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Market Update

May 2018

European politics add to a volatile month

A government crisis in Italy roiled global financial markets in May. Demand for government bonds, which are traditionally considered less risky than shares, rose sharply while European stocks declined as the crisis broke over the weekend of 18-21 May. The situation improved, however, by the end of the month as Italy moved towards forming a government. The turmoil in Europe helped boost the US dollar, which has also gained strength as the market focuses on the prospect of US interest rate increases. Political turmoil was not restricted to Europe. The United States moved towards raising tariffs on steel and aluminium imports from the European Union and its North American neighbours. Separately, the US pulled out of the Iran nuclear deal and re-imposed sanctions, which helped drive up the price of oil.

The two relatively Eurosceptic parties, which did well enough in Italy’s March elections to potentially create a coalition, reached agreement on forming a government in May, but their initial proposed ministerial line-up was rejected by Italy’s president. As a result, markets reacted sharply to fears of fresh instability in the Eurozone. The yield on the 10-year Italian government bond spiked (meaning the price fell sharply), while yields on UK, US and German government bonds dipped (prices rose) as investors sought safer options. The value of the currency, the euro, dropped during the month and European stocks underperformed those in other regions. (Italian bonds were able to recover some of their losses in early June as the political crisis eased.)

Global equity markets eked out gains despite these political developments, led by US stocks. The solid economic outlook in the US, as well as the strong earnings reported by US companies, boosted investors’ appetite for American stocks. The UK’s benchmark FTSE 100 Index rose as well, supported by the effect of sterling’s depreciation (FTSE 100 companies tend to have a high share of foreign earnings, so a weaker pound helps profits because customers have to pay more in their own currencies). Strength in the price of oil for most of the month lifted UK energy stocks. European and emerging-market (EM) stocks underperformed. (Emerging markets are those countries whose economies are still developing – for example, Brazil, India, China and Russia.)

Credit markets, which include government and corporate bonds and other debt instruments, broadly followed the lead of equity markets. ‘Spreads’ (the difference between yields on government bonds and lower-quality, higher-return ones) were little changed in the US, got wider in Europe and emerging markets, and widened more modestly in the UK. EM assets have come under pressure from rising US interest rates (many emerging-market nations hold a great deal of US-dollar-denominated debt, so it will cost them more to pay back). Emerging markets have also been facing home-grown problems in several countries, including signs of economic overheating in Turkey and chronic fiscal deficits in Argentina. Indeed, Argentina turned to the International Monetary Fund for support in May. An environment of higher oil prices also affected the outlook for some oil-importing EMs.

The oil price rose further over May, although it dipped back somewhat by the end of the month as investors grew concerned about what impact the US sanctions on Iran might have on global supply. (Lower supplies usually mean higher demand, which is what drives up prices.) Real estate assets generally underperformed stocks, with one vehicle tracked by Scottish Widows rising 0.5% on the month.

Equities data sourced from Financial Express. All other data sourced from Macrobond.

Should I make any changes to my investments?

Everyone’s circumstances are different and we aren’t able to give you advice on what is appropriate for you. As always, if you are considering your own position, you should remember why you invested in the first place and consider the lifespan of your investments.

One way in which you can help reduce the impact of any market volatility is to spread your investments across different asset classes and regions. For more information about investing across different asset classes take a look at our Introduction to diversification in multi-asset funds guide.

Remember that before making any changes to your investments, you should seek financial advice. If you don’t have a financial adviser, you can find one local to you by visiting Speak to an expert , which is responsible for promoting financial advice in the UK.

All figures quoted are in sterling terms to 31 May 2018 unless otherwise stated.