Markets & Economy

Global Markets Weekly Update

May 19, 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.

Midweek tumble partially reversed by Friday rally

Midweek tumble partially reversed by Friday rallyStocks closed lower after a highly volatile week that saw a Friday rally partially compensate for a steep sell-off on Wednesday. The large-cap S&P 500 Index and the S&P MidCap 400 Index fared better than the other major benchmarks. After reaching its lowest level in over two decades the previous week, the Chicago Board of Exchange’s Volatility Index (VIX) spiked by almost half on Wednesday. Other markets were also notably volatile, with the dollar reaching its lowest level relative to the euro since October, while the price of gold rose sharply.

Russia allegations send markets reeling…

On Wednesday, the Dow and the S&P 500 fell the most since September, while the Nasdaq tumbled the most since the Brexit vote in June. The declines followed allegations the previous evening that President Trump had requested ex-FBI Director James Comey to drop his investigation into possible ties between former Trump campaign officials and the Russian government. Most observers agreed that the deepening controversy threatened to undermine the Trump administration’s efforts on tax reform and other market-friendly policies.

…but sentiment recovers as hopes grow that partisan rancor will dissipate—at least temporarily

Intermediate- and long-term Treasury yields ended slightly lower for the week, but not before the yield on the 10-year Treasury note touched its lowest level in a month in the aftermath of Russian investigation revelations. U.S. municipal bonds posted positive returns for the week, matching the performance of U.S. Treasuries. The new issue market continues to be the focus of investor demand, while the secondary market remains devoid of sellers as the market heads into a historically strong summer season.

Investment-grade corporate bonds advanced as healthy new issuance was met with strong demand. Despite the active primary calendar, the impact on secondary spreads continued to be negligible. The energy sector performed well and spreads narrowed after OPEC and Russia proposed extending production cuts.

Equity weakness at midweek contributed to risk-off sentiment and tempered gains in the high yield market. Volumes were light overall, but exchange-traded funds (ETFs) reported positive flows after two consecutive weekly outflows. ETFs kept sales activity relatively subdued despite the moves in stocks, contributing to price stability. The automotive sector underperformed in part due to weakness in Avis Budget Group bonds after the car rental company's CEO announced that he will be stepping down in June.

U.S. Stocks1
Index

Friday’s Close

Week’s Change

% Change YTD

DJIA

20804.84

-91.77

5.27%

S&P 500

2381.73

-9.17

6.38%

Nasdaq Composite

6083.70

-37.53

13.01%

S&P MidCap 400

1711.85

-6.66

3.19%

Russell 2000

1367.99

-15.04

0.93%

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

The pan-European Stoxx 600 benchmark was down about 1% for the week as political turmoil in Washington weighed on equity performance and offset an eighth consecutive week of strong cash flows into European stocks. Local indexes in Germany and France also lost ground, although the UK’s FTSE 100 Index held on to small gains after reaching an all-time high earlier in the week.

Demand drives bond yields lower; eurozone GDP rises

Political worries in the U.S. fueled demand for high-quality debt, driving down yields on most eurozone sovereign bonds. In Germany, the benchmark 10-year bond yield fell to around 0.36%, while the yield of a 10-year Italian government bond dropped to 2.12%.

Eurozone economic data were mostly positive for the week, although T. Rowe Price traders said it generally met expectations and did little to drive market movements. The eurozone recorded 1.7% annual growth through March. The only notable weak spot in the data involved Greece, which slipped back into recession as its economy shrank for the second straight quarter.

UK consumers return to stores in April

Retail sales in the UK recovered from a weak first quarter and unemployment fell to its lowest level since 1975 in a week that featured several notable economic reports in the UK. Retail sales rose 2.3% in April—significantly higher than consensus forecasts of about 1%—after a slowdown in the first quarter. The recovery was attributed to warm weather and shopping for Easter, which fell in April this year. The pound strengthened on the news, reaching its highest point in eight months.

Unemployment fell to 4.6% in the latest report, but wage growth trailed inflation and raised concerns about potential weakness in consumer spending in the near term, although these were partially allayed by the strong retail data. Meanwhile, in another report, inflation for the most recent 12-month period came in at 2.7%, its highest level since 2013 and above the Bank of England’s 2% target.

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Japan

Japanese stocks declined for the week, as President Trump’s domestic political woes prompted a broad global equity market sell-off on Wednesday. For the week ending Friday, May 19, the Nikkei 225 Stock Average fell about 1.5% (293.14 points) and closed at 19,590.76. For the year to date, the Nikkei is up about 2.5%, the broad-based TOPIX Index is ahead about 2.7%, and the TOPIX Small Index has advanced 6.3%.

The yen strengthened versus the U.S. dollar, as investors favored the yen’s safe-haven status during Wednesday’s global downdraft and ended the week around ¥111.5 per dollar versus about ¥117 per dollar at the end of 2016. While a stronger yen versus the dollar helps the total return performance of Japanese stocks in dollar terms, a stronger yen hurts the prospects for Japanese exporters—a key element of the country's economy.

Japanese economy grows for fifth consecutive quarter

Economic data from Japan were encouraging. The government’s Cabinet Office released preliminary data showing that Japan’s economy grew at an annualized rate of 2.2% in the first quarter of 2017, which was stronger than expected. In addition, it was the fifth consecutive quarter of positive growth—something Japan has not experienced in more than a decade.

T. Rowe Price’s Japan-based equity Portfolio Manager Archibald Ciganer believes that Prime Minister Shinzo Abe’s “Abenomics” policies deserve much of the credit for Japan’s improving economic situation, even though it has taken four years for results to appear. Ciganer has been optimistic that the “three arrows” of Abenomics—fiscal stimulus, monetary stimulus, and structural reforms—would eventually jump-start growth and inflation, even though skepticism has been growing. That said, he has grown a bit more cautious about the Bank of Japan’s ability to weaken the yen over time, as the global currency environment has grown more uncertain and volatile. In addition, Ciganer notes that the Japanese market is more exposed than most to the health of the global economy. While he expects modest global growth to continue, an unexpected strengthening or weakening is likely to resonate with Japanese stocks.

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China

China’s economy softens in April after strong Q1

China’s latest monthly economic indicators signaled slower growth in April following a stronger-than-expected first quarter. Readings of value-added industrial output and retail sales both slowed in April from March and came in weaker than forecast, according to data from China’s statistics bureau. Meanwhile, fixed-asset investment excluding rural areas—a gauge of money spent to buy and build machinery, buildings, and other fixed facilities—grew at a slower-than-expected pace in the first four months of 2017. Taken together, April’s data signaled that China’s economy lost momentum following the surprisingly strong 6.9% growth pace in the first quarter. Additionally, the data supported analysts’ views that economic conditions in China appear to have peaked early this year and will likely moderate in the second half.

Despite slowing headline growth, China’s economy still offers plenty of opportunities for individual stock pickers, points out Nick Beecroft, a T. Rowe Price portfolio specialist in Hong Kong. Though headlines are fixated on China’s long-term growth slowdown, domestic demand on the mainland has stayed resilient and many sectors and companies in China are exhibiting strong growth. Additionally, many businesses in China have begun to generate significant cash flow after slashing capital spending—a complete reversal of management behavior from just a few years ago and a sign that capital discipline has finally taken hold in China, Beecroft adds.

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Other Key Markets

Political risk spikes in Brazil

On Wednesday, one of Brazil’s leading media outlets reported that it had obtained recordings of President Michel Temer allegedly condoning bribes from the owner of a meatpacking conglomerate to win the silence of former House Speaker Eduardo Cunha, who was a potential witness in the ongoing investigation into the country’s huge government corruption scandal. Most observers had believed that Temer has not been involved in the bribery of government officials, so the news came as a shock. Temer replaced Dilma Rousseff, who was herself ensnared in the scandal and removed from office. Temer’s government had implemented investor-friendly reforms and is in the process of trying to enact pension reforms, the fate of which has now become somewhat uncertain.

Brazil’s stocks, bonds, and currency plummet

Brazilian stocks plummeted when trading opened Thursday morning, immediately dropping 10% and tripping a circuit breaker that temporarily halted trading. T. Rowe Price traders noted that the market then traded roughly sideways and even recovered a small amount of its losses before finishing the day down almost 9%. Brazilian bonds also sold off sharply on Thursday, and the country’s currency, the real, fell about 8% against the U.S. dollar. At a press conference Thursday afternoon, Temer said that he would fight the corruption allegations and would not resign. The real and Brazilian stocks regained some of their lost ground on Friday.

Pension reform delayed but still likely

While the situation in Brazil could change rapidly, T. Rowe Price’s Latin America credit analysts and equity specialists anticipate that the pension reform legislation will ultimately pass, although it could be delayed until the next administration comes into office. This would make the 2018 presidential elections an even more pivotal event for investors in Brazil. In addition, the weakness in the real is likely to force Brazil’s central bank to slow its pace of interest rate cuts to support the currency. This could then hamper the country’s recovery from a deep recession.

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