After a period of remission verging on complacency, markets were dramatically infected by coronavirus in the final week of February, with the sharpest weekly fall in equities since the financial crisis. The trigger was the realisation that the spread of the virus beyond China, and in particular into Europe, was not only inevitable but immediate, with Italy’s economic
heartland suffering an extremely serious outbreak which is still in its early stages. Taking a line from the damage caused to China’s economy, investors began to discount a very sharp contraction in economic activity in Europe, and globally, as the virus continues its inevitable spread, now in 86 countries and rising. The impact on economies is immediate, with factories closed, supply chains interrupted, travel and leisure activities curtailed, services withdrawn and large parts of the worst affected countries, China, Italy, South Korea and Iran (and the expectation of many more to follow), in effective lockdown.
Markets started 2020 in much the same way that they ended 2019, with investors buoyed by the expectation of ultra loose monetary policy for a long time ahead, diminished risks from trade wars and Brexit, and the prospect of a recovery from 2019’s growth slowdown as manufacturing showed signs of recovering from the slump of the past 18 months. The sharp escalation in the US-Iran feud in early January led to a surge in gold and oil prices but fears of a more widespread and deeper escalation of hostilities quickly dissipated. By mid month global equities had added 2.5% to the strong returns of 2019.
As the year began, so it ended, with yet another strong month for risk assets in December, capping one of the best years for markets since the financial crisis. Equities again led the charge, but leadership for once slipped from the US to emerging markets, which returned 7.5% in the month, well ahead of the US and MSCI World with 3.0% returns. This resulted in full year returns for the US of 30.7%, MSCI World 27.7% and MSCI Emerging Markets 18.4%. The ‘risk on’ environment led to safe haven government bonds weakening while high yield and emerging market bonds produced gains of 2.0-3.0%, with annual gains of 14.3% (US high yield) and 12.6% respectively.
Markets are heading into the final weeks of the year with some extraordinary gains for the year to date. November proved to be another strong month for risk assets, led by equities and in particular the US, up 3.6% for the month, taking its return so far this year to 26.9%. The contrast with the fourth quarter of last year, when Wall Street fell 20%, could not be more stark, and reflects to a large degree the policy pivot by the Fed, followed by other central banks, from tightening to easing policy. Markets have shrugged off the sharp downturn in global trade and manufacturing, as well as a tough year for corporate profits, which have been broadly flat, and have recovered all the ground lost in that sharp setback of Q4 2018. While the US has led the way and has reached a new all-time high other equity markets have also performed well: Europe ex UK gained 2.6% in November, 25.1% this year so far, while even the laggards among developed markets, Japan and the UK, have gained 16.4% and 13.3% respectively this year, after solid returns in November. The MSCI World index, dominated as it is by the US, was up 2.8% in the month, 24.0% year to date.
Risk assets made further progress in October, with equities leading the way. Wall Street gained 2.1% and reached a new all-time high, but, as in September, the best returns came outside the US: Japan was up by 5%, Asia ex-Japan by 4.5% and emerging markets by 4.2%. Among the major markets, only the UK was down (-2.1%) as a strong rally in sterling put pressure on the big overseas earners, which dominate the UK stock market. The improved appetite for risk was reflected in bond markets, with safe-haven government bonds flat or down while credit markets produced positive returns, led by US corporate bonds up 0.6%.
After the spike in volatility in August, markets returned to a semblance of stability in September, but this masked some big underlying shifts across and within asset classes. Most notable was a sharp reversal early in the month of bond yields, which until then had trended inexorably lower throughout 2019: the yield on 10 year US Treasuries moved from below 1.5% at the beginning of the month to 1.9% within a matter of days. Somewhat more positive economic data and an apparent thawing of trade war rhetoric between the US and China proved to be the trigger for a reversal of some of the big bond moves seen in August, and risk appetite picked up.
The nervousness which had been creeping into markets during July intensified in August, with growing fears of a more broadly based global economic slowdown than the manufacturing contraction evidenced in the past 9 months. Equities fell sharply across the board, with the largest falls in the most economically exposed sectors and financials, the latter suffering from the dramatic shift down in interest rate expectations in recent weeks. In contrast, safe-haven government bond markets rose sharply, taking yields in many cases to new all-time lows. In the same vein, industrial commodity prices fell sharply, with the key iron ore price falling by 24% in the month, whereas precious metals rose; gold was up 7.5% in August, taking its rise this year to 19%, while silver did some catching up with gold, rising 13% in the month, bringing its rise this year in line with gold.
While most markets extended their gains in July and Wall Street reached new all-time highs, the moves were more muted than in the first half of the year, with some markets falling, notably in Asia, taking the Emerging Markets index down 1.2%. Gains that were made were modest, with the UK the biggest gainer in local currency terms, up 2.1%, but this was driven largely by a sharp fall in sterling which benefits the big listed offshore earners which dominate the UK stock market. Government bonds were generally firm as yields drifted lower while credit markets performed well with investment-grade corporate and high yield bonds each returning 0.6% and emerging market debt 0.8% in the month, taking a year to date returns for all 3 sectors into double digits.
The trade war-inspired sell-off in equity markets in May rapidly reversed in June, while yields on bonds continued the decline that started in late 2018, leaving nearly all asset classes in positive territory for the month. The US again led the way, returning 7.0% in June, taking the MSCI World index up 6.6%, while emerging markets participated fully in the rise, returning 6.2%. The notable laggard was Japan, up only 2.8%, while the UK was held back by Brexit worries, returning 4.0%. Bond markets also rallied strongly with most gaining 1-2% or in the case of emerging market bonds 4.1%.
To say we are living through extraordinary times is beyond dispute. The current economic expansion in the US is soon set to become the longest in history, employment growth in the US and elsewhere has been very strong, monetary policy across the developed world remains ultra-loose by any historical standard and yet inflation is still remarkably subdued. Indeed, recent falls in core inflation measures especially in the US have rattled investors and raised fears of weaker growth and tougher conditions for the corporate sector ahead, and in Europe and Japan of prolonged deflation. US inflation as measured by core PCE deflator has fallen to 1.6%, well below the Fed’s target of 2%, which has hardly been breached throughout the post crisis decade.