Equity markets continued to grind higher in September, reaching new highs while volatility dropped despite a geopolitically more agitated summer. The S&P 500 index broke above the 2 500 point level for the first time. European equities did even better with the German DAX index up by 6%. One driver was financials stocks, which benefited from a steepening yield curve. Across the English Channel, the FTSE 100 underperformed due to the rebound in sterling and a more hawkish tone from the Bank of England which signalled its intention to raise interest rates soon. Meanwhile, the US Federal Reserve started to reduce its sizeable balance sheet, inflated by several years of quantitative easing. This slow and cautious move had been well telegraphed by the Fed, so it did not destabilise markets as had the 2013 ‘taper tantrum’.
The performance of various asset classes in September illustrates the return of the ‘Trumpflation’ theme, i.e. the hope – kept alive by US President Donald Trump’s recent statements – of significant tax cuts, which supported equities, while dragging down bonds. These trends came in an economic environment already supportive of equities, particularly in the eurozone. Another potentially good sign is that crude oil prices rose even as the Vienna meeting of OPEC oil producers and its partners did not provide news for the markets. At this point, investors have become less concerned about the geopolitical context as any tensions appear to have been brought under better control by international bodies. In the US, some headway has been made in Congress, and the Republican party may now come around to approving fiscal measures, whereas voters had thus far been disappointed by the lack of reforms. For the moment, investors are not overly concerned about the outcome of the German elections. This could change if negotiations on forming a new coalition become bogged down, especially as investors are starting to look more closely at polls in the run-up to Italian legislative elections, which are expected to take place in the spring of 2018. Central banks remain cautious on normalising their monetary policy as they seek to ‘wean’ the markets off generously available liquidity. Even when done gradually, this could prove to be tough at a time when equities look overvalued, especially in the US.Download to read more