Global equity markets were broadly flat in Q2, with the S&P500 overperforming its euro area peers due to stronger momentum in economic activity
The second quarter of 2018 witnessed strong, albeit decelerating (ex-US), global growth and healthy corporate profitability, which were offset by the escalation of trade tensions between the US and major trading partners (mainly China and the EU), as well as political uncertainty (Italy).
Global equities were broadly flat on a quarterly basis (MSCI World: -0.1% qoq | -1.5% YtD). In the MSCI World index, 30-day realized volatility of daily returns was similar to that of Q1 (10%) and well above the exceptionally low 6% in 2017 which was ranked in the 5th percentile since 2003 (see our Asset Scoreboard on page 3).
Emerging market (EM) equities underperformed their developed market peers in Q2 (-8.7% qoq versus +1.1% qoq, respectively, in $ terms), as they are more vulnerable to a stronger US Dollar and higher US rates. This underperformance was corroborated by idiosyncratic factors related to policy uncertainty (equities Brazil: -14.8% qoq, Turkey: -16.0% qoq, Argentina: -16.3% qoq).
Intra-EM, Chinese (onshore | A-shares) equities entered a bear market (-20% since January 24th 2018), with the CSI300 index declining by 2.7% wow and 9.9% qoq, as the CNY depreciated to a 7-month low against the USD ($/6.62) following a cut of 50 bps to the Reserve Requirement Ratio by the PBoC in the past week (see graph). The Chinese authorities aim to loosen financial conditions in order to offset a weaker external environment due to trade-war risks.
Regarding developed markets, the S&P 500 overperformed its euro area peers in relative terms (+2.9% qoq versus +0.8% qoq for the Eurostoxx), due to strong US GDP growth (Q2 GDP is expected at 3.5% qoq saar according to Fed’s nowcast models) and corporate profitability. Consensus estimates for US 2018 EPS (earnings) growth stand at +22% yoy, revealing a large gap versus other markets (euro area: +7% yoy | Japan:+4% yoy | UK: +11% yoy).
US Government bond yields rose in Q2, particularly in shorter-term tenors, in view of monetary policy normalization by the Fed (+50 bps cumulatively so far in 2018, to 2.00%) and firming US inflation, with core PCE at +2.0% yoy in May, a 6-year high. Indeed, US Treasury 10-Year yields rose by 12 bps qoq to 2.86% and their 2-Year counterparts by 26 bps qoq to 2.53%.
In contrast, German Bund yields declined (10-Year: -20 bps qoq to 0.30%) on the back of intra-euro area “safe haven” demand and persistently weak inflation readings (see Economics). On the other hand, political uncertainty in Italy led the 10-Year BTP/Bund spread higher by 109 bps qoq to 238 bps. Italian bank equities also suffered in Q2, declining by 15% qoq.
Regarding credit, EM high yield bonds were among the worst-performing assets in Q2 (-3.3% qoq), due to “flight to quality” from investors. Euro area corporate bonds also performed poorly, in both the investment grade (-0.7% qoq) and the high yield (-1.2% qoq) spectrum, as investors demand higher compensation, in view of the ECB QE exit (December 2018).
The USD appreciated by 5.6% in trade-weighted terms qoq and by 5.2% against the euro to $1.168, due to an increasing gap in GDP growth momentum between the US and euro area. It was also affected negatively by a dovish ECB (regarding future rate hikes) and political uncertainty in Italy.