Equity markets continued to rise in October, with several indices hitting all-time highs. The MSCI AC World Index has now risen for twelve consecutive months, taking 12 month returns to 23.2%. Volatility, typically measured by the VIX index, also reached alltime lows. The global economic backdrop remained supportive for equities with the synchronised global recovery continuing, as many economies, irrespective of geography, continue to expand.
The global economic backdrop was particularly beneficial to emerging market equities which continued to outperform developed markets, posting a 3.5% return in US Dollar terms, versus 1.9% for developed markets. Japanese stocks also outperformed, posting a 5.4% return in Yen terms, with investors reacting positively to the re-election of Prime Minister Shinzo Abe which should ensure continuation of stimulative policies. US equities rose 2.3% during the month, following better-than-expected GDP growth in Q3 of 3.0% annualised versus a 2.5% consensus, robust earnings data and unemployment falling to 4.2%. Given the backdrop of low inflation and the disruption from Hurricane Harvey and Hurricane Irma, the US economy and equity markets remained resilient.
During September the global economy continued to be supportive for risk assets, with global equities performing strong. Government bonds retreated in light of the more risk-on environment, whilst the US Dollar strengthened towards the end of the period, a contrast to its large year-to-date falls.
During the quarter developed equity markets returned 2.2% with almost every major region partaking in the rise. Within developed markets, Japan posted the strongest returns in local currency terms advancing 4.3%, followed by Continental Europe with a 3.9% gain. Emerging markets posted returns of -0.4%, the first negative month since November 2016.
Economic trends globally remained broadly favourable and constructive for risk assets, demonstrated by equity markets realising positive returns for a tenth successive month. Despite this, a number of factors served to disturb markets and spike volatility to the highest levels since the US election. Three events were of particular concern to investors and led to flows into more defensive assets. Firstly, the serious escalation in the North Korean nuclear weapons crisis and increasingly bellicose rhetoric from the Trump administration has risen the risk of military conflict involving the US, China and Russia, potentially leading to dramatic global consequences. Secondly, Texas was hit by Hurricane Harvey, one of the strongest hurricanes ever to reach mainland US, causing immense damage, cost and disruption. Gasoline prices were immediately affected with the hurricane decommissioning 20% of US refining capacity, whilst insurance sector stocks fell steeply. Thirdly, the US debt limit came into light once again, with congress needing to raise the ceiling by 3rd October 2017 to avoid default.
So far this year, market trends have been dominated by strengthening economic activity in Europe and Japan, continuing growth in the US and Asia, and subdued inflation. Amidst this backdrop, markets have generally been benign, characterised by strong equity performance and stable bond markets. These trends continued into July, with equity markets again producing the best returns, led by emerging markets, whilst bond markets progressed with credit and highyield bonds outperforming government bonds. Volatility remained extraordinarily low with the VIX index reaching all-time lows. Perhaps the most notable feature of the month was the further slide in US Dollar, down 2.9% on a trade-weighted basis during the month and 9.1% year-to-date, moving to levels of early 2015. Oil was also a major mover during the month, forming a sizeable recovery with Brent Crude up 9.9% during July, reducing its year to date fall to 7.3%. The partial recovery of Brent crude was triggered by Saudi pledges to cut exports together with the first signs that the shale oil boom in the US is slowing.
The changes in tone from central banks drove global financial markets in June. The Bank of England and the European Central Bank appear unlikely to follow the path of the Federal Reserve in hiking rates this year. Political uncertainties in the UK grew in June following the Conservative party failing to achieve a majority just weeks before the beginning of already uncertain Brexit negotiations. In addition, questions linger over US economic policy and the ability to implement legislation.
Economic prospects in the Euro Area appear to be improving with GDP growth up to 2% this year, although inflation remains below target. The US has continued to grow, with an annual GDP growth rate of around 2%, whilst the UK has outperformed post-Brexit expectations, albeit with signs of a slowdown ahead. Emerging markets have benefitted from loose global monetary policy conditions and accelerating growth. In turn this has benefitted corporate profits, with earnings rising above the stagnant conditions of the past 2 years, up over 10% year-to-date in the US, and beyond this in Europe and Japan.
The benign conditions that have prevailed in markets through the past six months continued into May, with most risk assets producing positive returns. Equity markets again produced the best returns, led by the UK, Europe (especially peripheral markets) and Asia, but bond markets also made solid progress, as yields drifted lower and credit benefitted from a favourable corporate backdrop. Perhaps the most notable features, however, were a further slide in the US dollar, which fell 2.2% in May on a trade weighted basis, taking its fall to 6.1% from its early January peak and reversing all of the post election surge; as well as a further drop in the oil price in the face of stubbornly high global inventory levels and evidence of surging oil shale production in the US. Also notable was the continuation of extraordinarily low levels of volatility across markets, with the VIX ‘fear’ index hovering at ten year lows, punctuated only very briefly in May by concerns that the Russia/Trump scandal could lead to a further weakening of the President and his ability to implement some of his reflationary and business friendly policies and even lead to his impeachment.
In another good month for risk assets generally the pattern of performance and market leadership has shifted significantly. Following Donald Trump’s election victory in November the US equity market led the world up sharply, with the ‘reflation trade’ accounting for much of the rise. However growing evidence that winning Congressional approval for big policy initiatives such as tax cuts and reforms, and huge spending on infrastructure will be very difficult has meant the US market has stalled. Although the S&P 500 returned 1.0% in April it has traded sideways for two months. At the same time the USD has weakened against all major currencies on a trade weighted basis.
Despite a mid-month wobble in the US equity market, it was another benign month overall for equity markets and most risk assets made further upward progress, continuing the pattern of performance since Trump’s election success. Volatility remained remarkably low, and equities again outperformed bonds. The most notable moves included a change in leadership within equity markets, with Europe meaningfully outperforming the US, credit marginally outperforming sovereign bonds (which posted flat or negative returns), and a renewed slide in the US dollar against most currencies, leaving its trade weighted index down by 1.8% year-to-date. Despite further evidence of strengthening global growth, commodity markets were generally weak, notably the price of WTI oil declined by 6.3% over the month. A combination of accelerating growth and a weaker dollar helped emerging markets to another strong month, leaving them as the best performing equity market year-to-date (posting a total return of 11.4%).
The broad pattern of market performance since Trump’s election victory continued in February in a period notable for its particularly low volatility, with the Vix ‘fear’ index now at its lowest levels since the financial crisis. Equities, led by the US, significantly outperformed bonds again; global developed equities returned 2.8% in February compared with a return of 0.4% from global bonds, taking the year-to-date outperformance of equities to 3.9%.
The early weeks of 2017 in financial markets have been a sharp contrast to the same period in 2016, when markets fell sharply on fears about China’s slowdown and currency weakness. This year markets have continued their post-election pattern, rising on expectations of ‘Trumpflation’, and higher growth and corporate profits. Equities, again led by the US, have continued to outperform bonds, with the MSCI World index up 2.4% in January while global government bonds were up 0.9%. However, it was notable that global emerging markets, which underperformed markedly in the aftermath of the election amidst fears of trade protectionism and a strong dollar, recovered strongly, with the MSCI Global Emerging Markets index up 5.5% for the month, helped by currency gains and strong rises in Asian and Latin American markets.