Markets continue to adjust to Fed policy and inflation readings – will third quarter earnings help? Find out more in this edition of “The Week in Review.”
Last Week Review
Early fourth quarter global equity decline persists. All major regions finished the week with declines as rising U.S. bond yields continued to pressure equities1. U.S. equities struggled the most, returning -4.2%2 followed closely by non-U.S. developed market equities (-4.0%)3. Emerging market equities performed best of the major regions but still dropped 2.2% from the prior week4. Global equities (-1.5%) are now back in negative territory year-to-date5 with continued separation between U.S. equities (4.6%)6 and non-U.S. developed markets (-7.2%)7 and emerging markets (-13.9%)8. Finally, the 10-year Treasury yield (3.16%) sits 31 basis points above the 2-year yield (2.85%)9.
Markets continue to adjust around the Fed policy outlook. Federal Reserve (Fed) Chair Jerome Powell’s hawkish comments in the first week of October led to higher rates that continued into last week with the 10-year Treasury touching a 7-year high of 3.26%10. The Fed’s optimism on U.S. economic growth brought forth concerns about the end of easy global monetary policy. This pushed rates higher and worried investors that the economy was moving toward the late stages of the business cycle. Deteriorating trade between the U.S. and China as well as earnings concerns have also contributed to the equity market weakness. Even though global equities finished on a positive note last Friday11, the gains actually followed a 6-day losing streak that left global equities still down -5.5%12 during that time frame.
U.S. inflation comes in soft. September’s inflation data as measured by the Consumer Price Index (CPI) at the headline level fell below last month’s reading and surveys to 2.3% year-over-year (y/y). Core CPI matched August’s reading but also fell below consensus at 2.2% y/y. Shelter, one of the largest CPI components, increased at a slower rate than August, contributing to the large drop from headline CPI’s 2018 peak last month. Germany headline CPI was in-line with expectations and saw a sizable uptick from last month’s reading of 2.0% y/y to 2.3% y/y. The European Central Bank (ECB) will look for gradual increases in inflation from other European countries as it looks to begin hiking rates after the summer of 2019.
Tech stocks decline heading into earnings season. Technology stocks dropped 4.8% last Wednesday13 – the sector’s worst trading day since 201114. After being a strong contributor to the post-crisis bull market, we believe the tech sector is starting to see pressures on valuations from higher interest rates. Aggregate earnings growth (20.1% y/y) currently tops the pre-earnings season estimate of 19% y/y, while revenue growth stands at 7.4% y/y.15
This Week Preview
Third quarter earnings season continues. In addition to impacts from tariffs, we believe cost pressures across commodities, labor and logistics could be difficult for companies to pass on to the end customer. Investors will closely follow how these pressures impact corporate margins as earnings season continues. The financials and health care sectors could be a focus this week.
Global inflation expected to remain relatively stable. Inflation figures from Europe, Japan, and China will be posted throughout the week. Europe’s headline (2.1% y/y) and core (0.9% y/y) CPI readings are expected to be in-line with their respective prior levels. Japan consensus estimates show a stable pattern as well for headline (1.3% y/y) and core (0.4% y/y) inflation. After an uptick in August, UK headline and core CPI are both expected to decrease to 2.6% y/y and 2.0% y/y, respectively. Finally, consensus data shows an uptick in headline CPI for China to 2.5% y/y.
September Fed meeting minutes will be released. We believe investors will look for clarity on the Fed’s plan for monetary policy normalization after Fed Chair Powell’s hawkish comments in early October. After a difficult start to the fourth quarter for equity markets, investors will look for any updates on Fed leaders’ thinking around future policy. The Fed currently expects to hike four more times through the end of 201917.
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Unless otherwise noted, all opinions expressed in this post are those of the author and do not necessarily represent the views of Northern Trust. Information contained herein is current as of the date appearing only and is subject to change without notice.
1)Bloomberg, MSCI U.S. Equities IMI Index, MSCI ex-U.S. Equities IMI Index & MSCI Emerging Market Equities Index returns 08Oct2018 – 12Oct2018.
2) Bloomberg, MSCI U.S. Equities IMI Index return 08Oct2018 – 12Oct2018.
3) Bloomberg, MSCI ex-U.S. Equities IMI Index return 08Oct2018 – 12Oct2018.
4) Bloomberg, MSCI Emerging Market Equities Index return 08Oct2018 – 12Oct2018.
5) Bloomberg, MSCI World Index return 02Jan2018 – 12Oct2018.
6) Bloomberg, MSCI U.S. Equities IMI Index return 02Jan2018 – 12Oct2018.
7) Bloomberg, MSCI ex-U.S. Equities IMI Index return 02Jan2018 – 12Oct2018.
8) Bloomberg, MSCI Emerging Market Equities Index return 02Jan2018 – 12Oct2018.
9) Bloomberg, In this analysis we are making a comparison between the difference of the 2-Year nominal Treasury rates versus the 10-Year nominal Treasury rates using data available as of 12Oct2018. Basis Point (BPS) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument.
9) Bloomberg, In this analysis we are making a comparison of the 10-Year nominal Treasury rates using data available as of 01Jan2011 – 12Oct2018.
10)Bloomberg, MSCI World Index return as of 12Oct2018.
11)Bloomberg, In this analysis we are making a comparison of the MSCI World Index returns using data available as of 05Oct2018 – 12Oct2018.
12) Bloomberg. S&P 500® Technology Index performance 10Oct2018. Comprising those companies included in the S&P 500 that are classified as members of the GICS® technology sector. The Global Industry Classification Standard (GICS) is an industry taxonomy developed in 1999 by MSCI and Standard & Poor's (S&P) for use by the global financial community. The GICS structure consists of 11 sectors, 24 industry groups, 68 industries and 157 sub-industries into which S&P has categorized all major public companies. GICS is used as a basis for S&P and MSCI financial market indexes in which each company is assigned to a sub-industry, and to a corresponding industry, industry group and sector, according to the definition of its principal business activity.
13) Bloomberg. In this analysis we are making a comparison of the S&P 500® Technology Index performance using data available as of 02Jan2011 - 12Oct2018.
14) Thomson Reuters. S&P 500 Earnings Dashboard. Retrieved 05Oct2018 from http://lipperalpha.financial.thomsonreuters.com/2018/10/sp-500-17q1-earnings-dashboard/.
15) Bloomberg. In this analysis we are making a comparison of the MSCI World Index returns 01Oct2018 – 12Oct2018.
16) Bloomberg, Fed Funds Futures Index 12Oct2018. Fed funds futures are used by banks and fixed-income portfolio managers to hedge against fluctuations in the short-term interest rate market. They are also a common tool traders use to take speculative positions on future Federal Reserve monetary policy.
Past performance is no guarantee of future results. It is not possible to invest directly in any index and index performance returns do not reflect any management fees, transaction costs or expenses.