Euro area equities are held back by policy uncertainty in Italy and trade tensions with the US
The 2nd estimate for US GDP in Q2 confirmed the highest growth since mid-2014 (+4.2% qoq saar | +2.9% yoy). Tax cuts support private consumption (3.8% qoq saar | 2.6% yoy) and business investment (8.5% qoq saar | 7.0% yoy), in addition to increased expenditure for national defense (6.0% qoq saar | 2.2% yoy in Q2:18). According to the Brookings Institute, the overall fiscal impact on the quarterly US GDP growth was +0.68 pps in Q2.
Chinese authorities accelerated measures to support economic activity by announcing a new set of tax cuts (August 30th). According to the official target, the overall tax burden will be reduced by RMB 0.8tn in 2018 (0.9% of GDP) and non-tax burdens (mostly administrative fees) by RMB 0.3tn or 0.3% of GDP.
Moreover, fiscal spending is expected to accelerate in H2:2018. Overall, China’s fiscal deficit in the first seven months of the year, stood at only RMB 0.4tn (0.4% GDP), versus an annual target for FY:2018 of RMB 2.4tn (2.6% of GDP).
In global equity markets, US equities continued to overperform their major peers in the past week. Indeed, the S&P 500 rose by 0.9% wow (+8.5% ytd), while the EuroStoxx ended the week down by 0.6% wow (-1.6% ytd). Besides aggressive share-buybacks by US companies (circa $650bn or 3% of market cap ytd), the widening profitability gap between the US and other regions has fueled the overperformance in US equities, albeit it appears to be nearing a peak (see graph below with relative 12-month forward EPS expectations).
Recall that consensus estimates for S&P 500 EPS growth overall in 2018 stand at 23.1% yoy, versus +15.9% yoy for the MSCI World, while the respective figures for 2019 are +10.2% yoy and 9.7% yoy.
Regarding euro area equities, apart from uncertainty regarding the future trade conditions with the US, investors’ risk appetite is weighed by Italian policy uncertainty vis-à-vis the forthcoming 2019 Italian Budget. Note that Fitch maintained Italy’s credit rating at BBB, in line with Moody’s and S&P, but changed its outlook to “negative”, from “stable” previously. At the same time, Italian economic confidence has taken a hit in recent months, with PMI manufacturing declining by 3.2 pts since June, to 50.1 in August, a 2-year low.
Italian equities continued to underperform in the past week, down by 2.3% wow (-17% since mid-May 2018), led by Banks (-4.2% wow | -29% since mid-May 2018). At the same time, the 10-Year Italian BTP/Bund spread widened further, by 10 bps wow, to a 5-year high of 291 bps.
The US Dollar continues to appreciate against emerging market (EM) currencies, +1.7% wow (+6.2% in August) and further by 0.7% on Monday (+12.8% ytd). Apart from strong US economic data, this trend is exacerbated by idiosyncratic factors in certain EM countries, e.g. Turkey and Argentina.
Regarding the latter, in an effort to stem high inflation (July: 32.2% yoy) and restore confidence, the central bank raised its policy rate by 15% to 60%. Moreover, President Macri announced spending cuts, tax increases and requested ammendements and speeding up of further disbursements from the $50bn Stand-By Arrangement agreed with the IMF in June 2018 ($15bn are already disbursed).