20 August 2019 – Market volatility rises as recession fears mount; politicians and central bankers get together in Jackson Hole and Biarritz; but corporate news is thin on the ground as the world takes its annual holiday.
Trading is always thin during August as investors head to the beach. That can often lead to volatile markets and a stressful time for those left in the office. The last week has been a reminder that it’s not just September and October that we should fear but also that markets can bounce back quickly when sentiment improves.
The US stock market fell by 3% last Wednesday as a key indicator of economic trouble ahead started flashing red. Bond investors have long compared the yields on different maturities of debt for guidance on the health of the economy and last week the signals from this analysis started to look similar to those sent ahead of most if not all recession in recent decades.
The most widely-watched of these comparisons is between the yields on 10 year US Treasuries and those on the 2 year equivalent. Normally the yield on the longer-dated bond is higher than the shorter to reflect the greater risk of lending money for an extended period. When investors start to worry about the outlook for growth and inflation, however, the relationship can flip over and longer bond yields can fall below those on shorter bonds. This is called an inverted yield curve and it has in the past been a good indicator of trouble ahead.
Well last week this measure of the yield curve did invert and the stock market reaction was swift. It was as if all the many worries about trade tensions, Brexit, Argentina, Italy and the middle east were all confirmed at once.
Investors came back from the weekend, however, in much better spirits. In particular, the S&P 500 index started the week by rising more than 1% on Monday after President Trump gave Chinese phone maker Huawei another 90-day reprieve that will allow US companies to continue trading with it for another three months.
He also raised the stakes in his verbal stand-off with the Federal Reserve, calling on the US central bank in a tweet to cut interest rates by another 1 percentage point and suggested some more quantitative easing might be appropriate.
This is the backdrop to a busy week for both politicians and central bankers as the heads of the world’s biggest seven economies head to Biarritz in south west France for the latest G7 meeting while the world’s central bankers get together in the Wyoming mountains for the annual summer Jackson Hole symposium.
The Jackson Hole meeting comes at a tricky time for the heads of the key central banks as they try to understand whether to follow the US Federal Reserve’s recent U-turn on monetary policy as it cut interest rates for the first time in more than a decade. And the meeting will follow two days after the publication on Wednesday of minutes of the last Fed meeting.
With data out of China and Germany even weaker than that in the US, the likes of Mark Carney at the Bank of England and the ECB’s Mario Draghi would probably like to be able to ease their own policy, but they have less ammunition to play with than their counterpart in Washington having failed to get interest rates off the floor in the years since the financial crisis.
The theme of this year’s Jackson Hole meeting is Challenges for Monetary Policy, which says it all really as central banks try to stimulate activity in the face of mounting gloom about the economic outlook. That pessimism is most clearly indicated by a mountain of government debt - nearly $17trn - which is currently yielding less than zero as investors flock to safe haven assets like government bonds and price in little growth or inflation for years to come. Yields rose a little at the beginning of this week as risk appetite perked up again but they remain at historically very low levels.
Jay Powell, the chairman of the Federal Reserve, is due to speak on Friday and all eyes will be on his guidance which has often been less than decisive. His lack of clarity is easy to sympathise with, faced as he is by conflicting economic evidence and political pressure from an election-ready President who is calling on the Fed to ease his path to another four years in the White House.
On this side of the Atlantic, attention will be on the G7 meeting, at which Boris Johnson will make his debut as British leader on the world stage. Even before he reaches Biarritz, the Prime Minister will have met German leader Angela Merkel in Berlin and President Macron in Paris in his first tour of European capitals since he replaced Theresa May in Downing Street.
The G7 will provide the UK’s new leader with an opportunity to bang the drum for Britain’s proposed global role outside the EU, which he insists we will be leaving on 31 October come what may. His trip across the Channel comes days after a damaging leak about the Government’s plans for what Whitehall views as a highly risky No Deal exit. At the same time, momentum is growing behind a range of schemes to block that kind of cliff edge departure, although no-one is particularly sure which if any stand a chance of success.
This week, Jeremy Corbyn attempted to wrest back the initiative with a wide-ranging speech in which he promised to table a vote of no confidence in the government, to head an interim, caretaker government designed to prevent a No Deal exit and to call a general election. At that election Labour would campaign on a promise to hold a second referendum with credible alternatives including remaining in the EU.
The uncertainty over Brexit has kept the pound on the back foot, with sterling trading at just over $1.21 against the dollar and €1.09 versus the euro, although negative bets have been modestly reduced over the past week. Sterling weakness is obviously bad news for UK holiday-makers and only partial relief for UK exporters and overseas earners who are sometimes seen as beneficiaries of a weak pound.
The main topics for discussion at the G7 will actually not be Brexit, of course, which matters more on these shores than in the wider global context. The Iran nuclear accord and taxation of multi-nationals like Google are likely to be higher up the agenda.
Also on the European radar this week will be today’s no-confidence vote in the Italian government of Giuseppe Conte. Matteo Salvini, head of Italy’s co-ruling League party, has split with coalition partners the Five Star party, leaving their alliance close to collapse. Snap elections in October look likely, with financial markets fretting that a stand-off between Italy and the EU over the country’s budget will be re-ignited.
For investors looking to focus on the corporate news which ultimately drives markets up and down, there are only thin pickings this week. There will be a sprinkling of US retail results to build on the relatively upbeat message from last week’s US retail sales data. Results are due from Home Depot, Target and Lowe’s. Meanwhile over here it is literally just a handful of companies that are due to announce results in the run up to the Bank Holiday weekend. Thursday is the busiest day, with numbers from Antofagasta, CRH, Rank and Premier Oil.
The good news is that second quarter earnings season has gone quite a bit better than feared when it started a month or so ago. With 93% of S&P 500 constituents having reported on the April to June quarter, earnings are tracking just 0.4% lower. That compares with expectations of a 2.8% decline. That said, if profits do remain in negative territory it will mark the first ‘earnings recession’, two quarters on the trot of lower profits, since 2016.
Another key driver of stock market prices, dividend yields, came under pressure in the second quarter as pay-outs grew at their slowest rate in more than two and a half years, according to the latest Janus Henderson Global Dividend Index. Dividend growth in the UK was faster than the global average at 8.6% but the record total of $35bn was boosted by some one-off payments as the likes of Rio Tinto paid special dividends.