Softer-than-expected flash PMI readings from Germany and France added to Italian government worries and trade war-related pessimism on Wednesday, spurring a classic risk-off session. Equity markets retreated in Asia (Hang Seng –1.8%) and Europe (Euro Stoxx 600 –1.15%), while 10-year US Treasuries and German Bunds fell more than 5bps early in the day. Safe-haven flows drove the Japanese yen higher against its peers, with EURJPY and USDJPY falling 1.6% and 1.2% respectively.
Signs of slowing Eurozone growth, along with global trade risks, are worth monitoring. And recent market developments underline our view that investors should prepare for choppier markets. But they should not conflate the need to manage risks with an impulse to avoid it altogether:
- PMI sentiment surveys tend to command more attention than they deserve, in our view. Since 2010, the correlation of the German manufacturing production PMI with actual German manufacturing production has been extremely low. An unusual surplus of public holidays near the weekend may have encouraged more "bridge" holidays in Europe, which may spur a production catch-up in the second half.
- Eurozone economic fundamentals remain promising. The labor market is showing strength, with healthy hiring expectations. The housing market has been robust, too, which should still underpin consumer confidence. We anticipate progress in US trade talks bolstering business confidence.
- Earnings, while not as stellar as in the US, offer some optimism. Despite base effects after last year’s strong showing (when earnings rose 30% over the same quarter), profits rose 3% for the quarter. And that’s against the backdrop of a 6% trade-weighted euro appreciation. The recent weakness in the single currency should relieve some pressure on exporters.
So we believe the market reaction today, like the PMI itself, reflects more sentiment than reality. An increase in volatility, including greater market sensitivity to data, is in line with our advice to rebalance portfolios and consider hedges for this stage of the cycle. We remain overweight global equities within our tactical asset allocation.
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