Equities continued to sell off – weekly update 12 February

US equity market entered correction territory

It was another very volatile week in the markets which saw the US equity market officially enter correction territory – a somewhat arbitrary measure, meaning the market fell more than 10% from its recent highs. The sell-off was broad-based and lacked a clear driver, though this did not stop many commentators from trying to assign blame.

The scale of the move was enough to wipe out two short-volatility products – complex strategies designed to make money as long as markets remain calm – which had around US$2 billion of assets before the market rout. The impact of these fund closures was negligible for the market as a whole, but is yet another example of how complacent markets had become.

Higher volatility is actually a more natural state in the markets, and whilst it might not seem it in the short term, it is actually a healthy sign for markets. See our CIO’s note for more on our reaction to this recent volatility.

The Bank of England left monetary policy unchanged

The Bank of England (BoE) left monetary policy unchanged as expected, but the supporting output was relatively hawkish. In its quarterly inflation report, the Bank upgraded its GDP forecasts given the strong global economic backdrop, though interestingly forecasts for productivity growth were trimmed.

The full year GDP forecast for 2018 rose by 0.2% to 1.8% and by 0.1% to 1.8% for 2019 whilst the forecast for 2020 was unchanged at 1.7%. In the statement, the Bank made reference to growth in wages and unity labour costs, which may help the economy but could act as a drag on corporate earnings.

No change in inflation forecast, but a clear change in stance

Although there was no change to the inflation forecast, there was a clear change in the Bank of England’s stance, with the Monetary Policy Committee less patient over the timeframe for inflation normalisation than it was at the end of last year.

With the statement reading that “monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period”, UK gilt yields sold off, and expectations for the next rate hike shifted forward to May.

Last week’s other events

• UK industrial production was flat in December, falling short of forecasts for 0.3% year-on-year (yoy) growth and down from 2.5% in November, however this number was distorted by the closure of the Forties pipeline
• Manufacturing Production was 1.4% yoy, down from 3.5% previously but ahead of the 1.2% forecast. The Services PMI reading fell 1.2 points to 53.0 (54.1 was expected)
• China’s Services PMI from Caixin showed an improvement from 53.9 to 54.7 (53.5 was expected), whilst the trade data showed imports surged to 36.9% yoy, from 4.5% (10.6% was expected), dwarfing the 11.1% growth in exports, from 10.9% (10.7% expected)
• Eurozone retail sales rose in line with expectations, at 1.9% yoy in December, down from 2.8% previously
• In Japan, Services PMI rose from 51.1 to 51.9 in the January survey. The Leading Index of economic sentiment cooled from 108.3 to 107.9 (108.1 expected), whilst the Eco Watchers Outlook Survey softened from 52.7 to 52.4 (53.6 was expected), and Bank Lending (excluding trusts) rose at 2.3% yoy, from 2.4% in December

The markets

It was another tough week for equities, though bonds were more range-bound compared to the week before.

Equities

Equity markets were down again last week with significant intraday swings as well. Of the main developed market regions, Japan had the toughest time, as the TOPIX index fell -7.1% on the week. The US was down -5.1% on the week after bouncing on Friday. On this side of the Atlantic, the UK fell -4.5% and Europe ex-UK was down -5.0% (all as measured by the MSCI indices). The MSCI Emerging Markets index was down -6.4% on the week.

Bonds

In contrast to the week before, core sovereign bond yields were relatively directionless during the course of the week, albeit with a reasonable amount of volatility. 10-year gilt yields finished 1 basis point (bp) lower to 1.57%, whilst the equivalent US Treasury yield was 1 bp higher to 2.85%. German 10-year bund yields were down 2 bps to 0.75%.

Commodities

The broad commodity complex continued to sell off through the week. The price for Brent Crude Oil fell by US$5.79 to US$62.79 per barrel, whilst gold slipped to US$1,316.65 per ounce. Copper weakened to US$3.03 per lb.

Currencies

Sterling was weaker through the week, whilst most other currencies stayed relatively stable. Sterling ended the week at US$1.38, €1.13 and ¥150.

The week ahead

With attention acutely focused on inflation at the moment, the prints this week will be especially closely watched. UK CPI inflation on Tuesday is expected to have cooled from 3.0% to 2.9% yoy, with US CPI reported on Wednesday forecast to be 0.2% lower at 1.9% yoy. It would be fair to expect a significant market reaction if there are any surprises in these numbers. There are also some other core economic data releases next week, including Eurozone Industrial Production on Wednesday (4.2% month on month (mom) from 3.2% expected), US Retail Sales also on Wednesday (0.2% mom from 0.4% expected), US Industrial Production on Thursday (0.2% mom from 0.9% expected) and UK Retail Sales on Friday (2.5% yoy from 1.4% expected). The daily breakdown is as follows:

Monday: China reports the latest money supply growth in the morning. In the afternoon, the US budget statement is expected to be used by President Trump to launch his new infrastructure spending plan.

Tuesday: UK CPI inflation (covered above) will be interesting to watch in the morning, and then in the afternoon we have the Japanese GDP for the fourth quarter (a slowdown from 2.5% to 1.0% annualised quarter on quarter is expected).

Wednesday: Eurozone industrial production in the morning (covered above) will be released alongside the second estimate for Eurozone GDP. The main event is in the afternoon with US CPI data being released. As well as the headline data, covered above, the Core CPI measure, which excludes food and energy, is expected to have slowed 0.1% to 1.7% yoy. In the evening, Japan reports Core Machine Orders, with 1.8% yoy expected for December, from 4.1% in November.

Thursday: The EU trade balance is reported in the morning. In the afternoon, there is a slew of data from the US – aside from the Industrial Production data mentioned above, the US will also report PPI, jobs claims, the Philadelphia Federal Reserve Business Outlook, Capacity Utilisation and Consumer Comfort data from Bloomberg among other releases.

Friday: Aside from UK Retail Sales, the end of the week also gives us Import and Export Price data from the US, Housing Starts and economic sentiment measures from the University of Michigan.