markets & economy | AUGUST 31, 2020
Global Markets Monthly Update
Global equity markets produced positive results, supported by favorable developments regarding the coronavirus.
Bond faced headwinds from rising Treasury yields.
Corporate earnings fell from the same period in 2019 but were better than expected.
The major U.S. stock indexes recorded strong gains in August, as positive news regarding the coronavirus and a dovish policy shift by the Federal Reserve helped lift the S&P 500 Index and the Nasdaq Composite Index to record highs. The Dow Jones Industrial Average also rallied but remained below its February peak. The S&P 500’s recovery from a bear market was the fastest in history, according to Barron’s and Dow Jones Market Data.
The S&P 500 only experienced five down days during the month, and daily losses never exceeded 0.80%. The market seemed to largely shrug off concerns about the economic impact of the July 31 expiration of extended unemployment benefits. Congress began work on a new stimulus package, but House and Senate negotiators were unable to reach agreement on a new deal before heading into summer recess.
Positive Coronavirus News Helps Lift Stocks
Some familiar themes continued in August. Large-cap shares generally outperformed smaller companies, and growth stocks continued to outpace their value counterparts in the large- and small-cap universes. Moreover, the information technology sector continued its year-to-date dominance and was the strongest segment within the S&P 500. Apple, which became the first U.S. publicly traded company with a market capitalization over USD 2 trillion, was up more than 20%. However, some stocks that were hard-hit by the pandemic, such as airlines and hotels, rallied as coronavirus cases declined following July’s surge and reports of progress in developing a vaccine.
Stocks received a boost late in the month when Federal Reserve Chair Jerome Powell announced that, after a review of its monetary policy framework, the central bank will move to a policy of average inflation targeting, which will allow inflation to run above its 2% target to make up for past shortfalls. As the economy recovers, this will effectively allow the Fed to keep rates at the current near-zero level for a longer period without raising them to preempt an increase in inflation.
Despite Decline, Corporate Earnings Beat Expectations
Better-than-expected economic and corporate earnings reports also seemed to provide a favorable backdrop for stocks. July durable goods orders were stronger than consensus forecasts, and housing data remained a bright spot amid low mortgage rates. Existing home sales surged 24.7% in July to a record seasonally adjusted annual rate, and new home sales jumped to the highest level since December 2006. The Labor Department’s nonfarm payroll report showed that employers added 1.76 million jobs in July, which was more than expected, but the economy has yet to recover all the jobs lost in March and April.
Second-quarter earnings reports showed a dramatic drop from the same period in 2019 but widely beat analyst expectations. According to financial data provider FactSet, S&P 500 companies reported a 32% decline in earnings, the largest since 2009. However, 84% of companies in the benchmark reported actual earnings per share above analyst estimates—the highest percentage since the company began tracking the number in 2008
High Yield Bonds Outperform Investment-Grade Debt
As measured by the Bloomberg Barclays U.S. Aggregate Bond Index, investment-grade taxable bonds lost ground as longer-term Treasury yields rose. The yield on the benchmark 10-year Treasury note increased from 0.55% to 0.72%. (Bond prices and yields move in opposite directions.) Securitized debt, including mortgage- and asset-backed securities, held up better than U.S. Treasuries and investment-grade corporate bonds. Tax-exempt municipal bonds faced headwinds and posted negative returns after strong results in recent months. Despite the busiest August on record in terms of new issuance, high yield bonds benefited from strong demand and recorded positive returns.
Stocks in Europe rose on further economic stimulus in France and Germany, easing U.S.-China trade tensions, and signs of progress in the development of COVID-19 treatments. In local-currency terms, the STOXX Europe 600 climbed 2.86%, with the major country indexes posting solid gains. Germany’s Xetra Dax surged 5.13%, the CAC 40 in France gained 3.42%, and the UK’s FTSE 100 added 1.12%.
The net long position in euro futures rose to a record level in August, U.S. Commodity Futures Trading Commission data showed. The euro reached its highest value relative to the dollar since May 2018, partly on the view that the eurozone economy could recover faster than the U.S. from coronavirus lockdowns.
Germany Extends Jobs Program, France to Unveil Recovery Plan
Germany’s ruling coalition extended a program to help keep workers on companies’ books and increased its funding by EUR 10 billion. Additional measures would allow struggling companies to delay insolvency filings until year-end. The German economy shrank at a record rate in the second quarter, although the initial estimate of a quarterly decline of 10.1% in gross domestic product (GDP) was revised to a 9.7% contraction.
French Prime Minister Jean Castex indicated that the EUR 100 billion recovery plan to be unveiled on September 3 would also support small and medium-sized businesses and include cuts to commercial and industrial property taxes as well as reductions to local value-added and corporation taxes. Finance Minister Bruno Le Maire extended the emergency support program for businesses, increasing state-backed bank loans to businesses and guarantees for quasi-equity financing that would provide between EUR 10 billion and EUR 15 billion for small companies.
Eurozone Rebound May Be Slowing; ECB Stands Ready With Extra Support
Preliminary readings from purchasing managers’ indexes (PMIs) suggested that the eurozone’s economic recovery lost momentum in August, driven by flattening growth in the service sector due to a rise in coronavirus infections and renewed travel restrictions. The composite output index, which combines manufacturing and services, fell to 51.6 from 54.9 in July. (PMI readings of 50 mark the difference between an expansion and a contraction in output.)
In the first policy comment since the European Central Bank (ECB) adopted a wait-and-see approach at its July 16 press conference, Chief Economist Philip Lane reiterated in a blog that “the ECB is committed to providing the monetary stimulus needed to support the eurozone economy.” Despite the bounce in economic activity, Lane warned that “the level of economic slack remains extraordinarily high and the outlook highly uncertain.” His comments raise the possibility that the ECB could further expand its Pandemic Emergency Purchase Program when the bank updates its economic forecasts in September.
Despite renewed surges in coronavirus infections, France, Spain, Italy, Germany, and the UK appeared to reject the need for nationwide lockdowns to curb what could be a second wave of the pandemic. Key policymakers in these countries warned that regional lockdowns might have to be imposed if infections were to increase. However, they downplayed the need for countrywide shelter-in-place orders.
UK Economy Shows Signs of Recovering
Economic activity in the UK rebounded sharply as consumers and businesses began to reopen. The composite PMI surged in August to more than 60 and reached an 82-month high. Bank of England (BoE) Deputy Governor Andy Haldane wrote in the Daily Mail newspaper that the UK was on the path to a rapid recovery from the coronavirus crisis, helped by retail spending that he said had reached pre-pandemic levels in June. The central bank’s latest revision to its full-year economic outlook called for less of a contraction than its May forecast. However, the BoE also predicted a slower recovery, with the economy clawing back its losses by the end, rather than by the middle, of 2021.
Japanese stocks posted solid gains in August but remained under water for the year-to-date period. Within the Japanese equity market, as measured by the MSCI Japan Index, value stocks outperformed growth shares, and small-caps slightly outperformed large-caps. The yen was relatively stable versus the U.S. dollar and closed the period near JPY 106. The yield on the 10-year Japanese government bond remained in positive territory as investors believe the Bank of Japan will not lower policy rates. The benchmark 10-year government bond finished the period with a yield near 0.05%.
Abe’s Resignation Unlikely to Result in Change in Policy
Shinzo Abe, who has been prime minister since December 2012, said he is resigning because of declining health caused by ulcerative colitis, a bowel disease. Abe, who has served longer than any other prime minister in Japanese history, instituted a series of economic reforms during his time in office that were collectively known as Abenomics and were aimed at reinvigorating the Japanese economy and boosting inflation to a 2% target rate. However, economic growth under Abe has been stunted by two tax increases, which were planned before he took office.
Aadish Kumar, a T. Rowe Price international economist, does not believe that Abe’s resignation will result in significant changes for Japanese fiscal and monetary policy. “The views of Abe’s potential successors indicate that expansionary fiscal policy is likely to continue given the economic damage from the pandemic,” he said.
Abe’s successor will be chosen by the ruling Liberal Democratic Party (LDP). According to Kumar, the leading candidates at the end of August included Yoshihide Suga, the chief cabinet secretary; Fumio Kishida, chair of the LDP’s policy research council; and Shigeru Ishiba, a former LDP secretary-general. Although Ishiba has questioned the sustainability of the Bank of Japan’s ultra-loose monetary policy in the past, Kumar believes he would be unlikely to push for change given the potential harm tighter monetary policy could inflict on the economy.
Japan’s Economy Contracts Sharply
Japan’s Cabinet Office reported that the economy suffered its largest contraction on record in the three-month period ended June 30, 2020, as companies experienced the full impact of the global pandemic. Gross domestic product fell 7.8% in the quarter, which equates to 27.8% on an annualized basis, largely due to steep declines in exports and domestic consumer spending.
Domestic consumption, which accounts for more than 50% of Japan’s GDP, dropped a record 8.2% versus the March quarter (approximately 29% annualized) due to business closures and stay-at-home mandates. The prior record decline, 4.8%, occurred in the same quarter of 2014, after the consumption tax was increased to 8% from 5%. Exports fell 18.5% quarter over quarter (56% annualized) as the slowing global economy curbed the demand for cars, trucks, and other Japanese goods and services.
Economists polled by the Japan Center for Economic Research are forecasting 13% economic growth in the current quarter, as personal spending was in an uptrend, in part thanks to a one-time JPY 100,000 special government relief payment. The consensus prediction is that Japan’s economy will contract 5% to 6% in the current fiscal year, which ends in March 2021. While acutely sensitive to plunging export demand, Japan has also managed to largely avoid the drastic economic shutdowns seen elsewhere.
Business Sentiment Improving
The Reuters Tankan manufacturers’ (monthly) sentiment index rose to ‑33 in August from ‑44 in July, its best level since February. The service sector reading showed modest improvement at ‑23 from ‑26 a month earlier. In the August Tankan, every industry reported improvement in sentiment except oil refinery/ceramics, but many companies remain concerned about a resurgence of the coronavirus and U.S.-China trade tensions. Looking ahead three months, sentiment in the manufacturing sector is expected to show continued improvement, while the services sector is less optimistic about business conditions except for those in information/communications and retailers.
However, according to research from the Nikkei, Japanese-listed companies expect their profits to decline 36% in fiscal 2020 from the year-earlier period. Approximately 60% of Japan’s businesses have forecast lower revenues and net income for the fiscal year. The projections for the second half of the year were stronger: Companies expect a 2% decline in sales coupled with an income gain of 19%, which implies the implementation of stringent cost-cutting initiatives.
Mainland Chinese stocks rose in August, with the large-cap CSI 300 Index and the benchmark Shanghai Composite Index both recording solid gains. Year-to-date, Chinese A shares have gained roughly 25%, making them among the best-performing equity markets globally.
In fixed income markets, the yield on China’s 10-year sovereign bond rose six basis points to 3.04% amid further evidence of economic recovery. The central bank left the loan prime rate (LPR), which serves as a reference rate for new loans, unchanged for a fourth straight month. China reported record foreign investor inflows of USD 24 billion into its bond market in July, twice the level recorded in June and underscoring its attractiveness to foreign investors.
U.S. Tightens Restrictions on Huawei
In currency markets, the yuan strengthened 1.8% against the U.S. dollar despite wavering in times of increased U.S.-China tensions. During the month, the Trump administration tightened restrictions on Huawei Technologies by making it harder for the Chinese telecommunications giant to maintain production after September without a supply of advanced semiconductors from the U.S. or Taiwan. Over time, analysts believe that the U.S.’s efforts to restrict Chinese companies’ access to overseas semiconductor technology will spur Beijing to accelerate China’s domestic technology capabilities.
Economy Shows Signs of Strength
Economic readings for August signaled that the production side of China’s economy strengthened despite the impact of torrential rains that flooded much of the country over the summer. China’s official purchasing managers’ indexes of manufacturing and services activity remained in expansionary territory in August. Meanwhile, the Caixin/Markit survey—an influential private survey of economic activity focused on small to medium-sized companies—improved for the fourth straight month and recorded its fastest expansion rate since January 2011. In other readings, profits at large-scale industrial enterprises surged 19.6% in July over a year ago in the fastest year-over-year growth since June 2018. Taken together, the latest data suggested that China’s containment of COVID-19 will allow Beijing to focus on supporting its services sector, an increasingly important driver of economic activity.
Other Key Markets
Mexican GDP Slumps Amid Struggles With Pandemic
Mexican stocks, as measured by MSCI, returned 0.61% in U.S. dollar terms in August. The peso’s 1.4% appreciation versus the greenback boosted returns in dollar terms. However, the market underperformed the MSCI Emerging Markets Index, which returned 2.24%.
Mexico continued to struggle as one of the hardest-hit countries in the global COVID-19 pandemic. According to Johns Hopkins University data, the country registered about 600,000 confirmed coronavirus cases and reported more than 64,000 related fatalities as of the end of August. As for the economy, the country’s official statistics agency recently reported that gross domestic product dropped 17.3% in the second quarter from its first-quarter level. While this was mostly in line with consensus estimates, T. Rowe Price emerging markets sovereign analyst Aaron Gifford observes that it consolidates a fifth subsequent quarterly contraction that began well before the pandemic hit.
In the latter part of the month, Mexico reported that its year-over-year reading for inflation for the first half of August was 3.99%. This was slightly higher than expected and at the top of the central bank’s 2% to 4% inflation target range. Gifford notes that the underlying data confirm the presence of recent supply-side pressures, particularly related to food. While he believes that these factors will ultimately fade, he highlights that inflation inertia has become a sticking point for the Mexican central bank (Banxico) in recent weeks.
Banxico held its regularly scheduled monetary policy meeting on August 13 and decided to reduce its overnight interbank interest rate from 5.00% to 4.50%. A few weeks later, the central bank released its quarterly monetary policy report and the minutes to its policy meeting. Due to the pandemic, policymakers revised their growth outlook downward to a range of ‑8.8% to ‑12.8%. However, inflation projections were more mixed, even if below current levels. Meanwhile, Banxico’s minutes revealed discussions around the prospect of further easing as well as a terminal rate for its benchmark lending rate. Gifford believes the central bank will cut rates two more times in more modest 25-basis-point increments before pausing at a 4.00% rate. (A basis point is equal to 0.01 percentage points.)
Turkey: Weaker Lira Weighs on Returns
Turkish stocks, as measured by MSCI, returned -8.36% in U.S. dollar terms. The market significantly underperformed the MSCI Emerging Markets Index, which returned 2.24%. The weakening lira, which fell more than 5% versus the greenback and reached a record low during August, hurt returns in dollar terms.
Overnight lending rates in Turkey’s financial system spiked early in the month amid concerns about the central bank’s depletion of its foreign exchange reserves, and thus its ability to defend the lira in global currency markets. Long-term sovereign bond yields also increased in the first part of the month as the currency weakness raised investor fears about inflation in the form of higher import prices.
Amid reports that major global financial institutions were having difficulty completing currency transactions that involved lira, Turkey’s banking regulator and the government announced some policy measures intended to stabilize the situation. The banking regulator indicated that it will ease restrictions on lira currency trading for major global investment banks. Also, the government declared that, because recent fiscal and monetary policies have succeeded in containing the effects of the pandemic and maintaining the productive capacity of the economy, it was phasing out its targeted liquidity facilities that were established in March to stimulate credit growth.
The central bank also signaled that it will increasingly provide lira liquidity to Turkey’s banking system by way of more expensive liquidity channels. This means policymakers have made a stealth rate increase, according to T. Rowe Price sovereign analyst Peter Botoucharov. In response, longer-term interest rates retraced some of their ascent.
If financial conditions warrant, or if the lira depreciates rapidly, central bank officials could effectively tighten policy further by requiring—as they did in 2018—the use of the late liquidity window facility, whose interest rate is currently 11.25%. Botoucharov believes, however, that the current bout of lira weakness is not as severe as in 2018, when the lira plunged more than 30% versus the U.S. dollar over the course of several months.
Major Index Returns
As of 8/31/2020
Figures shown in U.S. dollars
|U.S. Equity Indexes||August||YTD|
|Dow Jones Industrial Average||7.92||1.30|
|Nasdaq Composite (Principal Return)||9.59||31.24|
|Global/International Equity Indexes||August||YTD|
|MSCI Emerging Markets||2.24||0.68|
|MSCI All Country World||6.16||5.12|
|Bloomberg Barclays U.S. Aggregate Bond||-0.81||6.85|
|Bloomberg Barclays Global Aggregate Ex-USD||0.29||5.38|
|Credit Suisse High Yield||1.17||0.13|
|JP Morgan Emerging Markets Bond Global||0.30||2.06|
Past performance is not a reliable indicator of future performance.
Note: Returns are for the periods ended August 31, 2020. The returns include dividends and interest income based on data supplied by third‑party provider RIMES and compiled by T. Rowe Price, except for the Nasdaq Composite Index, whose return is principal only.
Sources: Standard & Poor’s, LSE Group, Bloomberg Barclays, MSCI, Credit Suisse, Dow Jones, and J.P. Morgan (see Additional Disclosures).
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