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Global Economy & Markets, Weekly Roundup 23/10/18

23/10/2018 - Reports

Global Economy and Markets

US Q3:2018 corporate earnings begin on a positive note, albeit momentum in global equity markets remains weak

Key Takeaways

The European Commission rejected the Italian 2019 draft Budget on Thursday (which forecast a deficit of 2.4% of GDP in 2019), warning that it is an “unprecedented” deviation from EU budget rules, while GDP growth assumptions appear over-optimistic. Italian equities declined (FTSE MIB index: -0.9% wow | -12.7% ytd), with Banks underperforming (-2.9% wow | -25% ytd) and the 10-Year BTP/Bund spread widening by 18 bps to 327 bps on Thursday.

On Friday, Moody’s downgraded Italy’s rating by one notch to Baa3, with a stable outlook (see graph below). This move had been broadly expected by market participants, with the Italian 10-Year BTP/Bund spread down by -25 bps to 302 bps on Friday.

Key drivers to Moody’s decision were: i) the weakening in Italy’s fiscal strength as envisioned by higher deficits in the next 3 years, and the fact that, at current levels (130% of GDP), the public debt remains vulnerable to future shocks and weaker growth; and ii) hesitation to implement structural economic and fiscal reforms hence impeding medium-term growth prospects.

Overall, we expect elevated volatility surrounding Italian assets to continue until at least end-November (on Monday FM Tria stated that Italy will maintain its 2.4% deficit target, sending 10-Year BTP yields up by 16 bps intra-day to 3.47%). S&P is expected to update its current rating (BBB) on October 26th. Compared with H1:2018, Italian funding costs are up by 103 bps, suggesting that wider bond spreads could lead to capital erosion for Italian Banks that hold large amounts of Government bonds.

The Chinese economy continued to slow in Q3:18, with GDP growth at 6.5% yoy, from an average of 6.8% yoy in H1:2018, slightly below consensus estimates (+6.6%). However, fiscal and monetary policy easing is expected to support growth going forward. Moreover, following the recent mixed economic indicators (see Economics) and slowing growth, policymakers have agreed to further policy actions. As a result, Chinese equities recorded strong gains cumulatively on Friday/Monday (CSI300 index: +7% vs -19% ytd), albeit fell again on Tuesday.

The ongoing earnings season in the US remains optimistic, with mostly robust positive surprises and strong EPS growth delivery. Indeed, out of the 17% of the S&P500 companies that have reported so far for Q3:18, 80% have posted positive EPS surprises, with earnings growth of +19.5% yoy vs 25% yoy in H1. In terms of sector leadership, energy (+96.5% yoy) and financials (+35.1% yoy) exhibit the highest EPS growth.

Following the recent market correction and solid earnings delivery, the S&P500 12-m forward P/E ratio is now at 15.9x vs 14.5x (10-Year average) and 17x 2 months ago. The earnings season will pick up pace this week when circa 32% of S&P500 companies are due to report.

Overall, global equities were mixed (MSCI ACWI: -0.1% wow | -3.7% ytd in $ terms), with EM underperforming. On a regional level, US equities remained flat on a weekly basis (S&P500 +3.5% ytd), as defensives over-performed their cyclical peers, while euro area equities increased (EuroStoxx: +0.3% wow | -8.0% ytd), broadly led by Germany (Dax30: +0.3% wow).