Monthly viewpoint


Overview of markets in Q3 2016



  • It was a generally positive quarter for markets and volatility across equities and fixed income was markedly lower compared to recent quarters.
  • US equities advanced and expectations rose that the Federal Reserve (Fed) would increase rates again before the end of 2016.
  • Eurozone equities made gains with economically sensitive sectors such as information technology and consumer discretionary outperforming.
  • UK equities moved higher against a more stable domestic political backdrop following the EU referendum vote. The Bank of England launched a series of monetary easing measures.
  • Japanese stocks were supported as the government released details of a fiscal spending package designed to run alongside the Bank of Japan’s continuing aggressive monetary policy.
  • Emerging market equities delivered strong returns as investors focused on high yielding assets. Among the equity markets to benefit most from the yield-seeking trend were Brazil, Russia and South Africa.
  • In bond markets, the 10-year Treasury yield climbed over the period while gilt yields fell. Global corporate bonds performed strongly.

US equities performed well and the S&P 500 advanced 3.9%. Expectations rose that the Federal Reserve (Fed) would increase rates again before the end of 2016, firstly after the central bank suggested it was more relaxed about the potential wider repercussions of the UK’s decision to leave the European Union (EU), and then after it noted that the case for a further rise had become stronger.

Fed chair Janet Yellen told the annual Jackson Hole symposium of central bankers at the end of August that the argument for a hike had “strengthened”. This view was repeated in the statement following the 20-21 September meeting of the Federal Open Market Committee (FOMC), despite a mixed macroeconomic backdrop, with US non-farm payrolls1 falling short of expectations for August, albeit following strong numbers for June and July.

The technology sector outperformed on the back of strong results and, as the probability of a rise in base rates in 2016 increased, financials performed well too. Banks recouped some of their losses from earlier in 2016 when the market had expected interest rates to remain at 0.25% for much longer. Bond proxies, such as utilities and telecoms, underperformed as they reversed their marked outperformed during the first half, when the probability of another rise in interest rates this year had seemed remote.

Eurozone equities made gains in the third quarter, which was marked by significantly lower volatility compared to the previous months. The European Central Bank (ECB) left monetary policy unchanged during the period.

Some investors had anticipated that the €80 billion per month of asset purchases would be extended beyond the current March 2017 deadline.

Macroeconomic data continued to indicate lacklustre growth and low inflation. Annual inflation ticked up in September to 0.4% from 0.2% in August while GDP expanded by 0.3% in Q2, slowing from 0.6% in Q1. The flash eurozone composite purchasing managers’ index dipped to 52.6 in September from 52.9 in August, indicating that growth remains positive but somewhat fragile.

Eurozone equities were supported by a generally encouraging second quarter reporting season. At sector level, economically-sensitive sectors such as information technology, consumer discretionary and materials advanced strongly. By contrast, sectors perceived as defensive (i.e. less economically-sensitive) like health care and utilities delivered slightly negative returns. Financials delivered positive returns overall. However, Deutsche Bank was a particular focus in September after US authorities demanded $14 billion to settle the sale of mortgage-backed securities prior to the global financial crisis. Deutsche Bank said it would try to negotiate the fine lower and insisted it would not need a state bailout.

UK equities performed well against a more stable domestic political backdrop following the EU referendum as Theresa May was confirmed as prime minister. Investors were also reassured by comments from the new Chancellor of the Exchequer, Philip Hammond, who said UK fiscal policy could be “reset” at the Autumn Statement to counteract an economic slowdown. The market was further supported as the Bank of England launched a series of monetary easing measures which were more extensive than expected.

Cyclical areas of the market outperformed amid a general return in risk appetite in anticipation that monetary policy globally would be kept looser for longer given ongoing concerns about the outlook for world growth. Meanwhile, some internationally diversified large-cap sectors, including healthcare and beverages continued to perform well as the second-quarter results season reflected the positive impact of sterling weakness following the UK’s unexpected decision to leave the EU. The FTSE All-Share index delivered a total return of 7.8% over the period.

Domestically orientated sectors deemed most exposed to Brexit, among them UK financials, enjoyed a relief rally. This was as the first hard economic data for the UK published since the “Leave” decision suggested that the negative impact on growth had been less than feared. Financials more widely outperformed, led by the internationally-focused banks, including HSBC which announced plans to return excess capital, representing quite a change in stance and underlining the recovery in its balance sheet. Basic materials were another top performer amid better-than-expected Chinese economic data. Investor sentiment was further buoyed by the prospect of a potential renewal of merger & acquisition activity after semiconductor design specialist ARM Holdings was acquired by Japanese technology company SoftBank.

The Japanese equity market rose by 7.1% in the third quarter. After the sharp appreciation of the yen in June, the Japanese currency made further modest gains. July began with continued volatility stemming from the UK referendum result seen in late June. A much firmer tone was then established in Japan following the

Upper House elections which resulted in a convincing win for Prime Minister Abe. His stronger mandate cleared the path for a significant fiscal spending package to be announced, aimed at stimulating economic growth over the next two years. With Mr Abe’s position reinforced, there has also been renewed focus on longer term structural reforms which seemed to have drifted down the policy agenda in the first half of the year.

For much of the rest of the quarter, investors’ attention was drawn to the review of monetary policy to be undertaken by the Bank of Japan at its September meeting. In the event, there was no change in short-term rates but an explicit shift to yield curve targeting was announced. This is aimed at alleviating some of the pressures generated within the financial system by a flat yield curve and negative interest rates.

There was a sharp reversal in market leadership in July and August, with defensive areas of the market such as food and pharmaceutical stocks beginning to underperform after many months of outperformance, while the market leadership switched instead to more cyclical areas of the market. Financial stocks also rebounded after particularly weak performance following the introduction of negative interest rates in January.

Asia (ex Japan)
Asia ex Japan equities had a strong third quarter as robust returns for the region were driven by continued global monetary easing in the wake of a shock Brexit vote in the UK. Chinese equities saw some of Asia’s largest gains over the period, with data showing that GDP expanded by 6.7% year-on-year in the second quarter – in line with expectations. However, share prices were supported by expectations from investors that more easing from the People’s Bank of China (PBoC) will be forthcoming towards the end of the year, given disappointing manufacturing and trade numbers over the summer months.

Meanwhile, in Hong Kong stocks finished up strongly on positive policy sentiment from China and as attractive valuations tempted mainland investors into the market. Over the strait in Taiwan, share prices saw robust returns driven mainly by technology stocks and as foreign investors returned to the market. Similarly, in Korea, equity prices advanced on a wave of buying interest from foreign investors.

In ASEAN, equity returns were strong in Thailand and Indonesia as both markets benefitted from a delay in expectations over the hiking of interest rates by the US Fed. The Philippines was the region’s biggest loser as unpredictable policy from new President Rodrigo Duterte and expensive valuations saw foreign investors sell down shares. Meanwhile, India’s market saw gains on positive reform momentum, primarily the passing of a much-awaited Goods & Sales Tax bill.

Emerging markets
Emerging markets delivered a strong return in the third quarter as global central banks maintained an accommodative policy backdrop. This led investors to focus on high yielding assets, which was beneficial for emerging market equities and currencies. The MSCI Emerging Markets index increased sharply in value and outperformed the MSCI World.

China was among the strongest markets, as macroeconomic data appeared to stabilise, with manufacturing purchasing managers’ index (PMI) climbing to 50.4, and the market recovered from weak performance earlier in the year. Brazilian equities were firmly up, as the Senate voted to impeach President Rousseff, permanently removing her from office. Vice-President Temer, who has set out a market friendly adjustment programme to put the economy on a more sustainable path, takes the helm until the next scheduled presidential election in 2018.

By contrast, Turkey underperformed as elements of the military attempted a coup. The attempt failed but the government implemented a state of emergency, detaining large numbers of suspected collaborators. Two sovereign debt ratings agencies have since downgraded Turkey to non-investment grade. The Philippines also recorded a negative return and was the weakest index country, as the market gave back some of the strong gains generated following the election of President Duterte in May.

Global bonds
Bond markets were strikingly calm in Q3, particularly when compared to the tumultuous final week of June. An initially negative market reaction to the surprise Brexit vote passed quickly and in July markets returned to the more familiar ground of assessing policy moves from the world’s major central banks. The Chicago Board Options Exchange SPX Volatility Index (the VIX) – as a broad measure of market stability – reached lows in the quarter seen only a handful of times in the past 25 years.

In the US, economic momentum continued to track broadly in the right direction and by September the Federal Open Market Committee was split on whether to raise rates. The 10-year Treasury yield climbed from 1.47% to 1.59% in Q3. The extension of policy accommodation by the BoE in August pressed gilt yields lower, while the ECB’s decision to leave its current range of support measures unaltered meant that Bund yields barely moved. The 10-year gilt yield fell from 0.87% to 0.75% and the 10-year Bund yield fell fractionally from -0.13% to -0.12%.

Global corporate bonds performed strongly over the period. Sterling corporate bonds gained the most ground of major credit markets. The investment grade2 (IG) BofA Merrill Lynch Sterling Corporate index generated total returns of 7.3% and outperformed gilts by 5.2% despite a softer September. High yield sterling bonds gained 6.2%. The US IG index rose by 1.4% and outperformed Treasuries by 1.8% while euro IG credit generated a total return of 1.9%. The high yield dollar and euro indices generated 5.5% and 3.5% respectively.

Convertible bonds benefited from equity market tailwinds in the third quarter. Starting from post-Brexit lows, the Thomson Reuters Global Focus convertible bond index increased by 3.5% (in USD terms) over the quarter. This resembles a participation rate of about two thirds of the uptrend. On a risk-adjusted scale, convertible bonds showed their qualities especially in the short-lived setback during the second trading week in September. Implied volatility, as a typical measure of the price for the conversion right, stays suppressed and convertible bonds remain cheap.

The Bloomberg commodities index decreased in value over the third quarter. Agriculture was the weakest segment with declines in soybean (-17.3%), wheat (-14.1%) and corn (-10.7%) prices all weighing on returns. Favourable weather conditions in the US, which suggested that global supply may remain plentiful, served to push prices lower.

The energy component also posted a negative return. Brent crude was down 1.3% over the quarter, despite a rally in September as OPEC announced an outline agreement to a production cut. By contrast, industrial metals recorded a positive return, led higher by nickel (+11.5%), which gained on concerns over supply disruption in the Philippines, and zinc (+12.6%) prices.



1 Non-farm payrolls are a means of measuring employment in the US and represent the total number of people employed, excluding farm workers, private household employees and those employed by non-profit organisations.

2 Investment grade bonds are the highest quality bonds as determined by a credit ratings agency. High yield bonds are more speculative, with a credit rating below investment grade.


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