September saw a significant rally in most major markets, with many surpassing their previous highs back in May or July.  The OECD revised upwards its H2 2013 growth forecasts for the US, Japan and Germany (all to 2.5%) as well as for the UK (1.5%, up from 0.8%).  This came after China, the US and the Eurozone all released purchasing manager surveys that showed the fastest rate of growth in the past 2 years.  In addition, the UK reported its fastest rate of service industry growth in the past six years.  Furthermore, the US Federal Reserve surprised the markets by maintaining its quantitative easing policy of buying $85bn a month of Treasury and mortgage bonds after having previously indicated that it would begin tapering the programme.  This led to yields on US Treasuries and German Bunds falling to 2.61% and 1.78%, respectively although still much higher than what they were earlier this year.

Commodities, which had recovered somewhat from their declines earlier in the year, also experienced significant losses.  Oil and gold suffered some of the worst losses, down -4.9% and -4.7%, respectively.  The decline in commodities, the reduction of tensions in the Middle East, good economic data in developed countries, and a stabilisation of China’s growth rate all led to a rally in almost every major equity market worldwide, with the MSCI World index up +4.8% for the month and up +15.3% YTD.

South Africa reported that its inflation rate increased to 6.7% annualised in August, potentially providing ammunition for the central bank to increase rates.  As mentioned in previous monthly commentaries, inflation has the perverse effect of benefiting South African equity prices, especially those of retailers where it translates directly into higher revenues.  The market has also benefitted from the globalisation of three firms in particular, SABMiller, Richemont and Naspers, which collectively have accounted for one quarter of the market’s returns since the 2008 financial crisis.  As a result of these factors, the JSE All-Share Index hit another all-time high, up +5.1% for September and +15.1% YTD.  Confidence in the rand currency has recovered to some extent, with the rand up +2.2% versus the US dollar, though it is still down -15.7% YTD as a result of investor flight from slowing emerging market economies.  South Africa continues to be plagued by miner strikes and the ruling ANC is struggling to amicably resolve this.

Further north, Nigeria’s President Goodluck Jonathan sacked nine cabinet ministers after they, along with seven state governors and a former vice president, left the ruling party to form a new political platform.  The new party is mainly concentrated in the Muslim northern part of the country, in contrast with President Jonathan’s southern Christian political base, potentially widening the north-south Christian/Muslim rift.  After a strong bull market rally earlier in the year, Nigeria’s market has cooled in recent months and was up a modest +0.9% in September, though still up +30.3% YTD.

In China, the government sacked the official (and many of his associates) responsible for overseeing state-owned companies, accusing him of corruption.  This is part of new President Xi Jinping’s efforts to reduce corruption and increase transparency within the government (and eliminate rival powers within the Communist party) and should be seen as beneficial for the long-term health of China’s economy and political processes. After slowing down very substantially in the second half of last year, China’s economy seems to have stabilised.  The price of new homes in China rose at its fastest rate in two and a half years, with Beijing and Shanghai homes in particular rising by 14.9% and 15.4%, respectively, on an annualised basis.  After struggling at the beginning of 2013, China’s equity market has moved up sharply since June and was up +3.6% in September, though still down -4.2% YTD.

India’s parliament approved a plan to provide food subsidies for two thirds of the population, effectively an expensive gambit by the ruling Congress Party and its coalition to shore up support in anticipation of next year’s parliamentary elections.  High inflation, a slowing economy, a persistent current account deficit, stagnant economic reforms, and an antagonistic attitude towards business have damaged confidence in India and led to a significant slide in the rupee currency.  However, the SENSEX 30 equity index recovered like other equity markets and ended up +4.1% for the month, though still down -0.2% YTD.

Australia’s centre right Liberal/National Coalition won by a landslide in parliamentary elections against the incumbent Labour Party, in part due to a slowing economy.  However, Australia seems to be benefitting from the recent resurgence of the Chinese economy, which is the largest customer of Australia’s natural resources.  The ASX 200 index was up +1.6% for the month and up +12.3% YTD.

In Russia, the incumbent mayor of Moscow (backed by the Kremlin) won re-election with only a 51% majority.  Surprisingly, the contest was relatively open with leading dissident Alexei Navalny allowed to run even though he has been convicted on trumped up charges.  Navalny ended up winning 27% of the vote (he had been expected to win 5%) in the greatest show of political opposition since President Putin came to power.  The IMF also cut its growth forecast for Russia to 1.5% in 2013 and 3% in 2014, far below the 5-8% the country has grown accustomed to. As a result, Russia trades at the lowest price/earnings multiples of any major market.  It bounced back to some extent (along with other emerging markets) from a low point in June, and the MICEX index was up +7.2% during the month but is still down -0.8% YTD.

To the west, Germany’s parliamentary elections gave the ruling CDU a significant plurality of seats in the Bundestag (five seats short of a majority).  However, the CDU’s previous coalition partner, the FDP, did not make it into parliament, forcing the CDU to look for either a grand coalition with the main rival SDP party or a smaller coalition with the Green party.  Though a return of the previous governing coalition would have been the best result, the CDU’s significant share of vote should ensure a stable government is formed.  On the back of good economic data, the DAX 30 index was up +6.1% during the month and up +12.9% YTD. However, Germany may take a few months to form a new government, resulting in a leadership vacuum during a period when Greece will need another bailout.

Neighbour France unveiled a barely credible budget, proposing spending and tax increases (France already has the highest effective tax rate in the Eurozone) to close the deficit but delaying reforms by a year.  This highlights the downside of the Eurozone bailout of peripheral countries and the normalisation of European government bond markets, as the impetus for reform dissipates despite acute structural problems in countries like France and Italy.  Still, the CAC 40 index was up +5.3% during the month and up +13.8% YTD; the French market has recovered along with the rest of the Eurozone as economic conditions have begun to stabilise in the currency bloc.

The US Federal Reserve will likely see vice chairman Janet Yellen become its next chairman after former Obama administration senior economic advisor Larry Summers ruled himself out of the running.  Yellen is an inflation dove so her appointment should be considered a positive for equity markets.  The S&P 500 index was up +3.0% for the month and +17.9% YTD.  However, the main issue in the US is the need to agree on a fiscal budget and to raise the federal debt ceiling.  The Treasury department has indicated that the lack of a budget and the inability to borrow would force the government to close some services starting the beginning of October and to run out of money by 1st November, literally defaulting on some of its obligations.

With the rally in September, the surge in developed market equities since the latter part of 2012 is now long in the tooth.  The S&P 500 is now overvalued compared to its long-term P/E ratio, and earnings growth has slowed significantly.  However, continual improvements in sentiment and economic conditions may continue to drive the market higher in the medium term.  In contrast, European economies seem to finally be gaining their footing, and though the Eurozone still has significant long-term issues, the lack of a major crisis event and improving economic numbers could continue to drive those markets higher.  Furthermore, successful implementation of reforms in Japan seems to be translating into economic improvement and should aid earnings growth, driving the market there higher.  Finally, a stabilising Chinese economy is now leading to an equity market recovery there as well as providing a boost to other economies dependent on selling natural resources to the country.

The biggest concern remains the budgetary and debt ceiling battle in the US Congress.  As at the end of September, parts of the federal government are shutting down due to the lack of a fiscal budget.  Though the shutdown does not cause a major crisis, it can still detract 0.25% from US GDP for every week the government is closed.  A continuing resolution will probably pass and take the budget debate into mid-November.  Both the Democrats and the Republicans are digging into their positions, all but ensuring that a compromise will only be achieved at the eleventh hour at best and leaving the potential for a highly binary outcome.

Sources:  RisCura, Bloomberg, US Energy Information Administration.

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