Trade wars spark global equities retreat as investors seek safe havens
Global equity markets broadly declined in May as an escalation in the trade war between the United States and China sparked renewed concern over global economic growth, prompting investors to turn to ‘safe havens’ such as government bonds, driving bond prices up and yields down.
The MSCI World Index declined by 2.5% and all major equity indices fell in a broad-based sell-off, which, according to MSCI data, saw the value of global stock markets tumble by $2 trillion in May. The biggest declines were in emerging markets, particularly China, with the MSCI Emerging Markets Index falling 4.1% and China’s CSI 300 Index declining even more steeply by 6.0% amid worries over the impact of new US import tariffs.
US shares also fared poorly with the S&P 500 falling by 3.4% and the tech-heavy NASDAQ Index falling by 4.6%. Technology shares were impacted by a decision by the Trump administration to ‘blacklist’ Chinese tech and telecoms giant Huawei, barring US firms from supplying components, a move that hurt shares in semiconductor firms.
More generally, optimism over trade talks between the United States and China evaporated, as President Trump played hard ball with China, imposing 25% tariffs on a further $200 billion worth of Chinese imports into the United States, prompting retaliatory action by China.
The mood darkened further when Trump opened up a new front in international trade wars, targeting Mexico with a threat to impose import duties of 5% rising in increments to 25% unless Mexico stems the flow of illegal immigrants to the United States. The move came as a surprise to markets as the United States had previously agreed a tripartite trade deal with Mexico and Canada (the United States-Mexico-Canada Agreement).
A critical question now is whether given current turmoil, the US Federal Reserve is more inclined to cut interest rates to help the economy. Conflicting signals have emerged: the yield on the three month US Treasury bond exceeded that of the 10 year US Treasury bond once more in May (known as yield inversion), a market event that has historically been read as a warning signal for recession. US corporate profits also fell by 2.8% across all companies in the first three months of the year. However, US GDP data for the first quarter was higher than expected at 3.1%, indicating the economy is in reasonable shape. US Federal Reserve Chairman Jerome Powell indicated that the Fed is open to rate cuts if it deems they are “appropriate to sustain the expansion”.
European shares were also weaker, but declines less severe, with the FTSE Europe (ex UK) slipping 1.4%. Key events included the European Parliamentary elections which resulted in political upsets in Germany where hopes for a smooth transition of power were dashed as Chancellor Angela Merkel scrapped plans to retire. The European Commission made a modest cut in its 2019 economic growth forecast for the Eurozone to 1.2% from 1.3%, but a more radical cut in its 2019 forecast for Germany to 0.5% from 1.1%. China is a major trading partner for Germany and exports, particularly automotives, make a major contribution to Germany’s GDP.
In the UK, shares and sterling were pummelled by fresh political drama as Prime Minister Theresa May announced her resignation, leaving the country in political turmoil and without a Brexit deal in the run-up to a new departure date of October 31. The FTSE 250, which comprises companies mainly exposed to the UK economy, fell by 4.0% while the FTSE 100, whose companies derive two-thirds of earnings from exports, fell by 2.9%. A decline in the value of sterling against major global currencies generally pushed share values lower.
The UK economy has continued to expand despite Brexit worries although there are concerns that a jump in the manufacturing sector will prove to have been a short-lived blip caused by pre-Brexit purchases, while there are also signs of weakness in the construction sector.
Fixed income assets largely benefited from a flight from perceived higher risk assets into relative ‘safe havens’, particularly government bonds. Yields for both German and Japanese government bonds were both in negative territory in May, reflecting rising demand which boosted prices and depressed yields. The ICE BoAML European Broad Market Index rose by 3.7%.
In the United States the yield on the 10 Year Treasury bond ended May close to 2.1%, a level not seen since late 2017, while the ICE BoAML US Corporate Bond Index rose by 1.3% in sterling terms. Elsewhere in corporate bonds, the IBOXX UK Sterling Corporate All Maturities Index rose by 0.7%.
Among commodities, the biggest movers were oil and gold. Brent crude prices fell by more than 7% to around $62 a barrel and are now around 20% off their April peak, reflecting concern that slowing global economic growth will reduce oil demand. Meanwhile the gold price rose 2% in May to around $1,300 per ounce, the first monthly gain since January, driven by a hunt for ‘safe haven’ assets.