Despite all the geopolitical noise generated throughout the third quarter, it was a relatively flat period for markets. September saw the reversal of the falls experienced in August. As a result, the main UK index ended the quarter flat. The US fared slightly better with the S&P 500 recording a gain of around 0.7% (in USD terms). Markets in Europe were mixed. The German DAX index was down slightly; however, the French CAC 40 index fared better with a 1.9% gain (in EUR terms). One of the best performers out of developed markets was Japan, posting a gain of around 2.3% (in JPY terms).
Bond markets enjoyed much of the spotlight during the third quarter, with Gilts particularly volatile during the period. At the start of July, the yield on the ten-year Gilt stood at 0.9%. It gradually fell to a low of around 0.4% towards the end of August/beginning of September, spiked back up to 0.75% by mid-September before settling back around 0.5% at the end of the month. Whilst some of this volatility was attributable to political/Brexit-related uncertainty in the UK, other bond markets (US Treasuries for example) experienced similar swings.
For the bond markets as a whole, some startling figures emerged. There is now some $17 trillion of negatively yielding debt – an unprecedented amount. Moreover, analysis by Bank of America indicated that some $27 trillion of non USD-denominated investment grade debt was, on average, yielding close to nothing and that the US share of global investment grade yield (I.e bonds returning above zero percent) was around 94%. Even parts of the European high yield market have reached negative yield territory.
US Federal Reserve
The end of July saw the US Federal Reserve (Fed) lower interest rates by 0.25% – the first time since financial crisis of 2008. Whilst delivering what the markets craved, the reaction was broadly negative. In fact, this was the tenth time out of twelve Jerome Powell press conferences that stocks fell in the immediate aftermath. The issue this time round was a significant dichotomy of opinion: some believed that the cut was not necessary (healthy US economy) whilst others (including a vociferous President) believed that the Fed were behind the curve and that a larger cut was required. By voicing concerns about possible headwinds to the global economy, there was also the question of whether the Fed was operating outside of its remit. Moreover, an increasingly embattled Fed Chairman faced accusations of bowing to political pressure and consequently undermining its credibility and independence.
Mario Draghi’s penultimate meeting as President of the European Central Bank (ECB) saw the announcement of some modest easing measures. The deposit rate was cut by a further 10 basis points to minus 0.5% (this is the rate at which banks pay to deposit excess reserves with the ECB). Conscious of the potential damage to the banking system of negative deposit rates, the ECB will operate a tiered system, whereby some excess reserves will be exempt. There was also the resumption of quantitative easing (QE) – the ECB is to buy EUR 20bn a month of eligible securities from November onwards. These announcements were slightly below expectations; however, the open-ended nature of the QE programme was a positive surprise. Mr Draghi stressed however, that fiscal policy should take more of the strain going forward.
Interest rate cuts from other central banks globally re-affirmed that the current easing cycle was well under way. Traditionally a beneficiary of lower real yields (nominal bond yields minus the rate of inflation), gold was one of the best performing asset classes, with a return of approximately 8%.
Oil spiked in September after a drone attack on the world’s largest oil refinery reduced Saudi Arabia’s capacity by around fifty percent (approximately 5-6m barrels). This equates to around five percent of global oil supply and the price spiked up by around 15% on the day as markets digested the news. The price subsequently dropped back after the Saudis restored production quicker that initially thought.
Whilst the market mood is generally cautious at present, weighed down by trade war escalation fears, Brexit uncertainty and a deterioration in macroeconomic data (amongst other things), it is worth re-iterating that many markets remain at or near all-time highs. A number of factors suggest that a US recession is not imminent. Firstly, the US service sector remains resilient to weakness in manufacturing (easing of credit conditions is helping to offset). Secondly, US housing activity is starting to pick up again as mortgage rates fall on the back of recent interest rate cuts (contributing to a positive wealth effect on consumers). Finally, the US corporate sector remains healthy and the usual shocks that cause companies to retrench are currently absent.
Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.