Economic Summary for the week ended 17th Dec 2014

Market movements

Last week was a very poor week for equity investors. Around the world, there were signs of slowing growth: weak data from China; multiple downgrades of global oil demand accompanied by further declines in prices; more stringent collateral requirements in China; and renewed angst over European politics. The dichotomy between the US and other countries was sharply represented this week by fund flows, with US exchange-traded funds gathering $2.5 billion of inflows, while those in Europe saw $1.6 billion of outflows. It was a particularly poor week for equity investors in Europe, led by the Greek stock exchange, as there is potential for the Syriza Party to triumph in a series of presidential elections, which start on 17th December. The Greek stock market plunged 18.6% on the week, and Greek bonds sold off. Other equity markets in Europe were also weak as the potential risk to global growth suggested by the declining oil price led to people fleeing those markets in anticipation of earnings downgrades.

In spite of a still-resilient economy, US assets are demonstrating that they’re not immune to the global slowdown. The S&P 500 traded down to a five-week low, with technology and energy leading the way down. Volatility, as measured by the VIX index, rose above the 20 threshold for the first time since October. This increase in volatility was consistent with the further widening of credit spreads, which are now at their highest level since June 2013. The sell-off in high yield has been largely driven by growing concern over energy issuers. Indeed, since the OPEC meeting at the end of November – when no cut in the quota was suggested – we’ve seen the spread on energy stocks rise by 260 basis points. The oil price is the central topic of the moment. Is it the canary in the coal mine, warning us about global growth declining, or is it actually a stimulus to global growth? It’s probably a bit of both in that we’re seeing reductions in energy intensity in a number of countries (China, in particular), but we would expect there to be some activity boost from consumers, who are now finding it cheaper to fill up at the pump. And that is the dilemma that investors find themselves in, because bond markets are rallying strongly: last week, US 10-year Treasuries touched 208, which is the lowest level in over a year, and government bond markets in Europe also rallied.

Another big event of the week was the re-election of Prime Minister Shinzo Abe in Japan; the market will now be looking for an acceleration of institutional and structural reform over the next few months. However, it must be said that investors are a bit nervous as we head into year end. A couple of important things to look out for this week: firstly, as mentioned, there will be a Greek parliamentary vote for a new president, the final round of which will be held on 30 December. If the Syriza Party should prevail, we will need answers to the following questions: will they pull out of the euro? (They’ve said that they will not.) Will they renegotiate or ignore Greece’s International Monetary Fund payments and loans? (In terms of austerity, almost certainly, yes.) And would that be a crack in the eurozone’s recovery? Our view is that while there are some extreme parties in Europe, this is an unusual case, because Greece has suffered more than most in terms of the aftermath of the crash. The decline in European assets has as much to do with the falling oil price and the time of year, but there are concerns that the Greek presidential election will set off a kind of snowball effect. The other thing that spooked people about Europe last week was the relatively small take-up of the European Central Bank (ECB)’s targeted long-term refinancing operations. Investors still hope for quantitative easing involving sovereign-bond purchases by the ECB in the first quarter of 2015. Otherwise, as we head into year-end, Wednesday will be an important day, with the Federal Open Market Committee’s last meeting of the year. All eyes will be on the language of their statements regarding, specifically, whether they remove the reference to not changing rates for a “considerable” amount of time. Also, purchasing managers’ indices across Europe will give us a sense of how flat that economy is.

There is a hangover from this party; it’s being felt in high-yield markets & leveraged-loan markets most of all

It’s important, with regards to economic policy, to look beyond the stream of economic releases and remind ourselves that this is the time of year when markets tend to trade quite thinly. The only major issue that people are having difficulty with is the decline in the oil price. We can see this if we look at stock market indices again, because much of the decline in those indices and the widening in spreads is down to the energy sector. And the question that people want to look into as we move into next year is: has there been a lot of bad lending to energy companies that will impact our capital markets and our banking ratios? The answer is: there probably has been a lot of bad lending, because the oil price has been remarkably stable at a very high level for three years, which set off an increase in global exploration and production. So there is a hangover from this party; it’s being felt in the high-yield markets and the leveraged-loans markets most of all, and in the equity markets in terms of downgrading earnings forecasts for energy companies. But there are bright spots as well: this fall in energy prices is essentially a tax cut for consumers, and as we move into the new year, we feel that investors will start to look at the positive side of the coin as well, and will almost certainly be looking to bargain-hunt in equity markets.

Economic Summary for the week ended 10th Dec 2014

Market movements

As we move toward the end of 2014, the themes that we expect to drive markets in the coming year are really starting to take shape. Foremost among them is the divergence of monetary policy. To that end, the past week has seen two major events that we believe will set the scene for 2015. So far, the divergence theme has been dominated by the easing camp, with action in Asia and talk in Europe. The latest instalment of the European quantitative easing (QE) debate came in the form of the December meeting of the governing council of the European Central Bank (ECB). Expectations for more easing in Europe has risen sharply over the past month, and the collapse in oil prices has, once again, raised the fear of deflation in the Eurozone. In fact, yet more disappointing data has driven the inflation swaps market to price headline inflation dropping below zero for the first time ever in the first quarter of 2015. The hope for more action has been exacerbated, both by the rise in rhetoric from ECB members and by the actions of other central banks. In this regard, the recent easing by both the Bank of Japan (BoJ) and the People’s Bank of China (PBOC) have piled increasing pressure on the ECB to do more.

In line with our expectations, ECB President Mario Draghi stopped short of announcing any new policy tools. However, it was clear from the tone of the Q&A that sovereign QE in Europe remains very much in the cards. With a nod to one of the conditions he laid out last month – i.e. that if existing measures prove too little, they may have to do more – Mr Draghi said that the current policies will be reviewed in early 2015. This, for the first time, helped set a timetable to review the policies, and, if deemed necessary, to move to the next stage of monetary easing. The first sign for that condition will be the announcement of the take-up of the second-tier of targeted long-term refinancing operations (TLTRO) on 11 December. Also notable was the clear message that legal hurdles are surmountable. In fact, according to Mr Draghi, the only illegality is allowing the ECB to move away from its inflation and growth mandate – a clear shot across the bowels of the QE doubters. Market reaction to the announcement (or lack of an announcement) was to price out some of the more exuberant price action of recent weeks, in both peripheral bonds and European equities, on Thursday afternoon. However, the disappointment didn’t last long, with markets bouncing back sharply on Friday – helped by some positive press on the chances for QE in 2015 – most notably in Germany.

On the other side of the Atlantic, the divergence theme has been particularly quiet. In fact, US Treasury yields have been held low, driven by the widening gap in yield with core Europe and the expanding search for income around the world. Behind the scenes, though, the drivers of the tightening camp are starting to pick up. This was confirmed by the latest non-farm payrolls data, which showed the strongest positive surprise since January 2012, coming in at 321,000 versus a survey estimate of 230,000. With October revised upward as well, and hourly earnings beating expectations, it was a strong report all around. Coming on top of the increase in the recent employment cost index – the Federal Reserve (Fed)’s favoured measure of income – the pressure for rising wages is clearly growing. And this is key: the missing link of wages and incomes in the US looks to be appearing fast. As we move into 2015, it is difficult to see the Fed not moving to a more hawkish stance as it prepares for what we believe will be a first hike in the Fed’s funds rate by the middle of next year. That step could come as early as this month, when the Fed may adjust the language regarding timing in a Federal Open Markets Committee meeting.

The strong growth data was taken positively by equity markets, with the S&P 500 creeping up to end on yet another weekly high – its seventh in a row – and the Dow Jones fast approaching 18,000. So far, the good news of an improving labour market is outweighing the bad news of what it might mean for the Fed’s easing stance once they start the hike. This is no small measure, due to the baton change of central-bank QE from the Fed to the BoJ, and possibly the ECB, next year. Even bond markets were relatively sanguine: the 7 basis-point (bps) rise in 10-year yields on Friday took them to 2.31%, still below where they were before September’s Fed meeting.

The winners continued to be Japan & China

While the main news came from Europe and the US, for markets, the winners continued to be Japan and China. Both sustained their positive recent momentum, with A shares up another 9% and the Nikkei up over 2.5% to close at a seven-year high. Rising volumes in A-share markets are encouraging hopes that domestic investors may finally be buying back into their own equity market. The strength of the US dollar also continues to provide strong support to Japan, with the dollar-yen exchange hitting 121.5 on Friday. For emerging markets, the dollar strength remains a significant headwind: broad emerging-market indices were down just shy of 2%. The combination of ongoing European QE hopes and the spectre of the Fed has pushed the euro-dollar exchange below 123, which will continue to help both exporters and Germany. After months of disappointment, tentative signs of a cyclical improvement in the Eurozone economy are appearing, with factory orders in Germany rising strongly. Note that autos helped drive the pick-up in these orders; this is a sector we think should benefit as we move into next year.

Economic Summary for the week ended 7th Nov 2014

Market movements

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.

Economic Summary for the week ended 1st Nov 2014

Market movements

This week, we focus on how to interpret the last few rather interesting days of market activity. The theme underlying recent weekly reviews has been the market sell-off – in particular, what caused it and whether it will continue. The common view is that the sell-off reflected a genuine slowdown in the global economy, particularly in Europe. However, the market reaction was – not for the first time in the history of financial markets – greater than the macro data in isolation might have warranted. We also stated that we are not expecting a sustained slowdown in global economic conditions. The severity of the sell-off also appeared to reflect technical issues, in particular some widespread long-equity and short-duration positions that were cut as risk assets fell, contributing further to the selling pressure.

So how does this analysis currently stand up? Last week there was a material rebound in risk assets: equity markets rose, spreads over high-quality sovereign bonds fell, and government bond yields themselves rose. As of Monday afternoon, some of this had reversed; there’s nevertheless been some recovery in markets. As a broad rule of thumb, the equity correction has been around 10% on average, and the average rebound up to the end of last week was some 4%. Government bond yields have reversed at a broadly similar proportion to their previous decline.

So what do we know now that we did not know a week ago? First, there has been some good economic data. The European purchasing managers’ index rose in September; Chinese GDP for the third quarter and industrial output for September surprised on the upside; and industrial output also rose strongly in the US last month. It’s also worth pointing out that the current earnings round in developed economies has also been very supportive. US corporate earnings over the year to the third quarter rose at close to a double-digit rate (based on some of the companies that have reported so far) and numbers look similar, if a bit lower, for companies which have reported elsewhere in the world. Finally, in Europe, the recently released results of the European Central Bank’s stress test on bank capital suggest that there is no longer a glaring hole in the heart of the European banking system, even if some individual institutions, particularly in Italy, may have more work to do in that context.

“Perfectly feasible” does not mean “inevitable”

If you add it all up, the soft patch that the global economy hit during the summer does appear to be reversing, although as always, we remain vulnerable to short-term noise in the data. Concerns that the market correction may have reflected some sense of deeper malaise in the global economy have therefore moved a little further offstage. Looking ahead, it does seem perfectly feasible that the global economy will continue to struggle through and that the remainder of 2014 to 2015 will be a period of positive, if less than stellar, growth. After all, global monetary conditions are very loose, global fiscal policy is becoming much less restrictive, financial conditions are easier than a couple of months ago, and there has just been a major fall in the oil price, which will help to put money into consumers’ pockets. And it also seems perfectly feasible that in this environment, inflation will remain low; inflation expectations will remain close to central-bank targets in the long term, and therefore, there will be little or no pressure for central banks to tighten monetary conditions. And if all of this happens, then it’s feasible to expect a diversified portfolio of growth assets to outperform very defensive assets such as cash or high-quality bonds – albeit, at pretty modest absolute returns given the extent to which valuations have normalized. Remember, there are few very cheap asset classes around, and there are some at which the pricing is more aggressive. Still, the correction in high-yield spreads in recent weeks means that some valuation support is now back in that asset class. However, “perfectly feasible” does not mean “inevitable.” The fundamental message behind the market correction is that the feasibility of the scenario just described may no longer be what it was. One month of good data does not, after all, suggest that the Chinese growth model is fixed or that Europe is on the verge of a strong, self-sustaining recovery that will push deflation concerns to one side. Indeed, last week, the good news from the output side of the purchasing managers’ report for the euro area was offset to some extent by a sharp decline in inflation in the services survey for the same area. The recent market correction has also led markets to push out potential monetary tightening from the US Federal Reserve (Fed) and the Bank of England from mid-year to the end of next year.

However, the lower level of bond yield does mean that fixed-income markets remain more vulnerable to a reversal of sentiment. This week, the Fed is likely to announce the end of its asset-purchase program, which over recent months has already been minimized very considerably. The largest casualty of the events of recent weeks is volatility, which had previously been very low across all asset classes for an extended period. This development was not irrational; we were simply in a very low-volatility macro environment. But as the range of possible macro outcomes broadens, so does the potential for markets to flip from pricing one regime to another. It’s difficult to believe that this process is going to stop. Therefore it is highly likely that volatility is not going back to the low average levels that we’ve seen over the past couple of years.

Economic Summary for the week ended 21st Oct 2014

A week is a long time in politics, and this last week has felt like a long time in financial markets: the first half of the week with plunges in equity markets worldwide, the second part of the week with a sharp recovery, both in equities credit and high yield. There were almost unprecedented swings on a daily basis – sometimes on an intra-day basis – in the trading of US 10-year Treasury bonds. It was a week that led people to ask a lot of questions about investment policy, the world economy, and the enormous spike in volatility. Before addressing those, let’s briefly remind ourselves that for a long time volatility has been extremely low. Until recently, the volatility of commodities, of bonds, of currencies and of equities has been, by historical standards, exceptionally low. Uncertainty presents itself in many ways. It’s rather like holding a beach ball under the water – when you let the beach ball go, it bounces up further. That’s what I think we’ve seen; that’s what we continue to see. The proximate cause has been a reconsideration of the race of economic growth globally. Interestingly, although much of the commentary has been on Europe, the sector volatility in the equities space and the bond market volatility has been far greater in the US, probably because it was a given part of everybody’s investment thesis that US growth is recovering strongly and it wouldn’t be long before the Federal Reserve (Fed) would be starting to raise rates.

The turning point came this week when a number of Fed governors said that they would not rule out further stimulus in the future, or that they are arguing the case for an interest-rate rise to be pushed further out into the future. The markets rallied around that. That’s a straightforward signal that global markets still need either price stimulus or quantity stimulus, or that they’re going to reset their valuation base very rapidly. We think that the valuation base has already been reset, because even if rates are going to rise, they’re going to rise quite gently. That was true before the last two weeks, and it’s truer now. The higher-yielding end, and the slightly riskier end, of the fixed-income complex really has got some considerable value in it, and it’s worth looking closely at exposures there.

By contrast, long-duration government bonds have rallied very strongly because they’ve been the only diversifier around, and are almost certainly overvalued. For equities, the case still remains that they are the asset with the real rate of return whereby corporate earnings, as we’re seeing in the current earnings season, and cash flows are rising, and the ability to reward shareholders to increase dividends and corporate activity still remains very much in place. At the centre of this somewhat disastrous last couple of weeks has been economics. This week, we will get a number of economic releases which will be closely scrutinised, particularly on Thursday, when Japan, China, France, Germany, the Eurozone, and the US release their purchasing managers’ index figures for October. The market will examine those numbers very closely. It will also examine China’s figures on Tuesday for investment retail sales and third-quarter GDP. All the evidence suggests that the government in China is working overtime to ease policy on housing and the availability of credit at this stage, partly to meet the 7.5% GDP target the central government has set, and partly because they are probably concerned that things are slowly down too fast. Over the next few months, we expect a cyclical, but not a secular, recovery in the low levels of Chinese output led by upgraded activity in the housing market. We’ve also got a series of corporate earnings this week: from the pharmaceuticals sector, Glaxo, in Europe; from the banking sector, Credit Suisse, in Europe; and consumer plays such as Daimler and Amazon and, finally, Caterpillar. The latter will paint a picture of very considerable traction in the demand for global construction equipment. The reason for focusing on that is that it leads one back to the epicentre of the change in views about the economic outlook, which has been filled with disappointing numbers from Germany. We believe that the European economic outlook is very flat, but that there will be some cyclical improvement in numbers over the next six months. Fiscal easing and a little bit of policy change will help things along. We believe that the overselling of cyclical stocks in the stock market has provided a deep valuation opportunity.

Fortune could favour the brave

In summary, volatility has come back; it’s probably risen too far. Economics are low and flat, but in some areas they are going to improve relative to quite low expectations. Positioning has been flushed out quite a bit. There is some good value at the longer end of high-yield and emerging-market debt as a consequence of recent events, and for those who want to be brave, deeply cyclical shares have fallen so considerably in value and might just be positioned for a bounce-back.

Economic Summary for the week ended 16th Oct 2014

The past week has been a very difficult one for many financial markets as the severity of the risk-off phase – which began a few weeks ago – intensified further. Global equities are now more than 5% down from their previous peak. The year-to-date gains in global equities have now been eliminated: of the main indices, only US equities are still in positive territory. There has also been a major correction in commodity prices and, while the weakness this past week has been across the board, the $20 decline in the oil price over the past few months remains the most noteworthy move. Credit spreads have widened in recent days, but the selling pressure on investment-grade spreads has been relatively muted. Almost inevitably, high-quality government bond yields in this environment have declined further, but they have edged lower rather than collapsed. They still remain within recent ranges in the US and the UK, but the 10-year German government bond yield has hit new lows. So what’s driving these moves? Are we looking at a technical correction within a bull market, or a more fundamental change in the global financial background? And if this is a more fundamental move, exactly what fundamentals are we talking about? It’s important to emphasise that some of this correction does appear to be technical. The consensus in the global financial community has been more risk-on than risk-off, hence the chance that positions would get closed out if markets move in the opposite direction. This factor does appear to have been at work in recent weeks, with volumes relatively high. On a technical basis, many markets do now appear to be rather oversold. However, if we focus more on the fundamental factors, it appears that you’re potentially spoiled for choice. The dominant fundamental factor at the moment seems to be – not for the first time this cycle – about global growth, or rather, the lack of it. It’s pretty clear that the global economy had been subdued at the first half of the year, but there’s been a fairly widespread expectation of some lift-off occurring in the second half and into 2015. However, this expectation has been challenged, to date, rather than confirmed by recent data. At the global level, industrial production just seems to have stalled over the summer.

Digging deeper, there’s been some acceleration in US growth, but not really a powerful lift-off. Elsewhere, there have been clear losses in growth momentum in China and the Eurozone. The rebound in economic activity in Japan, after the inevitable slowdown following the tax rise earlier in the year, has been muted. Digging deeper still, within the Eurozone, it’s Germany – rather than the more troubled peripheral countries – that is at the core of the slowdown. German growth had been negative in the second quarter, and has been soft again recently, raising concerns about a potential shift back into recession. It’s worth emphasising that the markets are reacting to what is a fairly small incremental change in the global growth backdrop. There is little evidence that there is a marked slowdown in economic activity underway. There is a case to be made that the weakness in commodity prices is telling a different story, but this week, this appears to be as much supply-driven as demand-driven. We have seen many fluctuations in global growth before, and while we know that these are important, it is also potentially dangerous to extrapolate them.

Eyes on US earnings

It is possible to make some broad generalisations about recent events in the global economy. First, underlying demand conditions have remained stronger than output growth. Weakness in industrial output does seem to have been partly the result of inventory reductions, which are more likely to prove a temporary rather than permanent influence. Second, this inventory challenge has been concentrated in the global auto industry, where output looks likely to rebound quickly and possibly strongly. And third, some corrective mechanisms are potentially coming into play. In particular, much lower food and energy prices should increase consumer spending power. There is also the possibility that slower growth would lead the Federal Reserve and the Bank of England to delay rate rises, which are a particular issue hanging over markets. So our current conclusion is that the global economy is not in free-fall, and there is scope for a rebound as we go into 2015. However, in environments like the one we’re in, the market’s sensitivity to macro data is even greater than usual, so the upcoming earnings season in the US will be particularly important in providing a greater outlook on what really is going on in the global economy

Economic Summary for the week ended 9th Oct 2014

Market movements

It was an interesting week in markets, with new themes emerging, old themes persisting, and some resumptions of themes that we saw earlier in the year. It’s fair to say that one new theme has been the increase in volatility across equity markets (most of which were down 1% to 2% on the week). The driver of this has been fear about growth and ongoing concerns about deflation. To that end, it’s fair to say that on both sides of the Atlantic, investors’ expectations for inflation continue to fall. For example, let’s look at bond markets and what they’re pricing in for inflation over the next 10 years: in the US, that level of expectation has fallen below 2%, when historically it’s been closer to 2.5%. In the Eurozone, that number is now below 1.5%, where typically it has been closer to 2%. In fact, on a data front, we saw Eurozone-wide inflation (CPI) drop to 0.3%, getting very close to that zero-deflationary level that people have begun to become fixated on. Perhaps another way of thinking about inflation expectations is to look at the price of gold. Gold last week fell below US $1,200 per ounce: with the exception of the start of this year, you have to go back to August 2010 to find a point when gold traded less than that number. This is also an indication of the broader weakness that we’re seeing in commodities, which is adding to this expectation of inflation being lower that we had previously assumed.

On the growth side of the equation, it’s fair to say that Eurozone growth remains weak, particularly in northern Europe. On Monday, German factory orders were released for September, which had almost 6% on the month and is now down 1.3% year-on-year. The picture is better in the US, where we saw decent employment data on Friday, with the unemployment rate falling to 5.9%. But even there, people are concerned. For example, we saw the forward-looking indicator of manufacturing data come out weaker than expected, although very much in positive territory. In terms of new themes for the market, this idea of equity volatility is largely driven by concerns about growth and deflation. As mentioned at the start, old themes – such as the strength of the US dollar – continued to dominate the week. In fact, the dollar continues to hit new highs for this cycle across many of the major currencies. For example, the currency is getting very close to 1.10 versus the yen, dropping to about 1.25 versus the euro, and with sterling, falling below the 1.60 level. It’s a continuation of monetary policy driving this theme, specifically expectations for the Federal Reserve raising interest rates early next year and the European Central Bank (ECB) and the Bank of Japan continuing to pump liquidity into the system.

Last week, we saw the ECB give further details of its asset-backed securities purchase, which some are alluding to as being very similar to quantitative easing. One question around this is that sterling has been particularly weak versus the dollar, yet expectations in the UK are still tilted towards a rate rise at the start of next year – which is puzzling. But you have to look at this through the lens of the Eurozone, where sterling has been trading very closely with the euro. And in fact, some of the worries are focused around how the economy will be impacted by this slowdown we’re seeing.

Where do we go from here?

The obvious question raised by the dollar strength is “where do we go from here?” The strength of the dollar last week suggests that there are still many people tempted to jump onto this trend; but we have moved a long way and I would expect that, while that trend of dollar strength will continue, price action isn’t likely to be much more two-way going forward.

The third of last week’s themes was the resumption of a topic that dominated markets earlier in the year. Emerging markets started 2014 very weak – they outperformed over the summer, but there are a couple of things now driving that re-emergence of weakness. The first relates to the broader volatility in equity markets and concern around growth, but also the dollar strength. Historically, it’s worth noting that, in periods of dollar strength, emerging markets have generally underperformed or been weak. I would caution against reading too much into this: if the dollar is strong due to some positive momentum from an economic perspective, that could be an environment that is broadly more supportive for emerging markets, particularly those in Asia. We continue to see some idiosyncratic issues at play in emerging markets.

Russian assets were very weak last week. Democratic demonstrations in Hong Kong are putting pressure on all things Chinese. From a perspective of growth, we remain very confident about the outlook for the US; any slowdown in data should be examined in context with what is actually a robust growth picture for the country. There are some challenges around the Eurozone, particularly for some of the larger economies: some of those are starting to weaken quite markedly. Linked to this is an important point about deflation. Central banks will do all they can to avoid deflation, but the market is getting more and more concerned about it.

The economic background of being broadly positive should continue to be supportive for equity markets, but I think the question marks that are coming through in terms of that pattern of growth and the uncertainly around rates means that we can expect higher volatility as we head toward the end of the year. The message is one of being reasonably constructive about equities, but we shouldn’t expect the very low levels of volatility and risk that we’ve seen over the summer to continue into the end of the year – it’s going to be a bumpier ride.