-118.44

3.50%

Nasdaq Composite

7,496.89

-291.56

8.60%

S&P MidCap 400

1,873.64

-96.76

-1.42%

Russell 2000

1,548.42

-85.88

0.84%

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

Stocks in Europe fall amid global rout

European equities followed global stocks lower, as investors worried that rising interest rates would curb global growth. The STOXX Europe 600 Index was down about 5% for the week, hitting new 52-week lows. Luxury brands were heavily sold amid concerns of weaker-than-expected Chinese growth and new Chinese customs restrictions (see above).

Italy’s stocks fall into bear market territory; UK equities correct

Italy’s FTSE MIB Index was down 5% for the week and fell into bear market territory—a decline of at least 20% from a recent high. Germany’s DAX 30 and France’s CAC 40 lost about 5%. The UK’s FTSE 100 dropped 4.4% and entered correction territory, defined as a drop of at least 10% from a recent peak.

Italian sovereign yields rose as budget impasse continues

Yields on Italian 10-year government bonds hit 3.71% as worries about the country’s finances mounted. The country’s Deputy Prime Minister Matteo Salvini insisted that the government’s budget won’t change and that his coalition government won’t back away from campaign promises to raise welfare and pension spending and cut taxes despite the negative reaction from financial markets and European Union (EU) officials. As Italy continued its standoff with the EU, the spread between yields on 10-year Italian and German bonds, seen as a gauge of financial strain, widened, touching 308 basis points, close to its highest level since 2013. Finance Minister Giovanni Tria said the selloff is of concern but that the jump in yields is not justified by Italy’s economic fundamentals. Meanwhile, the International Monetary Fund’s top Europe official said Italy should be taking measures to reduce its deficit in accordance with EU fiscal rules, which require countries with high debt levels to reduce indebtedness.

Japan

Japanese stocks posted steep losses in the holiday-shortened trading week—the Japanese stock market was closed on Monday in observance of Health-Sports Day. The Nikkei 225 Stock Average declined 1,089 points (4.58%) and closed at 22,694.66. For the year to date, the benchmark is modestly in the red. The broad-based TOPIX Index and the TOPIX Small Index also fell sharply for the week; their returns for the year to date remain more significantly in negative territory, down 6.3% and 9.3%, respectively. At the close of trading on Friday, the yen stood at ¥112.31 per U.S. dollar, modestly stronger for the week, and little changed versus ¥112.70 at the start of 2018.

Japanese stocks mauled in global market sell-off

The Nikkei 225 Stock Average fell 3.9% (more than 900 points) and ended with its lowest close since mid-September on Thursday. The blue chip benchmark endured its largest daily decline since March and ended down approximately 8% from its 27-year high that was set earlier this month. All but one stock in the widely watched benchmark declined amid the steep sell-off. Industrials and information technology stocks fell the farthest, especially those with significant exposure to China. Japanese stocks clawed back some of their losses on Friday, with the Nikkei recouping about 100 points.

Many market participants believe that the third-quarter revenue and earnings reporting season will produce good results, reflecting the underlying strength of Japan’s economy. Many also believe that stocks will remain volatile, however, in large part due to the ongoing trade war between the U.S. and China.

BoJ slows pace of bond purchases

The Bank of Japan (BoJ) has slowed the pace of its bond purchases—what some call a “stealth tapering”—to about half of its guideline of about ¥80 trillion per year. In July, the BoJ reduced its purchase range for long-term bonds to extend the duration of its monetary policy expansion and in response to outcries from critics that its holdings distorted the trading operations in the world’s second-largest bond market. The quandary for the BoJ is its commitment to stimulate the economy until inflation is above its 2% target. Analysts believe that the central bank may make additional tweaks to its bond-buying program in October.

China

Reduced reserve ratio for banks as trade war intensifies

China decreased the amount of money that commercial banks must put aside at the country’s central bank, a significant move that could release an extra $175 billion into the economy, as Beijing steps up measures to support growth amid a worsening trade war with the U.S. The previous weekend, the People’s Bank of China (PBOC) lowered its reserve requirement ratio by 1%, effective October 15. The move marked the PBOC’s fourth reserve ratio cut this year and will hand mainland banks 1.2 trillion yuan—of which 450 billion is to be used to repay their own borrowings from the PBOC, the bank said on its site. The latest rate cut is a fairly sizable reduction that will release a net amount of 750 million yuan into China’s economy, or a little less than 1% of the country’s gross domestic product, estimates T. Rowe Price Sovereign Credit Analyst Chris Kushlis.

Though the PBOC’s rate cut should boost domestic activity, it will also likely renew downward pressure on the yuan, whose recent weakness has drawn the ire of the Trump administration. On Friday, U.S. Treasury Secretary Steven Mnuchin reiterated concern about the yuan’s weakness and said that exchange rates would have to be part of bilateral trade talks. The yuan’s steady deprecation this year has increased bets that the currency will soon break the psychologically key exchange rate of 7 yuan per U.S. dollar—something that hasn’t happened since the global financial crisis. Kushlis believes that despite U.S. charges of currency manipulation, the PBOC is going out of its way to manage expectations and doesn’t want to see a speculative buildup of selling pressure on the yuan.

Other Key Markets

Brazil: Investors celebrate Bolsonaro’s strong showing

Shares in Brazil rose as investors cheered the victory of far-right candidate Jair Bolsonaro of the Social Liberal Party, who nearly won the presidency in Sunday’s first round of voting. Much of the gain was wiped away later in the week, as Brazil’s equities succumbed to the rout that swept global markets. (The Brazilian market was closed for a holiday on Friday.) Bolsonaro won 46% of the vote on Sunday. The second-best performing candidate was Fernando Haddad of the left-wing Workers’ Party; he won about 29% of the votes. Bolsonaro’s strong showing suggests that he will likely defeat Haddad and win the presidency in the October 28 runoff election.

Turkey: Government unveils new inflation-fighting plan

Turkish assets were volatile amid the global market downturn. Early in the week, the lira struggled as investors were largely unimpressed by Finance Minister Berat Albayrak’s plan to fight inflation, which was recently measured at an annual rate near 25%. The plan encourages retailers to voluntarily reduce prices on certain goods by 10% and keep other prices unchanged for a two-month period. In addition, utilities are not to raise prices until the end of 2018. According to T. Rowe Price Sovereign Debt Analyst Peter Botoucharov, the measures proposed by the government may have a temporary positive impact on headline inflation, but they will also likely have a negative impact on corporate profitability.

Late in the week, U.S. Pastor Andrew Brunson, who has been held in Turkey for a couple of years due to alleged ties to terrorist groups, was released from house arrest. A Turkish court convicted him of terror charges on Friday but also decided that Brunson did not need to serve additional time beyond his two years of detention. Turkish assets were little changed on Friday, as the court’s decision appeared to be largely priced into the market.

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