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Market Insights – 22 october 2018

Each week, a team of experts shares its market views with you.

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Essentials

The Chinese government unveiled a series of measures to boost investor confidence in domestic markets. The measures, which include tax cuts and support for private companies, helped push the A Share Index up by more than 7% in two days.

Last week, sales of existing homes in the USA fell to their lowest level in three years. Mortgage applications were also down 7%. These are both signs that rising interest rates – especially the 10 and 30-years rates – have hit the property sector.

Despite the ratings downgrade by Moody’s, the Italian debt kept their investment grade status. This good news should increase the appeal of the Italian bond market, as risk premium should drop its yields after rising beyond 3.27%.

Brexit: the name of the game

The likelihood of a hard Brexit has risen in recent weeks. Talks on the UK’s future trade relations with Europe are not getting anywhere, and the deadline of 29 March is fast approaching. This is keeping the markets on tenterhooks. The reason for the deadlock is clear: London and Brussels remain stuck on certain points, especially on the issue of the Northern Irish border. Although some progress was made during the latest round of negotiations, it wasn’t enough to break the stalemate. The next chance for a deal could therefore be at the European Council meeting in December. If that happens, the next major hurdle – and one
that should by no means be underestimated – will be getting the deal through the Commons. That will be no mean feat, given the infighting within the Tory party. We still expect a last-minute deal to be reached in the first quarter of 2019. However, at this point, we can’t rule out the possibility of a no-deal or a hard Brexit. The financial markets would not react well to this, and the pound and the UK stock market would likely lose ground as a result. Looking beyond the short-term impacts, we still think the UK market offers longer-term appeal. On the one hand, Brexit has made it one of the most unpopular markets among investors, which probably means that most of the uncertainty has already been priced in. On the other hand, UK stocks are very at-
tractively valued in historical terms, as shown by the share buybacks conducted by UK companies recently. Once the markets know the Brexit outcome, the uncertainty should finally fade, and investors will be able to turn their attention back to the fundamentals. The UK economy has slowed over the past two years, which has led to an increase in pent-up demand. At the same time, UK companies have had time to prepare for Brexit, and even for the possibility of a no-deal.

But which sectors should we go for? We remain bullish on commodities, which should do well as we approach the end of the cycle. If the pound stabilises, or even picks up from current oversold levels, we may move back into domestic stocks.

Corporate America to the rescue?

More than 150 US companies publish their quarterly results this week – that is almost one third of the S&P 500. They will release their earnings against a backdrop of heightened market volatility, as investors fret about a possible slowdown in economic growth. Yet Q3 results are expected to be robust: earnings are set to rise by more than 20% and revenues by 7%. Firms that have already published their figures have done better than expected, with 85% beating analysts’ EPS forecasts.

US equities are selling, and this has brought indexes down to critical technical resistance levels. And the lacklustre rallies seen last week suggest it may be difficult for the US market to reach new record highs in the short term. For this lull to be short-lived, quarterly earnings need to be strong enough to convince market operators that the US economy is still on a firm track. Tech stocks, in particular, will have to do well, as most of them are still highly valued. Once the US market has passed this test, we will adopt a more constructive approach to equities and invest in stocks that have fallen excessively.

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