November 1, 2019 Reading Time: 5 minutes
Image Credits: Central Intelligence Agency/flickr
This year, markets around the world have recovered significantly from the sell-off experienced during the last months of 2018, when panic-selling of technology stocks, trade-war fears and concerns over a global economic slowdown in times of more hawkish Central Banks took the centre stage, sending equity markets down.
Developed markets lost 8.7% in 2018, posting their worst yearly performance since 2008, whilst emerging markets noted a 14.6% decline 1, particularly struggling with a strengthening dollar 2. In comparison, the Sri Lankan All Shares Index fell 5.0%, whilst the S&P SL 20 Index, which features the 20 largest and most liquid stocks on the Sri Lankan Stock Exchange, declined 14.6%.3
After last year’s sell-off, the development of equity markets year-to-date (YTD) can so far broadly be divided into two distinct parts; the first two quarters of the year, and from the start of Q3 onwards.
During the first six months, equity markets have taken a sharp U-turn, gaining strongly following easing trade war tensions and more dovish Central Banks. Despite a short-term dip in May, the MSCI World Index increased 17.0%,4 whilst emerging markets posted a gain of 10.6%, aided by a strong come-back of China (+13.0%).
Q3 brought more mixed results, with another global sell-off taking place in August on the back of heightened trade war concerns. Against this backdrop, a general shift from growth to value investing has been observable, reflecting investors’ risk-off sentiment.5 Whilst developed markets posted muted returns over the quarter, emerging market stocks fell, strongly influenced by the Chinese market, which came under pressure again when Trump’s trade war rhetoric escalated.
Central Banks grew more accommodative around the world over the summer, reflecting increased trade-war concerns and a global economic slow-down: In the US, the Federal Reserve lowered interest rates for the first time since 2008, reducing rates three times by 25 bps respectively. Various emerging market economies, such as India, Thailand, Indonesia and Mexico followed suit by cutting interest rates.6 In Europe, the ECB re-introduced quantitative easing, indicating that the programme will continue until inflationary targets have been met, thereby making it country- rather than date-dependant.
In August, the US treasury yield curve temporarily inverted for the second time this year, when short-term bond yields surpassed longer-term bond yields, triggering further uncertainty. Such inversions have historically been associated with a pre-recessionary environment.7
In Europe, concerns over an economic slowdown increased during the summer, as Germany, one of the growth engines in the region, struggled with export demand and a decline in manufacturing output. Calls for fiscal stimulus have been growing from within as well as outside the country. Further, continuing Brexit talks weighed on markets, with investors yearning for certainty.
After a mixed third quarter, October and November have seen developed as well as emerging stock markets surge again, largely driven by investor’s bullishness on the US-China trade talks and hopes that both countries will sign a deal, ending a 16-month trade war. Positive economic data in the US, indicating a slight uptick in economic growth, as well as a more positive tone struck by Federal Reserve Chair Jerome Powell 8, led markets higher.
Various economic as well as political developments are likely to keep markets in suspense till year end: The US-China trade relations and global manufacturing outputs alongside consumer sentiment will be closely watched by markets. On the political front, the ongoing congressional investigation of President Trump, the upcoming general election in Great Britain, and escalating protests in Hong Kong will be examined by markets.
Against the above, one may ask if this year’s market highs adequately reflect the underlying fundamentals as well as economic developments and wonder if investors have already priced in future easing measures? 9 Contemplating the markets’ interconnectedness, it appears that any large news can lead to chain reactions, with local jitters quickly translating into global movements.
One pressing question is, if Central Banks have more to give should the current and accommodative policies not be sufficient to bolster economic growth. Additionally, it remains to be seen if countries such as Germany are willing to employ fiscal stimulus measures, thereby delivering an important second cornerstone to boost economic growth.
Sri Lanka had a difficult year so far, faced with the Easter Sunday terrorist attacks and the resulting significant drop in tourist numbers, slowing GDP growth (2.6% forecasted for 2019, down from 3.2% in 2018) 10 and exchange rate pressures. Against this backdrop and with stock markets acting as a barometer of the economy, the YTD pre-election performance of -0.5% 11 did not come as a surprise.
Following a drop in business and consumer confidence, the Sri Lankan Central bank loosened monetary policy by lowering its key interest rate by 50 bps twice, in May and August respectively. The market welcomed this move after having temporarily plummeted to its lowest levels since 2012 in mid-May.
The presidential elections on 16th November were closely watched by investors as well as rating agencies, after the top three rating agencies (Fitch Ratings, Standard & Poor’s, and Moody’s Investor Services) had downgraded Sri Lanka at the end of 2018 against political turmoil, which put significant pressure on both, the market as well as the Sri Lankan Rupee. Following the election of Gotabaya Rajapaksa as Sri Lanka’s 7th Executive President, the market has posted a total gain of 3.0% 12, leading to a YTD increase of 2.5% and highlighting investors’ positive sentiment. The President’s recently announced tax cuts are likely to provide additional tailwind for the market and attract heightened investor interest.
The newly observable global shift of investor preferences towards value stocks may further lead to increased investor interest in the Sri Lankan market, which in the past appears to have been overlooked despite offering large diversification benefits to major markets such as the US 13 and regardless of its attractive valuations: The market is trading at a price-to-earnings (P/E) ratio of 10.8, a 1.0 price-to-book (PB) ratio and a 3.1% dividend yield. It thereby provides an interesting and lucrative investment alternative compared to other emerging markets in the region such as India (trading at P/E 27.9, 2.5 PB and 1.3% dividend yield) and Thailand (trading at P/E 16.3, PB 1.7 and 3.3% dividend yield).
November therefore has the potential to mark the start of an influx of significant investments into the Sri Lankan Stock Exchange.
1 Bloomberg: MSCI World Net Return Index USD; MSCI Emerging Markets Net Return Index USD
2Jones, M. (2018). Markets suffer worst year since global financial crisis. [Online] Reuters. Available at: https://uk.reuters.com/article/us-global-markets-2018/markets-suffer-worst-year-since-global-financial-crisis-idUKKCN1OJ13U [Accessed 15 October 2019].
3Bloomberg. CSEALL Index LKR; S&P Sri Lanka 20 Index LKR.
4Bloomberg. CSEALL Index LKR; S&P Sri Lanka 20 Index LKR, MSCI China Net Return Index USD.
5Carosa, C. (2019). How you can profit as market shifts from growth to value stocks. [Online] Forbes. Available at https://www.forbes.com/sites/chriscarosa/2019/10/10/how-you-can-profit-as-market-shifts-from-growth-to-value-stocks/#3644283c6cb7 [Accessed 14 October 2019].
6Strohecker, K. and Carvalho, R. (2019). Down, down they go: Emerging central banks deliver most rate cuts in a decade. [Online] Reuters. Available at: https://www.reuters.com/article/us-emerging-rates/down-down-they-go-emerging-central-banks-deliver-most-rate-cuts-in-a-decade-idUSKCN1VN1J2
[Accessed 15 October 2019].
7Leatherby, L. and Greifeld, K. (2019). About when the next recession could happen. Bloomberg.
8Mutikani, L. (2019). U.S. economy picks up in third-quarter; data surprise on the upside. [Online] Reuters. Available at: https://www.reuters.com/article/us-usa-economy/us-economy-picks-up-in-third-quarter-data-surprise-on-the-upside-idUSKBN1Y11LI [Accessed 29 November 2019].
9Stegeman, H. (2019). Partying on a sinking dancefloor. [Online]. Triodos investment Management. Available at: https://www.triodos-im.com/articles/2019/economic-outlook-q3-2019 [Accessed 15 October 2019].
10Asian Development Bank. (2019). [Online]. Available at: https://www.adb.org/countries/sri-lanka/economy [Accessed 15 October 2019].
11Bloomberg: CSEALL Index LKR. Performance for 31/12/2018 – 15/11/2019.
12Bloomberg: CSEALL Index LKR. Performance for 15/11/2019 – 28/11/2019.
13Preiss, R. M. (2019). Sri Lanka’s Market: An Investment Gem Hidden In Too Much Pessimism. [Online] Forbes. Available at: https://www.forbes.com/sites/rainermichaelpreiss/2019/08/07/sri-lankas-market-an-investment-gem-hidden-in-too-much-pessimism/#55e2ee675df6 [Accessed 22 October 2019].
14Bloomberg. CSEALL Index LKR (As at the end of September 2019).
15Bloomberg. S&P BSE 500 Index INR and FTSE Set All-Share Index THB (As at the end of September 2019)
*Angela Huettemann is a Research Fellow at the Lakshman Kadirgamar Institute of International Relations and Strategic Studies (LKI) in Colombo. This is an updated blog. The opinions expressed in this article are the author’s own views. They are not the institutional views of LKI, and do not necessarily represent or reflect the position of any other institution or individual with which the author is affiliated.