Early developments in 2019 have been dominated by IHS Markit PMI indices indicating slowdown in manufacturing activity both in China and the Eurozone. In turn, these suggest that equity market sentiment may face continued pressure in early 2019. Greater economic uncertainty also represents an adverse indicator for riskier categories of debt, with investors likely to seek a "flight to quality" favoring highly-rated instruments: this has been reflected in the limited 2019 issuance calendar so far.

The latest Caixin/Markit PMI index indicated manufacturing sector contraction in China for the first time in 19 months. The figure was significantly below consensus expectations, showing a December reading of 49.7%, down 0.5 percentage points versus November. It prompted a weak start to 2019 for Asian equity indices, with the Hang Seng Index falling 3% on the news.

Chinese equities were the worst performing globally in 2018. The Shanghai Composite index lost 24.65 during the year, with the information technology segment of the index down over one-third. The Shenzhen index lost 33.3% over 2018.

Adverse equity market sentiment was further supported by Eurozone PMI data, released for December on 2 January. The IHS Markit index fell to 51.4%, versus 51.8% in November, its lowest level since February 2016. The figure was described by Chris Williamson, Executive Director, as a "disappointing December" within a trend "in which a manufacturing boom faded away to near stagnation". Italy and France showed levels below 50%, indicating the prospect of overall contraction.

Continued indicators of economic slowdown encourage inflows to higher-quality bond assets, boosting demand for strongly-rated sovereign, supranational and agency debt but reducing enthusiasm for emerging market assets and other riskier instruments. Unsurprisingly this week's limited debt issuance has focused on higher-quality transactions. Both European Investment Bank and KFW have announced plans to raise sterling issues, with borrowers expected to front-load sterling issuance given Brexit uncertainties. KFW is planning a December 2021 benchmark fixed-rate sale. There have also been German covered bond sales, with Commerzbank opening the Euro-denominated sector with a EUR1.5 billion five and 15-year issue. LBBW also is opening books on a Pfandbrief sale on 3 January. EFSF has requested proposals for a Euro-denominated benchmark and is expected to launch a large short to medium-dated issue next week.

Our take

The new PMI data provides relatively grim indicators, pointing to slower economic growth both in the EU and China. Citing Chris Williamson, "continued worries over global trade, ongoing political uncertainties and tightening financial conditions served to undermine confidence in December". As such, the new PMI releases do little to revive sentiment in equity markets or for riskier classes of debt, and suggest that markets could well start the year with further volatility and pressure on stock valuations.

This week also is affected by continued holiday absences in Europe, with full market staffing likely from 7 January. Developments next week thus may give clearer indications of market direction. Nevertheless, in late 2018 we identified that many asset managers were taking a cautious stance: while potentially attracted by the sharply lower valuation levels available in equity market, they were also concerned by initial signs of economic slowdown and lower earnings growth trajectories. As such, the PMI releases are likely to dampen sentiment, and increase the risk that markets will start the year adversely. In such circumstances, early 2019 cash flow is likely to favor higher-rated debt instruments, and this certainly has been reflected in the limited amounts of bond supply so far.

Posted 04 January 2019 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence