Strength in the US Service Sector raises concerns over further rate rises
Data released this week surprised economists by pointing to continued strength in the US service sector, despite the sharp increase in interest rates. The Institute for Supply Management Service Sector index was released on Monday, which provides an insight into the business conditions faced by service sector companies. The index came in at 56.5 for the month of November, up from 54.4 in the previous month (any number above 50 equals expansion, and below 50 contraction), and higher than the decline forecast. This unsettled markets trying to gauge when the Federal Reserve may pause their interest rate hiking cycle, designed to crush the sharp increase in inflation, but risking triggering a recession as a result.
Chinese equities continue to rally, despite weak import and export data
However, despite some very weak import and export data for the past twelve months, both domestic ‘A’ shares and offshore Hong Kong stocks in China made further gains this week, on a gradual relaxation of zero Covid rules. China has increasingly been seen to target economic growth over the virus for the first time since the pandemic began, accelerated by the wave of protests witnessed across China at lockdown rules.
As of 12pm on Friday, London time, US equities fell 2.7% over the week, with technology stocks dropping 3.3%. European markets fell 1.4% and UK equities slumped by 1.4%, with more domestic orientated mid cap stocks falling by 3.1%. Australian stocks fell by 1.2%, whilst Japanese equities bucked the trend in developed markets, rising 0.4%. Although for overseas investors this was all but lost through Yen weakness, which fell by 0.9% versus Sterling and 1.3% versus the Dollar. Emerging markets lost 0.5% despite Chinese and Hong Kong stocks rising by 1.6% and 6.6% respectively. The weakness came predominantly from Latin America, where markets fell by 3.0%, not helped by a sharp fall in the price of crude oil.
Government bond yields were broadly stable over the week, with the yield on 10-year US Treasuries now trading at 3.49%, German Bunds 1.88% and UK Gilts 3.12%.
Crude oil prices fall sharply, despite the European ban on Russian seaborne oil deliveries
Crude oil prices fell sharply in a week that Europe banned all seaborne Russian oil imports and the G7 countries imposed a $60 price cap. Although many thought this would have sent oil prices higher, a number of factors conspired to send crude oil around 10% lower. OPEC, the Organisation of Petroleum Exporting Countries, chose not to alter their production targets, having been expected to make cuts in response to the price cap. Future demand fears trumped supply constraints. This was exacerbated by the strong service sector data out of the US, raising concerns of the Federal Reserve sending the US into recession through further rate rises. And finally, the more limited supply destinations available to the Russians has meant Asian refiners have been able to negotiate lower prices. Brent crude is now trading at $76.3 a barrel and US WTI (West Texas Intermediate) $72.
Industrial metals rise as China relaxes Covid restrictions
Industrial metals made gains, helped by the gradual relaxation of covid restrictions in China. Copper rose by just over 1%, trading at $8,525 a tonne, and iron ore rose by almost 5%. Gold prices are up slightly, now priced at $1,813 an ounce.
Issues under discussion
Chinese ‘A’ shares have risen by over 10% since hopes have grown as to an end to the zero Covid policy, and offshore Hong Kong stocks have gone up by a massive 35% from very cheap, oversold levels. Whilst this continues to look like a gift to investors, especially against a difficult backdrop of western countries tightening monetary policy to combat inflation, there remain a number of headwinds for China’s switch to prioritising growth over health.
The efficacy of the Chinese vaccine is lower than those used in the developed world; the capacity of hospitals to deal with any sharp increase in Covid infections that comes with opening up is limited; and there remains a sizeable proportion of the population who are unvaccinated. All of this together means that although the opportunity in China looks attractive, as always, there remain plenty of risks. Our portfolios already have an overweight position to China versus global indices and at this juncture, we are not looking to increase exposure.