In a year of surprisingly muted market volatility, this month we saw risk assets tumble as investor concerns reached a decisive tipping point. Anxiety over a less accommodative Fed, the pace and sustainability of global economic growth, continued conflict in Ukraine, escalating violence in the Middle East, and even the Ebola crisis have investors fleeing to safe-haven investments. As we go to print, the S&P 500 index is down about 8% from its mid-September peak while the U.S. 10 year treasury yield has plummeted below 2% for the first time since May 2013. The selloff is not unique to stocks; commodity markets have been shaken as well with Brent trading at $84 per barrel, a 20%+ decline from its recent peak. This begs the question as to whether this is a buying opportunity or the beginning of a sustained downturn. As earning season begins, investors will be listening carefully for commentary that provides insight into the direction of the global economy.
Despite international economic growth concerns, U.S. data continues to indicate a generally positive economic environment. The Institute for Supply Management’s Manufacturing Index slipped slightly to 56.6 in September from 59.0 in August, but this is off a multi-year high and is still in expansionary territory. The new-orders component came in at 60.0 and, though down from a 10-year high of 66.7 in August, is still a strong reading. Housing market data has been somewhat soft this year, but the closely-followed NAHB Housing Market Index rose to 59, its highest level since November 2005. Pending and existing home sales, and traffic of prospective buyers all showed signs of strength as well. The September jobs report showed 248,000 jobs added, beating the 215,000 consensus estimate, and the unemployment rate dropped to 5.9%, a level not seen since before the Global Financial Crisis.
Elsewhere in developed markets, economic conditions are decidedly mixed. In the eurozone, the September inflation rate of 0.3% provided no reprieve from deflationary concerns as it remains well below the ECB’s target of just under 2%. Also drawing investor attention is the disappointing German production and export numbers. Having long been the primary engine of growth in the eurozone, a weaker German economy could threaten what is already a fragile and imbalanced recovery. Conversely, Britain’s economy, where projected 2014 annual output is now 3.2%, is faring better than its continental counterparts. Scotland’s vote against independence ended months of uncertainty and clears the way for continued strength in the UK.
In Asia, the Japanese government cut its overall economic assessment in September for the first time in five months, citing bad weather and the lingering impact of a tax hike in April. Private consumption continues to struggle and consumer sentiment worsened for the second consecutive month, as a sales tax increase from 5% to 8% impacted demand and output more than expected. Furthermore, inflation in Japan fell to 1.1% in August from 1.3% in July, marking the lowest reading since October 2013. The shift highlights the risks facing the Bank of Japan in delivering the promised 2% inflation by next year, and raises speculation over whether it might take fresh easing to keep prices up.
In emerging markets, third quarter Chinese GDP growth is expected to decline to 7.1-7.3% vs. 7.8% in the prior year’s quarter and 7.5% in Q2 2014. Market pundits are focused on the ailing property market, lackluster growth in the manufacturing sector, softening domestic and foreign investment, and rising credit risks in the commodity sector. In response to growth concerns, the central bank made $81 billion in special loans to the country’s five largest banks and announced a relaxation of mortgage lending restrictions. While these measures boosted the A-shares market, H-shares suffered losses due to intensifying pro-democracy protests in Hong Kong. Separately, Alibaba raised $25bn in its highly anticipated share flotation, making it the largest IPO on record. Outside of China, Russia’s central bank intervened in the currency market in an effort to stem the depreciation of the ruble amid lower oil prices and sanctions imposed over the continuing conflict in the Ukraine.
On a one-month trailing basis, the MSCI World Index (developed market proxy) outperformed the MSCI Emerging Markets index by about 1.5%, though it is still trailing on a YTD basis by about 1.2%. In a continuation of the recent trend of underperformance, small cap equities trailed their large cap counterparts by a considerable 5.2% over the last month, bringing the year-to-date underperformance to about 13.4%. From a sector perspective, defensives outperformed cyclicals. In the MSCI ACWI (broad index for both developed and emerging equities), consumer staples, utilities, and healthcare outperformed, while industrials, materials, and energy all lagged.
Michael Shavel, CFA, is the Research & Business Analyst at Cornerstone Capital Inc. and a former Research Analyst at AllianceBernstein’s Global Growth and Thematic team.
Dehao Zheng contributed to this article.