Equity markets remain under pressure, with 40% of S&P500 stocks in bear market
The European Commission officially requested the Italian government to submit a revised draft budgetary plan for 2019, after finding a serious non-compliance with previously agreed targets for a structural improvement of 0.6% of GDP (the budget presented by Italy had penciled-in a structural deterioration of 0.8% of GDP for 2019). Italian authorities were given until November 13th to submit a new plan that will comply with EU fiscal rules or likely risk facing disciplinary action.
Volatility on Italian assets continued, as expected, with the 10-Year BTP/Bund spread rising by 14 bps on Tuesday (draft budget rejection) and narrowing by 12 bps on Thursday as Mr Draghi expressed his confidence that an agreement can be reached, and ending the week up 7 bps to 309 bps. The spread declined further on Monday (-13 bps) as S&P maintained unchanged its rating for Italy at BBB (two notches above non-investment grade status), but changed its outlook to negative. With no other major rating agency updates due until the end of 2018, the risk of further downgrades has declined.
Euro area business surveys disappointed in October, with the composite PMI down by 1.4 pts mom to 52.7 (consensus: 53.9) -- a 25-month low -- mainly due to increased uncertainty for trade. GDP growth is expected (based on PMIs) at around 1.2% qoq (annualized) in Q4:18 from 0.6% in Q3:18 (first preliminary estimate from Eurostat) and 1.7% in H1:18 (on average).
The ECB left rates and QE guidance unchanged at its October 25th meeting and remains constructive on euro area growth, in line with the view that the economy is facing a deceleration towards more normal levels, compared with an exceptionally strong performance in 2017 (+2.5% yoy). The ongoing labor market tightening (declining unemployment rate, increasing wages), high capacity utilization rates and still accommodative financial conditions should help raise inflation, allowing the ECB to terminate its net QE purchases after December 2018 and begin increasing rates in Q4:19.
US GDP growth surprised positively, up by 3.5% qoq (annualized) in Q3:18 from 4.2% in Q2:18 (consensus: +3.3%) (see Economics). The headline figure was stronger than expected due to consumer-driven demand, but underlying trends (business spending decelerated and housing investment continued to weaken for a 3rd consecutive quarter) indicate a less sanguine outlook, as the fiscal stimulus boost begins to fade.
With the peak of the US and S&P500 earnings expansion likely behind us (see Markets), and risks to the outlook rising (e.g. the slowdown in China, “trade wars” and less accommodative financial conditions), investors have bid down equity prices in October heavily (MSCI ACWI: -9.4%) and are now seeking safe-haven assets (Gold: +3.4%, JPY NEER: +2.9%, German Bunds: +0.9% on a total return basis). The rotation to defensive from cyclical sectors and to value from growth-sensitive stocks has also gained traction in October (see charts page 3).
Global equity markets sold-off in the past week (MSCI ACWI: -3.8% | -7.4% ytd), with the S&P500 erasing its ytd gains (-3.9% wow | -0.6% ytd) and the Nikkei225 underperforming (-6.0% wow | -6.9% ytd). US industrials fell strongly (-5.6% wow), as bellwether corporates reported disappointing earnings, and energy recorded heavy losses (-7.6% wow) as oil prices weakened.