January saw a continuation of what was a very strong 2017 for financial markets, however, early February saw increased volatility return to the markets as concerns around inflation and tightening monetary policy weighed on investor confidence. Risk assets were sold off during the rest of the quarter; equities were the worst hit but global core bonds were also down making this a difficult environment for multi-asset investors.
A few other events continued to rattle the markets. First, there was increased rhetoric around tariffs and fears of trade wars, after the US announced levies on steel and aluminium. As trading partners such as Canada and Mexico were excluded, these measures were seen as mainly targeted against China. This was even more apparent when US President Trump announced more tariffs on an additional $50 billion of products. China’s retaliation with counter tariffs and the subsequent increase in the amount of targeted products by the US, created a significant escalation of tensions.
Though announcements don’t mark the start of the application of these tariffs, a period of discussion has started. As it becomes increasingly apparent that outcomes would be a lose-lose for both sides, Chinese President Xi made fairly open remarks and President Trump responded positively to these. It seems likely that the two countries will at least attempt to strike a deal.
The second event was the sell-off seen in technology stocks. Finally, further sanctions imposed on Russia by the US and announcements made by the US President on Russia's involvement in the Syrian war added to the uncertain environment.
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On the macroeconomic front, several recent data releases have pointed to slightly slower global growth. In the US, first quarter GDP slowed, though this seems temporary especially as fiscal stimulus is expected to boost growth going forward, a belief shared by the Federal Reserve. Furthermore, the minutes of the Federal Open Market Committee March meeting confirmed that it is more confident that inflation will return to 2 per cent over the medium term and, as such, over the next few years the path of rising rates will likely be slightly steeper than previously expected. However, the fact the Fed’s inflation forecasts of 2.1 per cent were above target for 2019 and 2020, suggests strongly that they are unlikely to risk choking off the recovery with significant hikes should inflation indeed run above target.
In Europe, growth also shows signs of a slowdown. Composite Purchasing Managers Indexes reached 58.8 in January and 57.1 in February; in March they came in at 55.2. Industrial production for February also came in worse than forecast with a decline of 0.8 per cent versus an expected rise of +0.1 per cent. However, the extremely high PMIs of the beginning of the year weren’t consistent with current and expected GDP growth, hence implying they would eventually have to come down. While PMIs seemed to have peaked earlier this year, the latest numbers are still in high expansion territory above 50 and point to 2 per cent real GDP growth.
The European Central Bank March meeting opened the door to potential changes to the end of asset purchases, which could now be extended beyond September. In addition, interest rate increases in Europe don’t seem to be on the cards any time soon.
During the month of March all of the above events shook markets. US equity markets were down 2.5 per cent and European markets were down 2.2 per cent. Emerging Markets (down by 2 per cent) were also affected by volatility but outperformed developed markets. Defensive assets outperformed risky ones as gold (0.5 per cent), 10 year US Treasuries (1.1 per cent) and 10-year German bunds (1.6 per cent) were all positive.
In the past few days, equity markets have responded positively to more conciliatory talks around tariffs as well as a bounce back in technology stocks, despite an escalation of the Syrian situation.
Earnings season started last week and expectations are for double digit earnings growth globally. Typically earnings growth is positively correlated with rising markets, apart from in infrequent cases of internal or external shocks. With a global growth picture that remains positive and solid earnings growth forecasts, equities could make further progress in the second quarter.
Ilaria Calabresi is a vice president at JP Morgan Private Bank