Mixed manufacturing indicators (US ISM) and political developments (SPD leadership, US tariffs on metal imports from Brazil and Argentina) add to market uncertainty
US equity markets recorded all-time highs in the past week. However, optimism was reduced late in the week following the signing into law of the Hong Kong Human Rights and Democracy Act, by President Trump, thus risking “firm counter measures” from China, while he also threatened to restored tariffs on metal imports from Brazil and Argentina. Weaker-than-expected ISM manufacturing (48.1 vs 49.2 consensus) also weighed on markets on Monday. Note that the tail risk of additional US tariffs on Chinese imports in the short term remains, albeit has declined to some extent. Moreover, domestic policy uncertainty (i.e. the impeachment process) could lead to a volatile equity market environment by end-year.
With global political uncertainty elevated (see graph below), a series of events could shape risk sentiment by end-year. Investor attention will inevitably turn to the November US labor report (December 6). While some softness is evident in the labor market recently, monthly non-farm payroll gains (+180k on a 6-month average basis) are above the necessary monthly pace (circa +110k) to keep the unemployment rate contained at its current rate of +3.6%, Overall, consensus expects robust nonfarm payrolls of 190k following (a negatively distorted by the UAW strike) 128k in October, with solid average weekly earnings of +0.3% mom or 3.0% yoy.
Major economic events to monitor are monetary policy meetings on both sides of the Atlantic (Fed:11/12 and ECB:12/12) and the elections in the UK (12/12). Regarding the latter, the closely watched YouGov MRP model (November 29) indicate the Conservatives securing 359 seats based on a Conservative poll lead of +11% versus Labor (>325 seats are required for an outright majority in the House of Commons). Nevertheless, according to poll experts, the model also suggests that a narrowing of the poll lead to below 7% could portend prospects for a Conservative majority.
In Germany, further political uncertainty ensued following the surprise victory in the SPD leadership of Borjans/Esken, which may complicate further the already dysfunctional Grand Coalition between the Christian Democrats (CDU/CSU) and Social Democrats (SPD). Indeed, Mr. Borjans said raising investments and scrapping temporary job contracts “were among the issues that needed to be addressed if Chancellor Merkel wanted to extend the coalition”. Referring to the Federal Government’s balanced budget commitment, he also stated that “we must improve the policies and perhaps loosen the black zero”.
Markets priced in a more expansionary fiscal policy path on Monday, with 10-Year Bund yields increasing by +7bps to -0.29% intraday, albeit yields declined following the weaker-than-expected US ISM report. Recall that Germany has sufficient fiscal space, with the 2020 structural primary balance forecast at +1.5% (+2% in 2019) and a General Government debt of 59% of GDP in 2019.
The MSCI ACWI ended the week up by 0.6% (+20% ytd), with developed markets over-performing their emerging markets peers by 160bps on a weekly basis. The performance gap between DM and EM equities has widened significantly year-to-date to 1400bps and, as a result, relative valuations have diverged further. Indeed, EM Equities are trading at a valuation discount of 26% vs DM relative to a 15-year average discount of 21% (based on P/E) and at a valuation discount of 36% vs DM Equities relative to a 15-year average discount of 18% based on P/BV (see graphs page 3).