Last week was a strong one for risk assets, with equity markets leading the way. Most equity markets were up by 2.5%; in fact, the US equity market is back to the year’s highs. The standout performer was Japan, which reached a seven-year high, up 7% on the week. There was also a surprise announcement from Japan, which is increasing its quantitative easing programme substantially and including the purchase of equities within that. The announcement surprised the market, pushing equities higher and weakening the yen. Combined with that, Japan’s Government Pensions Investment Fund announced a significant increase in its weighting to Japanese equities – from 12% to 25%. This fund is at $1.2 trillion – the largest pension fund in the world – giving scope to add significant new exposure to equities. This supported the move by the Bank of Japan (BoJ) on the quantitative easing side, resulting in very strong performance from Japanese equities.
Elsewhere, in bond markets, US Treasuries ended five basis points (bps) higher in yield, at 2.34%; in the gilt market, yields were flat over the week, with 10-year gilts around the 2.25% mark. Corporate bonds were stronger over the week; yield spreads to government bonds were narrower, in line with the rally that we saw in equities.
The stronger dollar theme continued, particularly versus the yen after the aforementioned move by the BoJ, where the dollar strengthened 3.5%. Elsewhere, commodities remained under pressure, particularly oil, which briefly dipped below $80 per barrel during the week. Gold was also weaker by about 5% as investors continued to move away from precious metals.
The future looks bright in the US
So the obvious question is: given the nervousness we’ve seen over the last couple of weeks and during the middle of October, what has changed? Firstly, we think the BoJ’s actions are very positive on the liquidity side for markets – but that happened on Friday, and markets were already rallying before then. So there is clearly something else at play? Turning to the macroeconomic data: it was positive in the US and this clearly benefited markets. We saw third-quarter GDP data coming in better than expected, up 3.5%. The last two quarters of economic data in the US represent the strongest back-to-back GDP gains since 2003. On the employment side, the situation in the US continues to be very supportive, with fewer Americans having filed for unemployment than at any time in more than 14 years. The unemployment rate is now below 6%. So the economic backdrop of the US is currently supportive of markets. Additionally, we are in the middle of the earnings season, and again are seeing some positive surprises. Within the S&P 500, we’ve seen over 70% of companies reporting, and in terms of performance versus expectations, 60% of those companies have beaten sales estimates and 80% have beaten on earnings.
The picture in Europe is less supportive, but you would expect that to be the case. The economic backdrop remains subdued. Markets continued to digest the results of the European Central Bank’s (ECB) asset quality review, where over 130 banks were reviewed in depth and tested against various economic scenarios. Only nine of those were seen as needing to raise further capital, and most of those were quite small banks. So markets seem to be taking some comfort over that. And while there are some questions regarding the toughness of the scenarios that analysis was conducted under – there was no deflation scenario, for example – it seems that markets are taking some reassurance that substantial amounts of capital are not required at this stage in terms of boosting banks’ balance sheets. This it does give considerable clarity about the state of play within the European financial system. In fact, some of the ECB’s data on lending continued to be modestly positive.
All in all, it was a good week for markets. But what happens looking forward? There will be a lot of data out this week: in the US, we will see the ISM survey and employment; within Europe, we have retail sales and an ECB meeting; and in the UK, we have manufacturing purchasing managers’ indexes and Halifax house prices, as well as industrial production and a Bank of England (BoE) meeting.
It’s worth noting is that we do not expect anything from either the ECB or the BoE this week. There will be a continuation of the earnings season in both the US and Europe, and there is scope for positive surprises there. In terms of market outlook, we are seeing significant flows coming back into equities, which do have the potential to continue further. We are now getting into the tail end of the year, so there is a question mark over the extent to which investors are willing to increase any risks they’re taking so late in the year. So the macro and the earnings backdrops should continue to be supportive on funds flowing back in, which could push equity markets higher. But at this stage in the year, it’s difficult to see that going significantly further, given investor sentiment.