While geopolitics dominated the headlines in April, it was economic factors that primarily drove markets during the month and underpinned the recovery in most risk assets after sharp falls in previous weeks. Developed market equities rose 1.1% while fixed income markets witnessed declines in credit spreads with gains in high yield bonds despite weakness in government bond markets. However, the most notable and important moves came in an acceleration in the recovery of the US Dollar and a rally in oil prices.
From its low point in mid-February, the US Dollar had already been recovering, but the trend accelerated in April with the Dollar rising by 2.1% on a trade-weighted basis. The trend has been supported by continuing optimism around the US economy, despite a relatively subdued Q1 GDP growth reading of 2.3% and increasing evidence of an upturn in inflation. In response to the uptick in inflation, the Federal Reserve appeared mildly dovish in its April meeting, indicating it was prepared to tolerate a period of overshoot in inflation above its 2.0% target, however investors are anticipating a further rate increase in June and another before year end. This pushed the yield on two-year Treasuries to 2.49% by month end, its highest level since mid-2008.
After a broad sell-off across many asset classes in February, volatility continued into March, with equity markets declining and government bonds rallying. Risk markets were impacted by the prospects of a US-China trade war with President Trump continuing to push his ‘America First’ philosophy. Emerging market and developed market equities fell, with emerging markets marginally outperforming. US equities fell 2.6% during the month, taking Q1 2018 returns to -0.9%. A key contributing factor seemed to be President Trump’s imposition of tariffs on imports of Chinese steel and aluminium and proposals for further tariffs on a wide range of goods.
China immediately responded, imposing tariffs on several US imports, including wine. This led to worldwide concerns of a potential trade war, which could have implications for global growth. In addition to this, tech stocks, among the strongest performers in 2017, suffered sharp share price declines. This followed a serious data breach at Facebook which led to a series of governments seeking to tighten the loose regulation of companies in the sector, while tax authorities are seeking to impose more effective taxes.
Financial markets had a turbulent and more volatile month in February, with almost every asset class falling while the US Dollar rose on a trade weighted basis. Notably, after a record streak of fifteen consecutive monthly gains, the S&P 500 fell 3.7% in February. After a particularly strong January, global emerging market equities underperformed developed markets, although emerging market equities continue to outperform developed markets year to date. Global bonds suffered with yields generally rising amidst a better than expected jobs report in the US.
US markets fell sharply early in the month, with the S&P 500 falling 6.2% in the first three days of trading. This followed a strong jobs report, with wage growth beating expectations at 2.9%. With the tightness in the labour market yet to feed into wage growth and subsequently headline inflation, investors have been focusing on wage growth figures in anticipation of the trend reversing. The better than expected data indicated this may finally be the case and investors adjusted their inflation expectations and subsequently their forecast for the timing of future US rate hikes. This initially put bond markets under pressure, before concerns spread to equity markets.
The pattern in market performance during 2017 of strong equities, rising bond yields and a weakening US Dollar continued into January. Notably the S&P 500 produced its fifteenth consecutive monthly gain, with a rise of 5.7%. Global emerging markets continued to perform solidly, returning 8.3%, supported by the strength of the global economy and a weak US Dollar. Global bonds had a more turbulent month, with yields generally rising.
However, as the month progressed there was a distinct change in markets. Indications of continuing global economic growth, particularly in the US following tax reform progress, began to weigh more heavily on bonds with US Treasuries notably affected. 10 year US Treasury yields had already risen from 2.0% in early September 2017 to 2.4% by year-end, but rose quicker during January to end the month at 2.7%, the highest level for nearly four years. Signs of an inflation pickup, especially in the US where wage growth is rising amidst a tight labour market, heightened concerns that bonds were increasingly vulnerable. Towards the end of the month the sell-off in bonds, which spread from US Treasuries through to the UK, Europe, and somewhat to Japan, began to have an impact on equity markets, which retracted some of their earlier gains.
In December, markets continued to climb upwards, capping off a year of strong returns across asset classes. Risk assets benefitted from accelerating global economic growth and strong corporate earnings. Commodities, followed by equities posted the largest returns during the month. Global equities advanced 1.4% during the month, with emerging markets outperforming developed markets, posting a 3.6% return versus a 1.4% return for developed markets. 2017 was the best year for emerging markets relative to developed markets since 2009, returning 37.3% versus 22.4% for developed markets. US equities rose 1.1%, taking returns in 2017 to 21.1%. 2017 was the first year in history US equity markets posted positive returns for every month during the year. Within developed markets, the UK was one of the strongest performers posting a 5.0% return, while continental Europe underperformed returning 0.2% and declining 0.6% in Euro terms. In emerging markets, emerging Europe outperformed returning 5.3%.
In November the global economic backdrop continued to be supportive for markets, with a majority of asset classes posting positive, moderate returns. Developed market equities mostly performed strong, but were led by the US, while emerging markets underperformed for the second time in three months. In fixed income, November was a slightly risk-off month, with high-yield bond indices posting small losses due to credit spreads increasing.
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.