International Equity Commentary: July, 2014

Geopolitical Tensions, Weak Euro-zone Data Weigh on Equity Market Sentiment

International equity prices saw a modest correction in July as geopolitical tensions worsened in Ukraine and the Middle East. The risk of these conflicts spreading to wider areas and pulling in more countries unnerved the markets. Weak economic data from the Euro-zone also dampened market sentiment as hopes of a sustained recovery in the common currency region have faded. The European Central Bank decided to leave its benchmark rate unchanged, but said it is preparing for a possible quantitative easing program. Meanwhile, better than expected U.S. GDP growth during the first half has led to renewed fears of an early interest rate hike by the Federal Reserve. Still, the Fed continued to maintain its earlier position of holding low interest rates through most of 2015 even as its bond purchase program is expected to end by this October.

The Japanese economy likely contracted during the second quarter as consumer spending slipped after April’s tax hike. Nevertheless, domestic demand in Japan appears to be recovering earlier than expected as recent data has been mostly positive. Among the emerging economies, China expanded at an annual pace of 7.5% during the second quarter helped by the government’s mini-stimulus program. Taiwan and Indonesia also saw steady growth during the second quarter, while output growth in Korea was softer than expected. Global manufacturing activity continued to expand during the month of July.

Near-Term Outlook

After raising expectations of a moderate recovery over the last one year, economic activity in the Euro-zone appears to be faltering yet again. Continuing tension between Russia and the developed countries over Ukraine has negatively affected business sentiment, and trade volumes are expected to decline as economic sanctions are enforced by both sides. Recent data suggest that the pace of expansion in Germany, the bulwark that prevented the region from slipping into a deeper recession, may be slowing. The German central bank estimates that the country’s economy, which accounts for nearly 30% of Euro-zone GDP, came to a standstill during the second quarter. German industrial orders declined unexpectedly in June, and could possibly restrict output growth during the second half of this year. Among the other large regional economies, France and Italy saw weak economic activity during the quarter. Both countries continue to struggle to regain industrial competitiveness that would support a sustainable recovery.

On the positive side, the Spanish economy continues to see a robust recovery. As well, labor markets across the region are also making slow progress as the unemployment rate has slipped marginally. Unless economic activity declines further, the Euro-zone is still expected to expand at a modest pace. The European Central Bank could widen its monetary policy support if the economy underperforms substantially, as the inflation rate has slipped further. Elsewhere in Europe, the U.K. continues to see better than expected economic expansion and is expected to sustain the pace during the second half of the year.

The outlook for the emerging market economies appears to be stabilizing after the uncertain trends seen at the beginning of this year. Chinese economic growth during the second quarter was better than expected and has allayed concerns that the country is facing a noticeable slowdown. Recent export trends from China have also been positive and, if sustained, should help aggregate growth during the second half. Select other Asian countries such as Korea and Taiwan also saw higher export shipments in July, lifting their economic outlook for the current year. Important elections to be held this year are expected to bring political stability and better policies in Brazil and Turkey.

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