October was the month that equities came back. Stock exchanges across the globe rebounded from their late summer drawdowns, with most developed market indices back in positive territory for the year.
Even emerging market equities posted healthy gains, leaving them down by only 1.8 per cent year to date. Corporate credit was more mixed, with US and European high yield gaining around 3 per cent each, while global investment grade only rallied 0.6 per cent. Government bonds moved with less dispersion, but peripheral European sovereigns outperformed US treasuries and UK gilts.
Market volatility was lower, perhaps because the focus was on longer-term economic outlooks and central bank policy. While the European Central Bank, the US Federal Reserve and the Bank of Japan actually made few changes, it was the change in language and signalling that really mattered for markets.
ECB president Mario Draghi said the bank’s attitude towards judging if further action was needed to achieve its objective of inflation near 2 per cent was no longer, “wait and see, but work and assess”. Markets reacted to this with the euro moving down against the dollar. If the ECB does implement further quantitative easing, the next steps would likely be to extend the current programme beyond its target end date of September 2016, expand the amount purchased each month, cut the deposit rate further into negative territory – or a combination of these measures.
European economic data underlined the eurozone’s recovery story. While the Consumer Price Index inched back to zero from 0.1 per cent in September, unemployment hit a four-year low, falling to 10.8 per cent. The Composite Purchasing Managers’ Index rose to 54 in October, above expectations and consistent with GDP growth of close to 2 per cent. Earnings season for eurozone equities got off to a decent start, with year-on-year earnings-per-share growth at a solid 4 per cent. While UK gilts lost some of their impressive year-to-date rally, Italian, Spanish and German sovereigns performed well. Additional stimulus announced by Sweden’s Riksbank, coupled with Draghi’s dovishness, sent certain eurozone government bond yields to lows seen in the second half of 2015.
As expected, the Federal Reserve announced no change in rates at its meeting on 28 October, but there were some changes in the language of its statement. The emphasis on international concerns was reduced and the Fed explicitly noted the possibility of increasing interest rates at its next meeting. The US economy continued expanding through the third quarter of 2015, with GDP increasing 1.5 per cent quarter-on-quarter (seasonally adjusted annualised rate). Inventories and trade proved to be a headwind, but the worst of the inventory drag appears to be behind us and domestic consumption remained strong.
US manufacturing weakness might be an area of Fed and market focus, as durable goods orders contracted 1.2 per cent in September, mirroring weak industrial production data released earlier in that month. US housing data also looked slightly weaker in September. The Employment Cost Index rose 0.6 per cent in the third quarter, showing a gradual pick-up in wages. This stream of mixed data has made it difficult for the Fed to tick all the right boxes for a rate hike, making every release until its December meeting all the more important.
While the timing of Fed lift-off remains uncertain, S&P 500 returns have been more dependable. The S&P 500 had its best month of the year, gaining 8.4 per cent on a total return basis in October. Earnings momentum supported the rally: 76 per cent of companies in the S&P 500 beat analyst EPS estimates and year-on-year ex-energy EPS growth was 3 per cent in the last week of October.
At the very end of October, the Bank of Japan extended its timeframe for achieving 2 per cent inflation for the second time this year. Haruhiko Kuroda kept a bullish attitude on inflation and growth, citing the low oil price as the biggest reason for the delay in reaching the 2 per cent target. At its 30 October meeting, the BoJ did not modify its asset purchase programme. Despite the central bank keeping additional easing on hold and mediocre earnings reports, the TOPIX rallied steadily over the month, topping the charts in year-to-date and month-to-date returns.
November and December could well see a continuation of current market positivity. But investors should prepare for volatility as markets adjust to US rates moving off the zero lower bound for the first time in almost seven years, and a possible extension of QE by the ECB and BoJ. Divergent monetary policies and growth prospects for large economies will continue to make a selective approach to equities and fixed income a key investment theme for the rest of the year and 2016.
Nandini Ramakrishnan is global market strategist for JP Morgan Asset Management
