Global share markets rise
Global share markets were higher in local currency terms in November, despite a difficult start to the month. Stocks traded lower throughout much of the period amid evidence growth in the euro-zone and China is slowing, a sharp drop in oil prices and a number of notable European earnings misses.
Share markets were also impacted by ongoing geopolitical risks, including uncertainty surrounding Brexit negotiations and heightened Sino-US frictions after US Vice President Mike Pence and Chinese President Xi Jinping traded barbs at the APEC summit in Papua New Guinea.
However, sentiment turned more positive in the wake of some surprisingly dovish comments from US Federal Reserve (Fed) chairman, Jerome Powell, who conceded that interest rates are now close to neutral. These were in stark contrast to comments he made back in October, when he said interest rates were a long way from neutral. Investors interpreted Powell’s comments to mean the pace of rate hikes next year may be slower than previously anticipated.
Stocks also benefited from some encouraging third-quarter US growth data—the US Commerce Department’s latest estimate putting growth for the year ended 30 September at 3.5%—and hopes toward the end of the month that the US and China might resolve their trade spat at the G20 Summit in Argentina.
At the country level, US stocks closed the month higher; though much of the gains came later in the period after Powell struck a less aggressive tone on interest rates. Share markets were also stronger in Japan and China but fell in the UK and Europe.
The Australian share market fell in November, driven by weakness across the major miners, mixed performances from the ‘Big Four’ banks and yet another tepid inflation reading. Stocks were also impacted by further domestic political uncertainty following Labor’s landslide win against the Liberals in Victoria’s state election, evidence growth in China is slowing and heightened geopolitical risks. Limiting the decline was the Reserve Bank of Australia (RBA)’s decision to upgrade its domestic growth forecast, Powell’s dovish comments on US interest rates and late hopes of a resolution to US-China trade frictions ahead of the G20 Summit.
Interest rates on hold
The RBA left the official cash rate on hold at a record low 1.50% in November, with officials remaining cautiously optimistic without showing any urgency to deviate from current policy. In its post-meeting statement, the bank said it now expects domestic growth to average around 3.5% this year and next; up from its previous forecast of a bit above 3.0%. Officials also noted that the labour market remains positive and that inflation, which is at the lower end of the RBA’s 2-3% target range, is expected to be higher in 2019 and 2020 than it is now.
Meanwhile, the outlook for household consumption remains a concern, with growth in household income low and debt levels high. The RBA concluded its meeting by saying that “taking account of the available information, the Board judged that holding the stance of monetary policy unchanged… would be consistent with sustainable growth in the economy and achieving the inflation target over time.”
At Russell Investments, we expect the RBA will raise interest rates in the second half of next year as wage and price inflation rises further. At the time of writing, the market is pricing in around a 44% chance of a rate hike by the end of 2019.
Australian dollar rallies
The Australian dollar (AUD) made strong gains in November; the local unit rising on the back of the RBA’s decision to upgrade its growth forecasts, some encouraging domestic jobs data and Powell’s dovish comments. The AUD also benefited from hopes of a resolution to US-China trade frictions ahead of the much-anticipated meeting between US President Donald Trump and his Chinese counterpart Xi Jinping at the G20 Summit.
Limiting the AUD’s advance were lower commodity prices, further domestic and global political uncertainty, and another soft inflation reading. Further evidence Chinese growth is slowing also weighed on the currency.
The AUD rose 3.4% against the Japanese yen, 3.3% against the US dollar (USD), 2.8% against the euro and 2.7% against the British pound. The broader Australian Trade-Weighted Index1 closed the month 2.3% higher.
We expect volatility to continue through the rest of 2018 and into next year, as investors contend with US policy agenda, potential further US rate hikes, and potential normalisation of monetary policy outside the US. Geopolitical uncertainty poses a further risk, with investors shifting their attention to the threat of trade wars. Acts of retaliation, particularly from China, already have had negative impacts on emerging markets. The spectre of trade war escalation and the potential impacts on global growth will need to be watched closely.
Relative to the US, we still believe other developed markets represent better value. Whilst Europe has significantly underperformed this year, we maintain the view that European equities are fairly valued. Although European corporate earnings have slowed and political risks are rising, we nonetheless expect European economic growth to rebound into next year as transient negative factors, such as a reduction in car production after a change in environmental regulations, begin to dissipate.
The risk from Italy has become greater over the past few months, with a draft 2019 budget poorly received by markets. Whilst there could be further headwinds in the near-term, we believe a more benign resolution will be found as 2019 progresses.
Emerging markets assets have weakened significantly due to a stronger USD and trade frictions. Momentum from positive corporate earnings has slowed, but resilient economic growth means emerging markets still offer attractive long-term value relative to their developed peers. Geopolitical risks remain along with the threat of tighter US monetary policy, additional USD strength and further trade war escalation. With equity markets remaining expensive late-cycle, a cautious approach is warranted; particularly given the uncertainty around the pace of Fed rate hikes and global trade issues.
Our base case is for the Fed to raise interest rates once more in December, and at least three times in 2019. Our more hawkish outlook has been driven by a reacceleration of wage growth along with strong data from US business surveys that show healthy manufacturing confidence.
We feel bonds remain expensive and may face headwinds in the form of potential rising inflation and higher US yields, especially given that the US labour market is tight. Any selloff in bonds could be amplified if the Fed decides to raise interest rates at a faster pace than expected, and if global central banks shift away from their accommodative monetary policy stances.
We hold an unfavourable view on high-yield debt, as valuations have become stretched given the compression in credit spreads to near-historical lows. Conversely, we favour local currency emerging markets debt, with fundamentals remaining strong. However, we acknowledge that the prospect of tighter monetary policy may present increasing challenges across the emerging markets complex.
In terms of currencies, the USD has staged a recovery in 2018, driven by interest rate differentials between the US and the rest of the G10. The strength of US growth relative to the rest of the world will continue to have implications on USD movements. We see continued upside for the USD versus other G4 and commodity currencies given our view on the Fed’s rate path into 2019. However, an expensive valuation and stretched market positioning is likely to limit the medium-term upside for the greenback.
We continue to favour the Japanese yen, which is not only cheaply valued but also has ‘safe haven’ properties due to its strong negative correlations with global equity returns. The AUD has suffered this year, driven by the widening US-Australian bond yield differential and the geopolitical risks negatively impacting China and other emerging markets. The future direction of the AUD is likely to continue to be influenced by these factors, as well as commodity price movements.
Overall, we expect global growth to remain modestly positive into next year, with downside risks of further selloffs as markets continue to adjust to potentially higher levels of interest rates and changes to global trade policies. Importantly, we believe financial markets will continue to provide further investment opportunities for our active management approach.
1The trade-weighted index for the AUD is an indicator of movements in the average value of the AUD against the currencies of our trading partners.