Global equity markets outside of the United States have completed a third negative quarter, with the MSCI ACWI ex US IMI Index down 11.26% in the three months through October 30. For the year to date, this index is down 27.19%, which clearly indicates a “bear market.” By historical standards, global stock markets are very highly oversold. Risk-off sentiment strengthened as the quarter progressed. We do not know how long this situation will continue.
There are a number of factors putting pressure on both equity and bond markets. In a response to stronger and more persistent inflation, central banks, except for the Bank of Japan and the People’s Bank of China, are raising interest rates and reducing balance sheets. This is occurring at a time when demand is slackening. Earnings estimates are being downgraded. Geopolitical uncertainty is high, in particular with respect to the Russia-Ukraine conflict, where no de-escalation is in sight.
Advanced-market equities performed slightly better than emerging markets during the third quarter, while, for the year to date, emerging-market equities are slightly in the lead. The correlation of equity markets has increased. The Eurozone and UK economies are now in or close to recession. Business activity in Germany’s private sector was declining as the third quarter ended, while inflation was persistently high. Increased energy costs are an important headwind for German equities. The MSCI Germany Index declined 15.79% over the quarter. The French economy, in contrast, recorded a slight increase in growth in September, following a low in August, driven by recovery in the services sector and particularly in tourism. Nevertheless, French equities also eased, with the MSCI France Index declining 12.31%.
Across the Channel, UK manufacturing registered a sharp drop in production in September, falling at the fastest pace since January 2021, with inflationary pressures running very high. UK equities, which earlier in the year had been outperforming, declined some 13.42% over the quarter, according to the MSCI United Kingdom Index. The destabilizing policy missteps of the new UK government, requiring dramatic action by the Bank of England, will be the subject of a separate note.
Two other advanced markets have fared somewhat better in the third quarter. Canada’s manufacturing PMI signaled contracting output in both August and September and an economy that is losing steam, with a deepening correction in housing. Rising interest rates, easing oil prices, and weaker external demand from the US and other economies are projected to lead to very weak growth in the current quarter and in 2023. The MSCI Canada Custom Capped Index declined 8.91% in the quarter. In Japan, where a modest economic recovery continued in the third quarter despite weakening external demand, the equity market has outperformed the advanced-market average. The MSCI Japan Index lost just 6.35%.
Emerging-markets equities outperformed advanced-market stocks earlier in the year, but as the growth prospects for their economies deteriorated, that outperformance has faded. Reduced global growth means weaker external demand. The strengthening of the US dollar and increasing interest rates are significant headwinds for emerging-market economies and even more challenging for frontier-market and developing economies. The Chinese economy has slowed to an estimated 2.7% growth for the current year after last year’s 8.1% advance as China continues its restrictive zero-Covid policies and battles a property market collapse. This projection is well below the World Bank’s estimate of 5.3% growth for the rest of the Asia Pacific region. The MSCI China Index dropped 22.66% in the third quarter. South Korea’s and Taiwan’s markets were also sharply down. In marked contrast, India’s economy is doing relatively well, growing more than an estimated 6% this year. Indian stocks are outperforming, with the MSCI India Index registering a remarkable gain of 4.06% in the third quarter. In Latin America, an economic recovery in Brazil led to the Brazilian stock market’s gaining 4.7% in the third quarter and achieving a positive 8.68% advance for the year to date.
Looking forward, the many reasons for rising risk premia and the general weakness in the global economy cloud the outlook and make forecasting particularly difficult. A recession and a cold winter in Europe look likely. The Asia Pacific region, including a strengthening Chinese economy, is expected to lead the eventual recovery of the global economy. Some of the heavily oversold equity markets will become attractive opportunities while others may remain oversold for an extended period. Both diversification and selectivity will be needed, and portfolio changes may occur at any time.
William H. Witherell, Ph.D.
Vice Chairman & Chief Global Economist
Email | Bio
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Sources: Financial Times, Oxford Economics, Goldman Sachs Research, S&P Global PMI, ETF.com
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