October was the month that equities came back. Stock exchanges across the globe had a great month, rebounding from the late summer drawdowns, with most developed market indices popping back into positive territory for the year. Even emerging market equities posted healthy gains for the month, leaving them down only 1.8 per cent year to date. Corporate credit was more mixed, with US and European high yield gaining around 3 per cent each, while global investment grade only rallied 0.6 per cent. Government bonds moved with less dispersion, but peripheral European sovereigns did outperform US Treasuries and UK Gilts. Oil prices bumped around USD 49.6 (month-end, Brent) and USD 46.6 (month-end, WTI) for most of October.
Market volatility was lower during the month, perhaps because the focus was on longer-term economic outlooks and central bank policy instead. Investors watched and waited for monetary policy announcements from the European Central Bank (ECB), the US Federal Reserve (the Fed) and the Bank of Japan (BoJ). While these central banks actually made few changes, it was the change in language and signalling that really mattered for markets.
Exhibit 1: Asset class and style returns (local currency)
Source: Barclays, Bloomberg, FactSet, FTSE, MSCI, J.P. Morgan Asset Management. REITs: FTSE NAREIT All REITs; Cmdty: Bloomberg UBS Commodity Index; Global Agg: Barclays Global Aggregate; Growth: MSCI World Growth; Value: MSCI World Value; Small cap: MSCI World Small Cap. All indices are total return in local currency. Data as of 31 October 2015.
The ECB’s Mario Draghi said the bank’s attitude towards judging whether further action was needed to achieve its objective of inflation near 2% was no longer, “wait and see, but work and assess.” Markets reacted to this outright dovishness as expected, with the euro moving down against the dollar after Draghi’s press conference. If the ECB does implement further quantitative easing (QE), the next steps would likely be to extend the QE programme past its target end date of September 2016, expand the amount purchased each month, cut the deposit rate further into negative territory—or a combination these measures.
European economic data underlined the eurozone’s recovery story. While the Consumer Price Index inched back to zero for October from 0.1% in September, unemployment hit a four-year low, falling to 10.8%. The Composite Purchasing Managers’ Index—a measure of activity in the manufacturing and services sectors—rose to 54.0 in October, above expectations and consistent with GDP growth of close to 2%. The generally positive sentiment surrounding the economy was mirrored in most asset classes. Earnings season for eurozone equities got off to a decent start, with year-on-year earnings-per-share (EPS) growth at a solid 4%. Technology, consumer staples, and financials have the strongest EPS growth so far and all sectors delivered positive top-line growth, except energy and materials.
Given the rally in European equities, a poor showing from European corporate and government bonds might have been expected. However, while UK Gilts lost a bit of their impressive year-to-date rally, Italian, Spanish and German sovereigns performed well. Additional stimulus announced by Sweden’s Riksbank, coupled with Draghi’s dovishness, sent certain eurozone government bond yields to 2H15 lows.
Exhibit 2: World stock market returns (local currency)
Source: FactSet, FTSE, MSCI, Standard & Poor’s, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency. Data as of 31 October 2015.
The Fed meeting on 28 October announced no change in rates, as both markets and economists expected. However, there were a few changes in the language of its statement. The emphasis on international concerns was reduced and the Fed also explicitly noted the possibility of increasing interest rates at the next meeting. In terms of actual growth, the US economy continued expanding through the third quarter, with 3Q15 GDP increasing 1.5% quarter on quarter (seasonally adjusted annualised rate). Inventories and trade were a headwind this quarter, but it appears the worst of the inventory drag is behind us and domestic consumption remained strong.
Exhibit 3: Fixed income sector returns
Source: Barclays, BofA/Merrill Lynch, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. IL: Barclays Global Inflation-Linked; Euro Treas: Barclays Euro Aggregate Government – Treasury; US Treas: Barclays US Aggregate Government – Treasury; Global IG: Barclays Global Aggregate – Corporates; US HY: BofA/Merrill Lynch US HY Constrained; Euro HY: BofA/Merrill Lynch Euro Non-Financial HY Constrained; EM Debt: J.P. Morgan EMBI+. All indices are total return in local currency. Data as of 31 October 2015.
Manufacturing weakness might be an area of Fed and market focus, as durable goods orders contracted 1.2% in September, mirroring weak industrial production data released earlier in the month. US housing data also looked slightly weaker in September. New home sales were lower than expected, while pending home sales fell 2.3% in the month. Rising home prices were cited as a reason for lower sales. The Employment Cost Index rose 0.6% in the third quarter, showing a gradual pick-up in wages. This stream of mixed data has made it difficult for the Fed to tick off all the boxes needed for a rate hike, making every release until its December meeting all the more important. The 10-year US Treasury yield jumped between 1.97% (the month’s lowest point in early October) and 2.17% (the month’s highest point, a day after the Fed meeting).
Exhibit 4: Fixed income government bond returns
Source: FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. All indices are J.P. Morgan GBIs (Government Bond Indices). All indices are total return in local currency. Data as of 31 October 2015.
While the timing of Fed lift-off remains uncertain, S&P 500 returns have been more dependable. The S&P 500 had its best month of the year, gaining 8.4% on a total return basis in October. Earnings momentum supported the rally: 76% of companies in the S&P 500 beat analyst EPS estimates and ex-energy EPS growth year on year was 3% in the last week of October. While half of the companies have yet to publish their statements, more than 70% of index market capitalisation has reported.
At the very end of October, the Bank of Japan postponed its time-frame for achieving 2% inflation for the second time this year. Haruhiko Kuroda kept a bullish attitude on inflation and growth, citing the low oil price as the biggest reason for the delay in reaching the 2% target. At the 30 October meeting, where some expected an announcement of further easing, the BoJ did not modify its asset purchase programme. Despite the central bank keeping additional easing on hold and mediocre earnings reports, the TOPIX rallied steadily over the month, topping the charts in year-to-date and month-to-date returns.
Chinese leaders met in the last week of October and enacted several policy changes. They are determined to manage the slowdown and we expect Chinese economic growth to stabilise near 6%. The One Child Policy has been abolished, but the economic impact will likely be limited in the short term. The Party will increase the emphasis on creating a “moderately prosperous society” by 2020, which likely means a renewed focus on fighting income inequality and improving social welfare.
Investment outlook for the rest of the year
Investors should prepare for an increase in volatility as markets adjust to US rates moving off of the zero lower bound for the first time in almost seven years, while simultaenously the ECB and BoJ might add more QE. European and Japanese equities look attractive given their supportive central banks. At the same time, US corporates head into 2016 with the previously detrimental high US dollar and low oil price challenges already factored into forecasts and business planning. Divergent monetary policies and growth prospects for large economies will continue to make a selective approach to equities and fixed income a key investment theme for the rest of the year and 2016.
Exhibit 5: Total returns from markets in October (%)
Source: MSCI, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. J.P. Morgan Government Bond Indices. Data as of 31 October 2015.