MARKETS & ECONOMY | 30/10/2020
Stocks suffer biggest drop since March
Equities suffered their worst weekly declines since March, as the resurgence in the coronavirus and election uncertainty weighed on sentiment. With the narrow exception of the S&P 500 Index, the major benchmarks fell into correction territory on Friday morning, or down over 10% from recent highs. The declines were broad-based, but information technology and consumer discretionary shares fell the most within the S&P 500. The small utilities, materials, and real estate sectors held up best, while the Cboe Volatility Index (VIX) reached its highest level since early June.
The week started off on a down note, with concerns over steeply rising coronavirus case counts in Europe and the U.S. weighing heavily on sentiment. Traders noted that waning stimulus hopes also appeared to be a headwind despite already low expectations for a pre-election deal. On Tuesday, shares fell further as data showed COVID-19 hospitalizations had risen at least 10% in the past week in 32 states and the nation’s capital. The pullback continued on Wednesday, as investors appeared to react to new shutdown measures in Europe. The accelerating coronavirus case count seemed to overshadow some positive vaccine news during the week, with AstraZeneca reporting early data showing that its vaccine candidate produced a robust immune response in elderly people.
Upbeat data cushion losses
The week’s economic data contained some positive surprises and may have limited the declines. Stocks snapped their losing streak on Thursday, seemingly helped by news that U.S. gross domestic product (GDP) had increased at an annualized rate of 33.1% in the third quarter, above consensus expectations of around 31%. Investors also seemed encouraged by weekly jobless claims, which came in lower than forecast and reached a new pandemic low. Continuing claims were more in line with expectations but continued to fall sharply, from 8.5 million to 7.8 million. Earlier in the week, the Commerce Department reported that durable goods orders had risen more than expected (1.9%) in September, with core capital goods (excluding defense and aircraft) orders reaching a six-year high. Regional manufacturing surveys also indicated improving factory activity. Personal income and spending both rose more than expected in September, but gauges of October consumer sentiment were mixed.
Macroeconomic and political concerns seemed to dominate sentiment even though the week marked the peak of third-quarter earnings reporting season—180 of the S&P 500 companies were expected to report earnings during the week, according to Refinitiv. Thursday evening brought the release of reports from tech and internet giants Apple, Amazon, Alphabet (parent of Google), and Facebook. Each beat consensus earnings and revenue estimates, but all except Alphabet fell in trading Friday. Apple, in particular, weighed on the benchmarks as investors appeared disappointed by iPhone sales.
Yields rise on falling jobless claims
Longer-term Treasury yields declined early in the week as surging coronavirus cases in Europe and the U.S. magnified uncertainty about the economic recovery. On Thursday, however, yields largely retraced earlier moves on better-than-expected economic data. The broad municipal bond market posted modest gains through much of the week. Large levels of new issuance persisted, as October was on pace to set a record for one-month supply, but Traders noted that new deals performed reasonably well. In credit-specific news, Fitch Ratings revised its outlook on Chicago general obligation bonds to negative from stable, while maintaining a rating of BBB-, and New York’s Metropolitan Transportation Authority submitted notice of intent to borrow USD 2.9 billion through the Federal Reserve’s Municipal Liquidity Facility.
Investment-grade corporate bond spreads—the extra yield offered over Treasuries, and an inverse measure of the sector’s relative appeal—moved wider, led by energy sector credits amid declining oil prices. Surging coronavirus cases, fiscal stimulus uncertainty, and the upcoming presidential election weakened macro sentiment. Nevertheless, increasing volumes and balanced flows contributed to a healthy technical backdrop, and new deals were well subscribed.
Equity losses weigh on high yield bonds
Falling stock prices and uncertainty about the timing of U.S. fiscal stimulus weighed on the performance of high yield bonds. Credit spreads widened across all rating tiers, and below investment-grade funds reported outflows. Our traders noted that increased selling by exchange-traded funds contributed to high yield market weakness.
Shares in Europe tumbled the most since their March swoon, as investors worried that lockdowns aiming to control the coronavirus’ spread could push the eurozone economy into a double-dip recession. Political uncertainty in the U.S. also weighed on sentiment. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 5.56% lower, while Germany’s DAX Index dropped 8.61%, France’s CAC 40 lost 6.42%, and Italy’s FTSE MIB slid 6.96%. The UK’s FTSE 100 Index declined 4.83%.
Core eurozone bond yields fell on the week. The yield on Germany’s 10-year sovereign bonds declined, as the country and France reintroduced national lockdown restrictions to combat rising coronavirus cases. Dovish messaging from the European Central Bank (ECB) after its policy meeting on Thursday also helped to support prices and compress yields on core eurozone bonds. Peripheral bond yields fluctuated. Yields in Spain and Italy drifted higher early in the week, as investors shied away from risk; however, yields on these bonds moved lower after the ECB reiterated its commitment to easier monetary policy. UK gilt yields followed their developed market counterparts lower.
France and Germany impose lockdowns
The major European countries implemented stricter measures to contain the coronavirus epidemic, although many businesses and schools will remain open, which could soften the hit to economies. In a televised speech, French President Emmanuel Macron ordered a nationwide lockdown until December, with limitations on outdoor movement and mandatory working from home. Germany also announced sweeping restrictions, shutting bars, restaurants, and theaters for a month. Spain extended a state of emergency for six months, enabling the regions to curb residents’ mobility, impose curfews, and shut their borders. Italy ordered bars and restaurants to stop serving in the evening and closed gyms, swimming pools, cinemas, and theaters. Greece ordered Thessaloniki, its second-biggest city, and two other regions to move into lockdown. In the UK, where the government came under pressure to impose a nationwide lockdown, the strictest, tier-3 containment regime was extended to Nottinghamshire and West Yorkshire.
ECB keeps policy unchanged, says “risks clearly tilted to the downside”
The ECB left its monetary policy unchanged, keeping its deposit rate at -0.5% and its emergency bond-buying program at EUR 1.35 trillion. The ECB said risks were “clearly tilted to the downside” and promised to carry out a “thorough reassessment of the economic outlook and the balance of risks” and to “recalibrate its instruments, as appropriate, to respond to the unfolding situation” in December. The ECB said it would “ensure that financing conditions remain favorable to support the economic recovery and counteract the negative impact of the pandemic on the projected inflation path.” And, in an indication of which factors might influence its decision, the ECB stated that it would “carefully assess the incoming information, including the dynamics of the pandemic, prospects for a rollout of vaccines, and developments in the exchange rate.”
Eurozone economy rebounds but deflation continues
The eurozone economy rebounded more strongly than expected in the third quarter, although growth was still below the levels seen last year, preliminary official data showed. Eurostat estimated that GDP grew 12.7% after contracting 11.8% in the second quarter. The German and Spanish economies expanded at record rates and faster than expected. Consumer prices fell 0.3% year-on-year for a second consecutive month, in line with consensus expectations. A sharp drop in energy costs exceeded price increases in alcohol, food, and tobacco.
Japanese stocks finished lower for the week. The Nikkei 225 Stock Average declined 2.29% (539 points) and closed at 22,977.13. The widely watched market yardstick lost ground in October and has declined about 2.9% for the year-to-date period. The large-cap TOPIX Index and the TOPIX Small Index, broader measures of Japanese stock market performance, also recorded negative results. Worsening coronavirus numbers in the U.S. and Europe weighed on sentiment, and some quarterly earnings reports released late Thursday seemed to disappoint investors and sparked a sell-off at the end of the week.
Yen strengthens in risk-off environment
The yen strengthened modestly versus the U.S. dollar and traded at about JPY 104.5 per U.S. dollar on Friday. Both the yen and the greenback benefited from increasing demand during the risk-off environment and were stronger compared with broader measures of global currencies.
Despite the yen’s recent strength, economist, do not believe that the currency has reached levels where it is likely to weigh heavily on the Japanese economic recovery. However, in his view, if the yen continues to appreciate and trades below JPY 100 per U.S. dollar, it could pose a risk to the export sector. According to Kumar, the Bank of Japan (BoJ) has signaled that it is not worried about the recent appreciation and the bar for action remains high. He doesn’t expect any policy action from the central bank unless the currency strengthened to the JPY 95 per U.S. dollar level over a short period.
Bank of Japan lowers short-term forecast as recovery continues
At its October meeting, the BoJ lowered its growth outlook for the remainder of fiscal year 2020 (which ends in March 2021). The central bank said that a recovery in demand for services may take longer than it forecast in July, but the policymakers revised their growth outlook higher for fiscal 2021. The BoJ’s statement also noted that inflation is expected to be negative in the near term as a result of the pandemic.
As expected, the central bank kept interest rates unchanged at the meeting. The BoJ’s short-term policy rate is set at -0.1%, and the bank said it will continue to purchase 10-year Japanese government bonds (JGB) to keep the longer-term benchmark close to 0%. At the end of the week, JGBs were trading at 0.04%.
Retail sales, industrial output remain below 2019 levels
Economic data released during the week showed the continuing impact of the pandemic. Retail sales fell 8.7% in September compared with last year, marking the seventh straight month that the number has fallen short of 2019 results. Industrial output also remained below last year’s level but, on the positive side, increased 4% from August—the fourth month in a row of improvement.
Chinese stocks fell in sympathy with the downturn on Wall Street, with the benchmark Shanghai Composite Index declining 1.6% and the large-cap CSI Index shedding 0.5%. The yield on the 10-year sovereign bond ended flat at 3.20%, and the dollar-renminbi currency exchange rate stayed broadly stable. In currency news, the People’s Bank of China (PBOC) asked domestic banks to suspend the use of a so-called countercyclical factor (CCF) in fixing the renminbi’s daily midpoint against the U.S. dollar, Reuters reported. The CCF—which is an adjustment made by contributing banks to influence the value of the yuan—was introduced in 2017 as a tool to dampen excessive currency volatility. The PBOC’s move to neutralize the CCF was interpreted as allowing the renminbi, which is tightly managed by the central bank, to become more market-driven.
Politics were in focus as China’s Communist Party held its fifth plenum in Beijing from October 26–29, during which party leaders outlined their 14th five-year plan for the country’s longer-term economic and social development. Guidelines for the latest plan focused on sustaining higher-quality growth through encouraging innovation and reform. Party leaders also released modernization targets for the next 15 years until 2035, including raising China’s per capita GDP to the level of “moderately developed countries,” reported state-run media. Beijing has eyed boosting domestic demand, upgrading supply chains, and seeking self-sufficiency in key technologies as ways to hedge against external uncertainties, including what it sees as an increasingly hostile U.S. Overall, however, the fifth plenum press release offered few policy specifics.
On the economic front, Beijing reported that industrial sector profits climbed roughly 10% in September from a year earlier, driven by strong growth in computer and other electronic equipment manufacturing. Though year-to-date cumulative profits growth is negative owing to the first quarter’s coronavirus-driven plunge, the rebound in profits at large industrial enterprises is noteworthy. However, a quarterly survey of small to medium-sized enterprises revealed that private manufacturers remain cautious and reported low inclination to borrow or invest, despite signs of recovery in profitability and orders.
In corporate news, Chinese fintech company Ant Group geared up for its mega initial public offering (IPO). The company, an offshoot of Chinese e-commerce giant Alibaba, aims to raise around USD 35 billion through selling an 11% stake in a dual Hong Kong-Shanghai listing in what promises to be the world’s largest IPO, exceeding Saudi Aramco’s USD 29 billion sale last year. In addition to Ant’s potential to shake up the traditional, bricks-and-mortar banking industry, the deal is a sign of China’s status as a leader in “new economy” areas, as well as the attractiveness of Chinese companies to global investors even at a time of rising anti-China sentiment in the West
Other Key Markets
Turkish stocks, as measured by the BIST-100 Index, returned -6.6%. The market was closed on Thursday for the Republic Day holiday, which commemorates the founding of the Turkish republic in 1923.
While weakness in world markets created a generally unfavorable backdrop, geopolitical developments weighed on Turkish assets and sent the lira to new all-time lows versus the U.S. dollar. For example, Turkey’s confirmation that it recently tested the S-400 missile defense system that it acquired from Russia in 2019 further strained Turkey’s standing with the U.S. and other NATO members. In response to the test, the Trump administration warned that Turkey is risking serious damage to its security relationships and potential sanctions from the U.S. News that a U.S. consular employee was convicted of terror charges also raised the risk of sanctions and greater tensions with the U.S.
Concerns about domestic inflation also weighed on Turkish assets. On Wednesday, the central bank of Turkey raised its year-end 2020 inflation target to 12.1%, which is more than 300 basis points (three percentage points) higher than its previous expectation. This reflects factors such as the effect of lira weakness on import prices and elevated food inflation. T. Rowe Price sovereign analyst believes that the change in the inflation outlook all but assures that the central bank will need to pursue further monetary tightening. However, there is no guarantee that the central bank will pursue an orthodox policy response, such as tightening only the one-week repo rate, to temper inflation. He believes that a continuation of unorthodox practices, such as using multiple liquidity channels to push “effective” funding costs higher, would be less helpful.
Stocks in Chile, as measured by the IPSA Index, returned -7.1%. Shares were dragged lower by weakness in world markets, as well as concerns that a second Chilean pension withdrawal bill, if it becomes law like one that took effect in August, could result in more outflows from the equity market.
On Sunday, October 25, the country held a national plebiscite—a referendum in which citizens voted either for or against the drafting of a new constitution to replace the one that has been in place since the Augusto Pinochet dictatorship. Chileans overwhelmingly voted for a new constitution, with about 78% approving and 22% rejecting. The question of which parties would draft the new basic law was similarly split. About 79% voted in favor of a 100% popularly elected constituent assembly versus 21% for a mixed constitutional convention in which half of the delegates would be popularly elected and the other half would be current legislators. Delegates to the convention will be elected in April 2021 in conjunction with regional elections and given up to a year to write a new constitution. Once drafted, the new constitution would need to be passed by two-thirds of the constituent assembly and voted for by citizens in an exit referendum. Emerging markets sovereign analyst Aaron Gifford notes that while he was not surprised by the general outcome, the margin of approval for the new constitution and the constituent assembly was larger than he expected.