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 be divided broadly into two distinct parts; the first two quarters of the year, and 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%, whilst emerging markets posted a gain of 10.6%, aided by a strong come-back of China (+13.0%).4
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, there was a general shift from growth to value investing, 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 twice by 25bps. Various emerging market economies, such as India, Thailand, Indonesia and Mexico followed suit by cutting interest rates.6 The European Central Bank (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.
The US economic data so far remains largely robust, with employment and consumer spending looking healthy. However, recent manufacturing data points towards cracks in the surface.7 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. Historically, such inversions have been associated with a pre-recessionary environment.8
In Europe, concerns over an economic slowdown have increased, as Germany, one of the growth engines in the region, struggles with export demand and a decline in manufacturing output. Calls for fiscal stimulus are growing from within, as well as outside the country. Further, progress in Brexit negotiations came to a halt on 20 October 2019, when the British Parliament rejected to vote on the new Brexit deal and asked Brussels for a further extension of the Brexit deadline past 31 October 2019.
In the meantime, the Chinese market continues to be heavily impacted by Trump’s trade war rhetoric and the ongoing protests in Hong Kong. During the quarter, emerging markets generally struggled against a strengthening US dollar.9
One may argue that this year’s market highs do not adequately reflect the underlying fundamentals and economic developments, with investors seemingly having already priced in future easing measures.10 Given the markets’ interconnectedness, any large news can lead to chain reactions, with local jitters quickly translating into global movements.
Various economic, as well as political developments, are, therefore, likely to keep markets in suspense till year-end: Markets will continue to closely watch US-China trade relations and global manufacturing outputs alongside consumer sentiment. On the political front, the ongoing congressional investigation of President Trump, the continuing Brexit negotiations, protracted protests in Hong Kong, and strained geopolitical relations between Iran and Saudi Arabia, will be examined by markets.
One pressing concern is, whether 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)11 and exchange rate pressures. Against this backdrop and with stock markets acting as a barometer of the economy, the 5.2% YTD market decline12 does not come as a surprise.
Following a drop in business and consumer confidence, the Central Bank of Sri Lanka loosened monetary policy by lowering its key interest rate by 50 bps twice, in May and August respectively. The market welcomed this move and performance has risen to 8.1% since the end of May 13 after having temporarily plummeted to its lowest levels since 2012 in mid-May. The upcoming presidential elections in November are likely to have a significant impact on the development of the Sri Lankan market.
The elections will be closely watched by both investors and 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 puts significant pressure on both, the market and the Sri Lankan Rupee. The elections are, therefore, an important building block to reaffirm investor confidence in the economic and political environment, as well as Sri Lankan businesses.
Alongside the election outcome, the recently observable global shift of investor preferences towards value stocks may further lead to increased investor interest in the Sri Lankan market. In the past the Sri Lankan market appears to have been overlooked despite attractive valuations, and large diversification benefits that is has offered to major markets such as the US.14 The market is currently 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.15 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).16 November, therefore, has the potential to mark the start of an influx of significant investments into the Sri Lankan Stock Exchange.
1Bloomberg: 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].
7Langley, K. and Bernhard, M. (2019). Dow Industrials Drop as Manufacturing Data Disappoints. [Online] The Wall Street Journal. Available at: https://www.wsj.com/articles/stocks-rise-as-investors-take-global-economys-pulse-11569917995 [Accessed 13 October 2019].
8Leatherby, L. and Greifeld, K. (2019). About when the next recession could happen. Bloomberg.
9Bloomberg: Dollar Index USD.
10Stegeman, H. (2019). Partying on a sinking dancefloor. Triodos investment Management. [Online] Available at: https://www.triodos-im.com/articles/2019/economic-outlook-q3-2019 [Accessed 15 October 2019].
11Asian Development Bank. (2019). Sri Lanka:Economy. [Online] Available at: https://www.adb.org/countries/sri-lanka/economy [Accessed 15 October 2019].
12Bloomberg: CSEALL Index LKR. Performance for 31/12/2018 – 30/09/2019.
13Bloomberg: CSEALL Index LKR. Performance for 31/05/2019 – 30/09/2019.
14Preiss, 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].
15Bloomberg. CSEALL Index LKR.
16Bloomberg. S&P BSE 500 Index INR and FTSE Set All-Share Index THB.
*Angela Huettemann is an incoming ODI Research Fellow at the Lakshman Kadirgamar Institute of International Relations and Strategic Studies (LKI). 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.