The first six months of 2018 were characterised by a slight slowdown in momentum and by growing trade tensions. This past month began with the USA and China tariffs announcements on goods. However, the heat has kept going up in financial markets. Global growth is reaccelerating, Emerging Markets have recovered, US dollar is stronger and volatility was higher at the end of the month. Indeed, the MSCI All Country World Index is up 3.45% for the month, while it was down 0.25% in June. The MSCI Emerging Markets equities Index gained 3.25% in the month of July compared to a drop of 8% during the first six months. In spite of the trade risks, we still believe that there is a window of opportunity even though the market sentiment has deteriorated.
After a six month slowdown, the global growth momentum picked up. In fact, in the major economies, fundamentals are solid. Global industrial production growth has been increasing since April. The growth is also helped by strong nominal income flows in developed markets that support consumer spending. In the Eurozone, lending to firms and households keeps accelerating despite the low short-term growth. Thereby, the GDP expectations have been upgraded for the major economies. Eurozone GDP is expected to grow 2.2% in 2018 better than its potential, while US GDP should continue to grow around 2.8%. The official policy target in China has eased in order to obtain a GDP growth of 6.5%-7%. We expect the growth to continue at the same time that major central banks are tightening their policies.
As global economy and earnings remain solid, equity markets have been driven higher. Earnings of S&P 500 companies are expected to have grown by 23-25% in second quarter of 2018. Despite tension between US and China, since end of May 2018, when White House imposed 25% tariff on $50bn worth of Chinese goods, US equities are up 5% and global equities by around 2%.Economists believe that the impact on the overall economy will ultimately be limited. Within Eurozone market, there are signs of improving growth. In fact, the total return year-to-date for Eurostoxx50 at end of July was 0.75% compared to the return of -3.32% for the month of June. We prefer US equities over European equities.
After multiple stresses on emerging markets, its assets reoffer value. The emerging markets equities are supported by microeconomic drivers: shift to technology sectors and strong consumers. The MSCI EM Index outperformed this month at the same time that the global economic momentum reaccelerates. On the currency side, rate and spread valuations have all moved into attractive territory. The total return for JP Morgan EM Currency Index in July was 1.83% compared to the month of June being down 2.32%. Within EM debts, local currency debts have increase by around 3% and dollar denominated debts by 2.6%.
Corporate credit continued to underperform equities in July, with the Barclays U.S. Aggregate Index up 0.11% versus a 3.40% gain of the S&P 500. We still prefer short duration credit given the central banks policies and higher inflation.
Undoubtedly, the market is dealing with a number of moving pieces ranging from politics to trade against a backdrop of less liquidity, higher rates and a slowdown in the momentum of growth. Risk assets have responded in kind. Still, the fundamentals remain encouraging and recessionary risk remains low this year. On this basis, we continue to advocate a cautious strategic long position in equities given our belief in the underlying economic picture. In our view, generating positive returns requires increased flexibility and the ability to look through periods of higher volatility. In that context, risk-management combined with rigorous sector and geographical selection will remain key factors for investment performance. As usual, don’t hesitate to contact us to discuss our investment views or financial markets more generally.
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