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Chief Investment Officer's team, 12.11.2018
Last week was relatively quiet for markets with a sharp fall in equity volatility, a small gain in developed markets and some pressure on emerging markets, linked to some USD strength and pressure on Oil prices.
US midterm elections were the key event to watch, and it is now behind us. Markets don’t like uncertainty, and removing a major one is always a good news. In addition, the policies of Mr Trump’s administration both internally and on the international scene have had such an impact on markets since the presidential election that the midterms took a particular importance with two potentially very different binary outcomes. A “red wave” i.e. a total victory of Republicans would have opened the door to even more radical policy action, while a “blue wave” could have triggered some reversal of the existing ones, not to mention an impeachment.
To that extent, the results and associated federal gridlock sends market participants back to business as usual, with some probable volatility to come around debt ceiling, and maybe some moderate bearishness on the USD which could support Emerging Assets. The FOMC hinted another hike in December and an absolute consistency in their pragmatic “data driven” mindset as well as a reiterated confidence in the strength of the economy. Our views for the near term as thus unchanged: volatility should remain, we favor equities over fixed income and recommend to keep on accumulating gold. Within equities, we favor US and EM over other Developed Markets. Within Fixed Income, we have reduced High Yield to Underweight and favor EM debt.
A rally in US equities in November, (the S&P 500 Index is +2.5% month to date) has given investors some respite, post the October sell off. Uncertainty around the midterms has been put to rest. Fiscal stimulus continues to drive US economic outperformance and a significant share of earnings growth in the US, but has also widened the gap with the rest of the world. Dollar strength has had spillover effects on the emerging markets. Trump and Xi may come to a more amicable structure on trade tariffs later this month at the G20, but any agreement needs to stand the test of time. However, fewer companies are now mentioning tariffs in their earnings calls compared to Q2. Fed tightening is gradual but a December hike seems highly probable. The shift from quantitative easing to quantitative tightening is driving liquidity worries. With so many factors at play we reiterate our focus on quality, as the single driving factor behind achieving outperformance in highly volatile markets.
US midterm results have myriad implications: a ‘check and balance’ within the legislative process: no additional tax cuts, no further attempts to repeal the Affordable Care Act and a meaningful infrastructure bill if the Democrats and Republicans can come to an understanding. Bigger concerns remain, around funding the government, with a key deadline on December 7th. Healthcare is also a common agenda for both parties, with pricing a concern.
On a technical front the S&P 500 needs to break above 2800 for an end of the year rally, which has been the historic norm post midterms, with an average 12% rally from October lows. Fundamentally too, valuations and growth justify a level closer to 3000. In the US, earnings growth rates remain elevated.
For Q3 2018, the earnings growth rate for the S&P 500 is 25.2%, with 90% of the companies having reported. However, increasing input costs from labor, raw materials (steel), transportation along with higher interest rates, are seen as risks to 2019 consensus margin estimates. So far the news is good, as it’s not only tax cuts that heave led to higher earnings. Revenue has grown by 9.4% in Q3 and net profit margins are at 11.9%.
European indices were flat to marginally higher last week, but are trailing losses for the year. MSCI Europe net return in USD is -9% YTD, with the Banking Index showing a negative -25% return in USD. Asia had a mixed performance last week. Indian markets were up c. 2% as concerns around higher oil prices at least for the near term faded. MSCI China has the occasional bright day but is yet to show a sustained rally and fell -3.9% last week. Singles Day, on the Alibaba platform, on 11th November is now officially the largest sale of online goods globally. It generated a record $ 31 billion of sales with Apple, Xiaomi and Dyson the most popular amongst branded goods. This should lift sentiment around China tech, which has been a dismal performer year to date.
In the GCC the UAE indices outperformed the other countries last week. Company results have been in line and strong tourism inflows continue to aid the Dubai economy. Emaar Malls saw 99 million visitors in the first 9 months of 2018. Dubai Parks & Resorts saw almost 2 million visitors in the first 9 months, a growth of 33% over the previous year. The Louvre Abu Dhabi has seen a million visitors over a year.
Fixed income update
Despite the ongoing trend on volatility in the broader bond markets, Emerging Markets issuers continue with their planned bond sales printing close to USD 48 billion in new debt in October - although short of last year’s issuance volume of USD 66 billion. With trade tensions between the US and China abating for now, strong economic data from the US together with the stronger dollar are still adding pressure on EM spreads. During October, the EM aggregate bond index has widened by 28bp to 300bp while benchmark US Treasuries have been trending between 3.06% and 3.14%
Indonesian bonds both in hard and local currency staged a sharp rally together with the Rupiah posting gains of close to 8% this month. The Indonesian domestic 10-year yields have dropped more than 80 basis points from the October’s high to 8.03% while the similar maturities of their USD denominated bonds also fared better and currently at 4.74%. Malaysia’s central bank kept its benchmark interest rate unchanged for a fifth meeting, helping support the economy as the government prepares to curb spending to restrain the budget deficit.
India’s Bharti Airtel, a leading telecom operator, has announced a cash buyback on their dollar-denominated bonds due in 2023. The bonds surged the most in five years after the company offered to buy back the securities with a premium on market price amid the risk of a rating downgrade. India’s second-biggest mobile phone carrier will pay $985 per $1,000 principal amount plus accrued interest for any or all of the $1.5 billion of March 2023 notes in the tender offer. The company highlighted the move to “proactively manage its capital structure’ reduce gross debt and leverage by acquiring the Notes funded out of equity proceeds and also provide liquidity to Noteholders at a premium to the market.
Written By:Maurice Gravier Chief Investment Officer, Maurice G@EmiratesNBD.com
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Sharp correction in equities
Volatility spikes - patience is paramount
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