Market Overview
Global equity markets fell in October, snapping a five-month rally as bond-market pressure weighed on risk appetites.
With the trajectory of global disinflation well on track, the focus was squarely on the interest rate-policy paths of key central banks. All eyes were on the U.S., where the Federal Reserve (Fed) began its highly anticipated monetary easing cycle last month with a larger-than-expected 50-basis point (bp) rate-cut. While a slew of better-than-expected data released during the month bolstered optimism that the world’s largest economy was headed for a “soft landing,” they also forced bond traders to reset their expectations for how quickly and how deeply the Fed would ultimately reduce interest rates, as the U.S. central bank now seeks to protect the labour market and the overall economy without triggering a resurgence in upward price pressure. These lower expectations led to a sharp rise in Treasury bond yields, which, in turn, cranked up the pressure on global stocks by undercutting their appeal. The Fed is widely expected to lower interest rates by 25 bps at its next policy meeting in November. The yield on the benchmark 10-year Treasury note ended October at 4.29%, 50 bps higher than a month earlier.
Across the Atlantic, the European Central Bank (ECB) lowered interest rates for a third time in four months with a 25-bp cut in October. Data released during the month suggested that eurozone inflation accelerated a bit more than expected in October, bolstering the ECB’s cautious approach to cutting rates. With the region’s economic growth remaining stagnant, the ECB is expected to reduce rates by 25 bps at its next policy meeting in December. In the United Kingdom, news that year-over-year inflation in September had fallen more than expected stoked optimism that the Bank of England (BOE) will cut interest rates in November. However, the release of the U.K. Finance Minister’s first budget raised concerns that it would reignite inflationary pressure and force the BOE to cut rates more slowly. In October, the yield on the 10-year German Bund, Europe’s principal safe-haven asset, rose 26 bps to 2.39%.
Meanwhile, in Japan, the country’s central bank held borrowing costs steady in September but signaled that a rate-hiking cycle was on the horizon despite recent political turmoil and as the yen weakened against the U.S. dollar. Elsewhere in Asia, China’s central bank lowered its prime rates for one and five-year loans in its latest effort to address the country’s mounting economic woes.
The start of the third-quarter earnings season provided investors with the latest update on how company profits have held up against a shifting global monetary landscape. In the U.S., 75% of the companies in the S&P 500 Index that reported results topped consensus estimates, which was above the long-term average of 67%. The third-quarter earnings growth rate is estimated to have increased 5.1% from a year earlier. In Europe, 49% of the companies in the STOXX 600 Index that reported results posted better-than-expected earnings, below the 54% that do so in a typical quarter. The year-over-year third-quarter earnings growth rate is expected to have contracted 4.4%. In Japan, 43% of the companies in the TOPIX reported positive earnings surprises, falling short of the 58% of companies that exceeded earnings expectations over the past four quarters. The third-quarter earnings growth rate is estimated to have increased 3.8% from a year earlier. In Hong Kong, 60% of the companies in the Hang Seng Index that reported results delivered better-than-expected earnings, exceeding the 49% of companies that outperformed earnings expectations over the past four quarters. The third-quarter earnings growth rate increased 11.9% from a year earlier.
Against this backdrop, equity markets in both the developed and developing worlds fell in October, with the former outperforming the latter. In the U.S., the S&P 500 recorded its first loss after five consecutive months of gains, thanks to a surge in Treasury bond yields and a sell-off of some index heavyweight Big Tech stocks. In Europe, the STOXX 600 suffered its worst decline of the year, as rising government bond yields, weak economic growth in the eurozone and lukewarm earnings results offset news of another ECB rate cut. In Japan, the TOPIX retreated, as the yen hovered near a three-month low against the U.S. dollar. Meanwhile, in China, the Hong Kong-based Hang Seng Index fell due to worries about the effectiveness of past and future stimulus measures to revive the country’s ailing economy.
Materials was the worst-performing sector, as investors feared that China’s ailing economy will curb the country’s appetite for raw materials. Financials was the best-performing sector, as strong quarterly results from some U.S. banking giants boosted their stock price.
Outlook
The long-awaited start to the U.S. Fed rate cutting cycle is now underway. Following a brief initial positive reaction in September, stronger than anticipated economic data and U.S. Presidential election uncertainty led to a substantial increase in U.S. long bond yields which weighed on a broad range of our holdings during October. The significant performance gap between the U.S. and several key international markets also contributed to a weaker outcome during the month.
Utilities have been a key positive contributor to performance this year, albeit this has been heavily concentrated in the U.S. While we maintain a favourable sector outlook for Utilities and foresee scope for upward earnings revision, valuations have also re-rated higher, and we do not expect the same pace of returns for utilities to continue in the U.S. On the other hand, we continue to find very compelling valuations and opportunities in utilities outside the U.S.
Outside of the utilities sector, midstream energy, namely oil & gas storage and transportation, looks to have mostly shrugged off the downward pressure from oil & gas commodity prices as the earnings outlook remains favourable and valuations look compelling. The vast majority of the cash flows associated with the portfolio’s holdings are fee-based and enjoy strong support from the volume of energy molecules transported as well as favourable spread differentials at key access points.
Elsewhere within the portfolio, we see an abundance of opportunities stemming from large-scale investment in transportation infrastructure and renewable energy development, leading to increased demand for materials, capital goods and industrial equipment. We believe the portfolio remains well-positioned to take advantage of these opportunities in real asset infrastructure businesses as well as key enablers, including materials, services, and technologies, that will both facilitate and benefit from increased investment in infrastructure.
We believe publicly-listed infrastructure remains well-positioned to benefit from a continued brisk pace of investment, with plenty of runway ahead, and an end to the rate-hiking cycle, as eventually lower interest rates are used to discount cash flows that have been adjusted higher either for regulatory or contractual inflation-adjustment, or the indirect benefit of inflation adjustment that tends to stem from owning and operating high fixed cost, long life assets.
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Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries.
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Published on November 20, 2024.