Market week

Investors should note that the views expressed here may no longer be current and may have already been acted upon by Fidelity.

Meet our authors

In this week’s market update: Better news from China and Italy stabilises markets after recent volatility; oil is in focus as Davos in the Desert gets underway; tech dominates the latest wave of earnings; and, looking ahead, investors prepare for the US mid-term elections and the UK Budget.

23 October 2018 - Tom Stevenson

Transcript - market week

23 October 2018 – In this week’s market update: Better news from China and Italy stabilises markets after recent volatility; oil is in focus as Davos in the Desert gets underway; tech dominates the latest wave of earnings; and, looking ahead, investors prepare for the US mid-term elections and the UK Budget.

After a couple of very nervous weeks, markets got off on the front foot this week thanks to positive developments in both China and Italy.

Chinese shares built on Friday’s gains as they enjoyed their biggest one-day gain in almost three years. Investors welcomed clear guidance from Beijing that it stands ready to support the economy and markets through a period of weakening demand and rising trade tensions.

The rally ran out of steam on Tuesday but the strong rebound on Friday and Monday does suggest that investors are at least starting to look at the appalling performance of emerging market shares so far this year as a contrarian buying opportunity.

The CSI 300 index of the largest companies in Shanghai and Shenzhen closed 4.3% higher on Monday. That was the best single day’s trading since November 2015 and the good mood crossed from the mainland into Hong Kong where the index of China Enterprises - Chinese companies listed in Hong Kong - jumped by 2.6%, its best performance since March.

The market rally was Beijing’s reward for a co-ordinated support programme by the Government, central bank and regulators. Measures announced at the end of last week included a promise from China’s central bank that it would ensure the banking system remains flush with cash. Over the weekend, temporary changes to the income tax regime were also announced to bolster confidence.

It is thought the so-called ‘national team’ of domestic fund managers was given orders to step in to buy shares just as they were in 2015 when worries about a disorderly outflow of capital from China created havoc in global markets.

The good news could not come a moment too soon for China’s beleaguered stock market, which has been the worst-performing major index this year. Chinese shares have fallen by 25% from the peak reached in January, deep into bear market territory. Emerging market shares generally are around 16% down.

A catalogue of worries has hit the country’s stock market. Top of the list is the trade war kicked off by US President Trump and showing no sign of easing up any time soon. Indeed, the worry in Beijing is that continuing weakness in the stock market and a slowdown in China’s economic growth could embolden Trump to go even further with his attacks on America’s main economic rival.

Last week, GDP growth emerged at 6.5%, the weakest quarterly growth since the depths of the financial crisis ten years ago. That economic slowdown has put downward pressure on the Chinese currency, which has fallen perilously close to what is seen as an important psychological level, 7RMB to the dollar.

The fear is that a dip below this level could become self-reinforcing, pushing Chinese savers to swap their domestic currency holdings into dollars to protect their value and so driving the currency even lower.

Another key market focus this week is Italy, where investors have been spooked by a different set of problems. Here the issue is an ongoing spat between a new populist coalition government and EU leaders in Brussels as Rome pushes through a budget plan which sharply increases public spending and risks extending Italy’s already sky-high debt levels.

Italy’s budget has been roundly criticised by Brussels and it has been sent back to Rome by bureaucrats unhappy with the way it blows a hole in the EU’s spending rules. This is the first time an EU member state has been ordered to re-draft its budget. It is not clear that Rome will oblige.

Despite the ongoing uncertainty, Italian markets rallied on Monday morning after the Moody’s debt rating agency cuts its assessment of Italy’s economy but held back from labelling Rome’s debt with the ‘junk’ label. It also described its outlook for Italy as stable, an improvement on its previous negative rating.

The better than expected rating pushed bond yields lower (they fall as prices rise) and this provided a particular boost to Italy’s banks, which are big holders of Italian government debt. A second rating agency, S&P, is expected to update its assessment on Italy on Friday.

Also in the spotlight this week is the oil price, which has been thrown into focus by the ongoing diplomatic row over the alleged murder of dissident Saudi journalist Jamal Khashoggi at the Saudi consulate in Istanbul.

Saudi Arabia has been the subject of almost universal condemnation for the death of Khashoggi. And that has raised fears among investors that the kingdom might use its dominant position among the world’s oil producers to hit back against countries advocating sanctions. Recent comments from Saudi officials about the importance of Saudi Arabia to the global economy were interpreted as a veiled threat to global oil supplies.

That has sparked memories of the 1970s, when Saudi-led oil embargos brought the global economy to its knees as the oil price quadrupled. Effectively the early 1970s oil crisis brought to an end the post-second-world-war boom and ushered in a period of economic stagnation and inflation.

Saudi Arabia’s energy minister has since back-tracked on that position, promising that the kingdom will continue pumping enough oil to keep a lid on the oil price which has threatened to spiral thanks to the imminent imposition of energy-related sanctions on the Middle East’s other big supplier Iran.

Pressure is on Saudi Arabia to behave responsibly, not least because it is currently hosting the so-called Davos in the Desert economic conference. It has seen many leading politicians and business leaders pull out of the event, concerned about associating themselves too closely with the Saudi regime.

New sanctions targeting Iranian oil production are due to come into force on 4 November, which without the co-operation of Saudi Arabia could see the oil price heading back to $100 a barrel or even higher. Recent market concerns have seen Brent crude reach a high of $86, more than three times the level the oil price reached amid fears of a global slowdown in early 2016.

How long Saudi chooses to continue playing ball with the West will depend on whether its key trading partners decide to follow the lead set by Donald Trump, who has been clear that commercial considerations are more important than the case of a single journalist’s unexplained death, or Germany, which said this week that it has stopped arms exports to the country and urged others to do the same.

While the economic uncertainties in China, Italy and Saudi Arabia work themselves out, investors have plenty of news to focus on this week. Earnings season really gets underway, with 160 companies on the S&P500 scheduled to report results. Technology is in the spotlight, with numbers due from Amazon, Alphabet and Twitter. By the end of the week we should have a better sense of whether the current 20% a year growth rate is likely to be maintained.

Technology has been the key driver of the post 2008 bull run, with the information technology sector’s having risen five-fold since the bottom in 2009. Tech accounts for 20% of the market value of the S&P 500. So a topping out of the sector’s shares would be a big problem for the broader market.

Back in the UK, political uncertainty remains the key market influence. The pound slid this week to its lowest level in two weeks as investors worried about faltering Brexit negotiations and the future of Prime Minister May. The PM is facing resistance from all sides to her proposed extension of the so-called transition period which is due to ease Britain’s withdrawal from the EU next March.

Current plans envisage a transition, or implementation, period until the end of 2020 in order that the terms of a new relationship between Britain and Europe can be thrashed out. Even that extension is now thought too ambitious and Mrs May and her counterparts have floated the idea of another few months of talks before life outside the EU really begins.

For Brexiteers this is just more evidence of the Government betraying the spirit of the 2016 referendum result and it has led to increasingly lurid speculation about a leadership challenge. The pound, which tends to feel the pressure first when the European saga turns sour, fell below $1.30, the bottom end of its recent trading range.

The other big focus in Westminster is on Chancellor Philip Hammond’s budget, scheduled for next Monday afternoon. One of the most powerless of post-war Chancellors, Mr Hammond has been dealt a poor hand. And his Budget risks falling victim to Brexiteers angry at the direction of negotiations or the DUP in Northern Ireland concerned about the province’s status within the UK.

The Chancellor believes that a Brexit that sees Britain leaving the EU’s single market and customs union is likely to damage the economy. There is, however, little that he can do about it and his aim of balancing the books has become even harder in recent weeks after his boss, the Prime Minister, announced a £20bn increase in health service spending and an, undefined, end to austerity.

In some ways, now is the right time to loosen the purse strings and start government spending again. The high budget deficits of the post-crisis years are now in the past. Tax revenues have been stronger than expected.

But the Conservatives were elected on a manifesto that committed to eliminating the deficit by the mid-2020s. And Britain remains heavily indebted. Borrowings at 80% of GDP are more than twice their pre-crisis level. Prudence or politics - Mr Hammond faces some difficult decisions over the next few days.

Past performance is not a guide to future returns. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.