The June quarter saw a battle between geo-politics and economics, as investors struggled to lift their eyes from dire headlines, only then to read about improving longer-term economic data and corporate earnings prospects.
The quarter was characterised by healthy gains across the US markets, a tepid performance for the European bourses and strong rises across Asia, with the exception of China’s Shanghai Composite Index which finished slightly behind its start point.
Washington bickering obscures strong quarter for markets
Politics from Washington also moved markets, as an increasingly bitter tone took hold, with a seemingly never-ending string of controversies surrounding the US President. For investors, the concern increasingly is that the Trump Administration will be unable to push ahead with plans for tax cuts, infrastructure spending and deregulation, all of which were seen earlier in the year as boosting economic growth and corporate earnings. In June, however, the administration did manage to introduce crucial health insurance and financial-sector legislation.
The quarter saw the long process of revision that the US Government uses to arrive at a real gross domestic product (GDP) figure for the notoriously weather-affected first quarter. Late in April came the first estimate from the US Commerce Department, which reckoned that GDP grew at 0.7% a year in the first quarter – well below market expectations, and the slowest growth rate recorded since the first quarter of 2014.
That was upgraded to 1.2% in May, with consumer spending, which accounts for more than two-thirds of US economic activity, growing at a 0.6% pace, twice the 0.3% that was previously reported. Finally, in June, the third GDP estimate released by the Bureau of Economic Analysis showed a 1.4% annual increase in the first quarter.
The March jobs figure (released in April) was much weaker than expected, with just 98,000 jobs gained in the month; but the unemployment rate fell to 4.5%, the lowest figure since May 2007. Job creation in April rebounded with a gain of 211,000 while the unemployment rate fell to 4.4%, its lowest since May 2007. But in May, employment optimism was nipped in the bud, with a disappointing 138,000-jobs gain reported – not only below expectations, but accompanied by 66,000 in downward revisions to March and April. That left the average for the three months to May at 121,000, well down on 2016’s 187,000 pace.
Fed to begin normalising balance sheet – and rates
In May, the Federal Reserve started the process of unwinding its US$4.5 trillion ($6 trillion) balance sheet – which grew from US$800 billion before the GFC – by outlining a proposed approach that would let increasing amounts of securities mature over time. The Fed plans to reduce that stimulus in a “gradual and predictable” manner so as not to worry the bond market. In June, the Federal Reserve delivered a 0.25% interest rate rise, with the federal funds target now between 1%–1.25%.
On the markets, three winning months in the quarter pushed the S&P 500 index 2.6% higher, while the narrower Dow Jones Industrial Average gained 3.3%. Despite a heavy tech sell-off in June that took it to a losing month (down 0.9%), the Nasdaq Composite Index gained 3.9% for the quarter. It was the seventh straight winning quarter for both the Dow Jones and the S&P 500, while the Nasdaq banked its fourth quarterly rise in a row.
Politics takes centre stage in Europe
In Europe, markets were also turbulent over the quarter in the face of political news, especially from France, where the first round of the presidential election saw the ruling Socialist party virtually obliterated and the perceived far-right (and anti-EU) party candidate, Marine Le Pen, proceeding to the second round, along with the centrist (and pro-EU) candidate Emmanuel Macron.
However, Macron prevailed strongly in the completion of the presidential election in May, following that in June with an emphatic triumph for his new centrist coalition in the parliamentary elections, claiming a landslide 350 seats out of a total of 577. The huge majority is seen as enabling the new President to push through his program of pro-business reforms.
The June UK election, called by Conservative Prime Minister Theresa May both to win a personal mandate and a mandate to negotiate the terms of the nation’s exit from the European Union, also affected the markets over the quarter. The result of the election, being a shock result of a hung parliament - with May continuing as Prime Minister leading a minority government, contributed to a weak quarter for the UK stock market, which declined by 0.1% after falls in April and June.
The economies of both the broader Europe and the UK were able to look past the politics, with solid company earnings and improving economic data the drivers for rising markets. UK manufacturing expanded in April at its fastest rate for three years, while the forward-looking IHS Markit Eurozone purchasing managers’ index (PMI) rose again in May, to a six-year high.
German business “euphoric,” then “jubilant”
The PMI readings for both France and Germany hit six-year highs, while in Germany, the Munich-based Ifo Institute for Economic Research’s index of business sentiment reached in June its most bullish level since the country’s reunification in 1991. The Ifo Institute started to run out of superlatives to describe the mood of German business: in May it described the mood as “euphoric,” but by June, it had become “jubilant.”
This was despite a weakening in June in Germany's manufacturing and services sector – which account for more than two-thirds of its economy – and business activity in France also easing, as growth weakened in the country's services sector. But factory activity rose to hit 57.3 in June from 56.8 in May, and IHS Markit says the 19-nation Eurozone’s manufacturing sector is enjoying its best period of health in more than six years. Moreover, Eurozone unemployment at its lowest since 2009.
According to Thomson Reuters’ collations, second-quarter earnings for European companies are expected to grow by 13.5% year-on-year, compared with 8% growth expected for S&P 500 companies and 6.4% for emerging markets in the Asia-Pacific Region.
On the markets, the pan-European STOXX 600 on a total return basis lost 2.4% for June – its largest monthly loss for a year – and 1.2% for the quarter, leaving it still however with a solid 18.2% rise for the year to date. European equities over the month were also undermined because of a firmer euro and pound. In Germany, the DAX shed 2.3%, while the CAC 40 in Paris lost 3.1%. In London, the FT-100 index lost 2.8%. For the quarter, the DAX gained 0.1%, the CAC 40 was down fractionally and the FT-100 was in the red by 0.1%.
China slows, but launches One Belt, One Road
China’s first-quarter GDP growth figure came in slightly better than expected at a 6.9% annual rate, up from 6.8% in the fourth quarter of 2016. But tempering optimism was the fact that industrial output grew at just 6.5% in May, the same as in April, and down from 7.6% in March. Retail sales rose 10.7% in May from a year earlier, unchanged from April and above analyst expectations for a 10.6% rise.
May saw the official launch in Beijing of China’s One Belt, One Road (OBOR) economic strategy, by which China proposes to link Europe economically to China through countries across Eurasia and the Indian Ocean, and also to link to Africa and Oceania. The OBOR plan envisages spending of more than US$1 trillion ($1.3 trillion) on infrastructure projects, enhancing China’s global influence, with the added benefits of exporting the country’s spare capacity, surplus domestic savings and labour, and bolstering domestic support for President Xi Jinping and the regime.
On the downside, in May ratings agency Moody’s downgraded China’s credit rating by one notch to A1 from Aa3, leaving S&P as the only ratings house to still have an AA- rating on the country.
China’s Shanghai Composite Index lost ground in both April and May, before a 2.4% lift in June resulting in a 1% fall for the quarter.
Japanese exports, corporate earnings rebound
In Japan, the export recovery continued, with the country’s exports growing at an annualised rate of 14.9% in May, almost double the April figure of 7.5%, helped by a weaker yen and demand for cars and steel. The surge in exports is helping Japan to its longest growth streak more than a decade: GDP grew at an annualised rate 1% in the first quarter of 2017, posting five consecutive quarters of economic expansion.
Japan’s industrial output grew at an annualised rate of 5.7% in April, and boosted that rate to 6.8% in May, despite slipping a seasonally adjusted 3.3% for the month.
Company earnings is also a strong story in Japan. Net profit at Japanese companies for the March 2017 year-end (fiscal 2016) climbed to a record high, with nearly 30% of firms reporting their highest-ever profit. The Nikkei responded to this improving backdrop with three winning months, gaining 6% for the quarter.
Strong corporate earnings also helped South Korea, arguably the share market most exposed to North Korean concerns, have a stellar quarter, as did the improved political environment, with a new President elected in May following the impeachment of his predecessor. The KOSPI index powered to record highs in every month of the quarter, ending it with a 10.7% gain.
Bank levies hit Australian market
The Australian market struggled over the quarter, hit by a proposed levy to the major banks announced in the Federal Government’s budget – and then augmented by a proposed levy-on-a-levy from the South Australian state government – and mounting concerns around the Australian residential property market. With the four largest Australian banks accounting for more than a third of the benchmark S&P/ASX 200 Index by market capitalisation, that placed heavy pressure on the market gauge, which responded with losses in May and June that resulted in a 1.6% loss for the quarter.
On the plus side, the local market was helped by a surge in the iron ore price, which gained 13.8% in June, but after steep losses in April (16.5%) and May (almost 20%) the commodity shed close to 20% for the second quarter.
For the 2016-17 financial year, the S&P/ASX 200 Index benchmark gained 9.3%, or 14.1% with dividends included.
This information is current as at 30/06/2017.
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