Beneath the Surface

A review of last month’s market-moving events across countries and asset classes.

In the World

A reprieve in trade tensions between the U.S. and China bolstered investor confidence in October even as political uncertainty increased around the globe. Washington and Beijing announced details of a potential deal – coined as “phase one” – for the U.S. to forego the next round of scheduled tariffs in exchange for increased agricultural purchases by China. While President Donald Trump described the interim agreement as “substantial” and negotiations indicated a desire to limit further escalations, the details fell short of addressing underlying structural issues between both administrations. Meanwhile, impeachment proceedings against Trump advanced as the House of Representatives passed a resolution on 31 October that formally laid out its plan for the investigation. Across the Atlantic, the Brexit deadline was postponed to the end of January, with Prime Minister Boris Johnson calling for a general election in December in an attempt to solidify support for his proposed withdrawal agreement. Elsewhere, major political demonstrations continued in Hong Kong and began in a number of countries – including Iraq, Chile, Spain, Ecuador, and Lebanon – stemming from grievances that included sovereignty, corruption, and the increased cost of living.

Central banks maintained accommodative policy as concerns grew amid generally weaker data. Despite better-than-expected U.S. Q3 real GDP growth of 1.9% annualized, strong consumer spending and faltering business investment painted a more mixed picture of the U.S economy. In particular, while the U.S. jobless rate reached a half-century low of 3.5%, the ISM purchasing managers’ index (PMI) contracted in September to its weakest level since June 2009, and the Chicago PMI fell to its lowest level since December 2015. The PMI trend was similar in the eurozone and Japan, reflecting a deepening global manufacturing recession. The IMF again downgraded its estimate for 2019 global growth to 3.0%, representing the lowest rate of expansion since the financial crisis. Against this backdrop, the Federal Reserve lowered its target fed funds rate by 25 basis points (bps) again in a widely anticipated move, although Chairman Jerome Powell indicated that any future cuts would be reliant on a material deterioration in the economy. Elsewhere, the European Central Bank (ECB) and the Bank of Japan (BOJ) left rates unchanged, with the former emphasizing stimulus measures announced last month and the latter slightly tweaking its guidance to allow for rate cuts in the future.

The renewed optimism about U.S.–China trade generally outweighed concerns over softer economic data and provided a boost to risk assets. Global equities posted strong returns in October – both in developed markets (+2.5%) and emerging markets (+4.2%) – on improved U.S.–China trade sentiment, positive Brexit developments, and continued accommodation by central banks. The S&P 500 set all-time highs and ended the month 2.2% higher, though the move appeared driven by more defensive sectors (see chart). The U.S. equity return also lagged other developed markets as the U.S. dollar weakened (–2.0% based on DXY). In a reversal of the recent trends where equities and bonds rallied in tandem, government bond yields across major developed economies broadly rose: The 10-year German yield rose 16 bps, the U.K. 10-year rose 14 bps, and the U.S. 10-year 3 bps. Meanwhile, credit markets were mixed over the month: Investment grade bond spreads tightened modestly, while high yield spreads appeared to price in the weaker fundamental data and widened.

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Under the Hood
U.S. equity markets hit record highs in October, surpassing the prior peak in July, as investor confidence rose on indications of progress in U.S.–China trade talks and interest rate cuts by the Federal Reserve. While the peak-to-peak story struck an optimistic tone, not all sectors participated in these fresh gains: Cyclical sectors that had led the rally through July, including financial and consumer discretionary stocks (i.e., sectors with more exposure to the business cycle), have generally lagged since then, displaced by defensive sectors like utilities and real estate – a cohort that tends to outperform in more adverse economic environments. Investors’ shift to defense may indicate a sense of unease beneath the recent market rally, particularly given weaker trends in manufacturing data, business sentiment, and private investment overall.