Global equity markets recovered in July due to an easing in trade tensions, strong earnings and policy easing in China
Trade tensions between the US and the EU eased somewhat after a bilateral agreement was reached. Both sides will work towards eliminating tariffs, subsidies and barriers in (non-auto) industrial goods. At the same time, the EU will increase its imports of soybeans and liquefied natural gas from the US.
The US and the EU also agreed to work on the reform of the World Trade Organization towards tackling more efficiently unfair trade practices, including, inter alia, “intellectual property theft and forced technology transfer”, a move which was seen as aiming to exert joint pressure on China. Note that, in early August, the US is expected to impose a further $16bn of tariffs on Chinese imports (in addition to the $34bn already implemented).
While the negotiations are taking place, the US will refrain from implementing higher tariffs (currently: 2.5%) on auto and components imports from the EU ($62.5bn in 2017). Note that the EuroStoxx Automobiles & Parts equity sector (SXAE) has significantly underperformed the market (SXXE) ytd (-9.5%) due to fears of US tariffs, as well as decelerating growth in the euro area. The SXAE ended the week slightly up, despite an increase on Thursday (+2.6%), with the German Big3 overperforming (Daimler: +3.5% wow, Volkswagen: +4.5%, BMW: +4.6%) (See page 3).
The complexity of production and supply chains weighs. Note that 34% of 16.4mn German autos are produced in Germany, while 30% of German autos are produced in China. Moreover, Q2:2018 EPS results for 5 out of 8 companies (total: 18) are below consensus expectations, including Daimler and Fiat Chrysler. On the other hand, SXAE valuations (P/Es) appear cheap following the recent correction, albeit the sector requires a catalyst (stronger consumer growth in H2, upward earnings revisions, a permanent agreement between the US/EU).
All four major central banks will have convened by the end of the week. The ECB on July 26th maintained its rates unchanged (at 0% and -0.4%). President Draghi appeared comfortable with the current market pricing for the first interest rate hike (i.e. fully priced-in by Q1:2020). Regarding QE, the ECB expects to end its net asset purchases in December 2018.
The Bank of Japan, at its meeting on July 31st, strengthened its commitment to achieve its inflation target of 2%, introducing forward guidance for policy rates “that are expected to remain at current negative/low levels for an extended period of time”. Moreover, the BoJ will be more flexible vis-à-vis its target (“around 0%”) for 10-year JGBs yields under its “yield curve control” framework, allowing for larger deviation relative to the target depending on economic conditions. Following the meeting, the 10-year JGB yield declined by 3 bps from a 1-year high of 0.10%.
We expect the Fed to remain on hold at 2.0% at its August 1st meeting, resuming its quarterly rate hikes in September, due to a strong economy (GDP: 4.1% qoq saar in Q2:2018 – see Economics), the unemployment rate (July data is due on August 3rd) hovers at 4% and inflation pressures are rising, with the core PCE price index at 2% yoy. Importantly, the Bank of England is expected to increase its policy rate by 25 bps to 0.75% on August 2nd due to record-low unemployment (4.2%), above target inflation (2.4%) and stabilizing growth following a weak figure in Q1 (see graph below).