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.
The extraordinary start to 2019 for global financial markets continued into April, with strong rises in most risk assets, led by equities, which have enjoyed their best start to a year in decades. All the major equity markets produced solid positive returns with developed equities again outperforming emerging markets, returning 3.5% versus 2.1%. US equities returned 4% in US dollar terms and hit another record high late in the month. The strong performance in the US was however exceeded by Europe, advancing 4.3% in euro terms, buoyed by signs that the sharp slowdown in growth across the eurozone was stabilising. Japan again underperformed, up 1.7% in April and 9.5% year-to-date, the latter making up half of the returns of the US (18%) and Europe (17.2%). Japan has been held back by slower growth this year, below 1% per annum, hurt by the slowdown in China and softness in global growth. The market’s underperformance leaves it attractively valued relative to other developed markets. China was the only market of note which slipped in April, however, this has followed a very strong first quarter performance, returning close to 30%.
Equity markets made further progress in March, despite a return to higher levels of volatility as concerns about the slowdown in global growth intensified. Developed market equities returned 1.3% over the month, taking the Q1 2019 return to 12.5% and recovering much of the ground lost in Q4 2018. US equities advanced 1.9%, supported by encouraging signs of progress in US-China trade talks and the increasingly accommodative stance of the Federal Reserve. In US dollar terms, Japanese equities underperformed the other major regions returning 0.6% while emerging markets returned 0.8%. Despite ongoing Brexit related uncertainty, the UK was a notable outperformer, up over 3% in sterling terms, with the UK’s big overseas earning companies boosted by weakness in the pound during the month.
The Federal Reserve inspired recovery in equity markets following the Q4 2018 sell-off, continued through February, albeit on a more mixed and less dramatic basis than January. European equities led the way with a return of 4.1% in euro terms, taking its recovery since the December low to 14%.
The US and Japanese markets broadly kept pace with Europe in February. US equities returned 3.1%, taking its recovery since the December low to 19% and leaving it only 4% off its all-time high. The major laggard was the UK, which returned 2.3% in February and 8% from its December low, held back by Brexit uncertainty and sterling strength, an important factor for UK stocks given that some 75% of listed company revenues are derived offshore. The MSCI World index returned 3% on the month and is up 17% from its December low.
What a difference a month makes. Following the despair of December, markets made one of their best ever starts to a new year, with virtually all asset classes and markets rising, some very sharply. Many equity markets managed to recover the ground lost in December.
The US led the way with a return of 8%, pulling the MSCI World index up by 7.8%. In this risk-on environment, emerging markets outperformed developed markets, up 8.8%, with Latin America again relatively strong, up 15%. While all markets were buoyant, the UK was the notable underperformer, up 3.7%. UK equities were held back by a strong pound which rallied 2.5% on a trade-weighted basis as fears of a no deal Brexit faded. All sectors of the markets rose, with
technology stocks leading the way after their particularly sharp falls in Q4 last year. The tech-heavy NASDAQ index was up 10% and the NY FANGs 13%, the latter having risen by 22% from the December 24th lows compared with a 15% rise in the S&P 500.
With broadening evidence of a global slowdown and both the Federal Reserve and European Central Bank continuing to tighten policy, investors took fright in December, resulting in steep falls across nearly all equity markets and a rush into safe haven assets. Having held up well during a difficult year for risk assets the key US market suffered a disastrous month, falling 9%, taking its return for the year into negative territory. The MSCI World index declined 8% for the month and 9% for the year, making this the worst year for markets since the financial crisis. Emerging markets also suffered but outperformed developed markets in December, the MSCI Emerging Markets index fell 3% in the month. That leaves emerging markets down 15% for the year but the nadir was reached in October and the big falls in markets in recent months have been concentrated in the US, Japan and Europe. Particularly steep falls came in the FAANGs stocks, which have fallen by around a third from their mid-year peaks.
Following the steep falls in October, a degree of stability returned to markets in November, but not without some considerable volatility during the month. Late in the month a more dovish speech from Federal Reserve Chairman Powell, together with hopes of some thawing of the US-China trade wars helped markets to post gains, led by emerging markets in Asia, up 5.2% in November, and the US, up 2.0%. This enabled the MSCI World Index to produce a gain of 1.1% and the MSCI Global emerging markets to gain 4.1% for the month.
The progressive removal of post crisis ultra-loose monetary policy, especially by the Fed, and the increasing evidence of a slowdown in global trade and growth, were the main drivers of markets. The US economy has remained buoyant, but the key housing sector is showing clear signs of slowing, with home sales down for the 6th consecutive month and other indicators pointing in the same direction. As the Fed has tightened policy the cost of finance has risen – the 30-year mortgage rates have increased by 1.5% over the past 2 years to around 5.0% – and has had a direct impact on costs to home buyers. Capital goods orders have also been softer, hurt by concerns about weaker growth globally.
Once again, the month of October delivered a torrid time for investors, leaving the goldilocks environment of 2017 dead and buried. In a sharp reversal of fortunes, which began at the end of September, very few asset classes produced a positive return in October. The classic safe-haven assets including government bonds, gold and the Japanese Yen produced positive returns, with the notable exception of US Treasuries posting a negative return of 0.5%. The equity market suffered the brunt of the selling, led by the Asian equity market falling over 10% in the month, while most other regions fell 7-9% in US Dollar terms. Despite a bounce in the final days of the month, the MSCI World Index declined 7.3%, a slightly smaller fall than the 8.7% decline in Emerging Markets.
After the sharp falls in emerging market currencies and markets in the previous month, a degree of stability returned in September. With the US equity market up 0.5% and indexes reaching new all-time highs, investors might be forgiven for thinking all was well. The MSCI World Index was up 0.6% with all regions producing gains, with the exception of Asia ex Japan equity market, which fell 1.4%. Emerging market equities were down modestly, falling 0.5%, dragged down by the poor performing Asian market. Emerging market currencies recovered by 1.6% in aggregate following the significant falls in August and emerging market bonds produced strong returns of 2.8%. However the modest headline moves and low volatility in the month hid a number of worrying undercurrents.
Perhaps August will go down as the month when the vulnerabilities to a US monetary tightening cycle and trade wars became abundantly clear. Although emerging markets have been under pressure since the peak in late January there was a marked deterioration during August, led by the most vulnerable countries, Turkey and Argentina. A toxic combination of factors in the current macroeconomic environment has resulted in contagion spreading. While some of the problems were self-inflicted a common theme as contagion spread was the high levels of offshore debt, built up in the era of very low interest rates and the majority being in US Dollar. Countries exposure to global trade has made them vulnerable to trade wars, and having high fiscal and current account deficits has raised uncertainty over their economic sustainability. In August, the Emerging Market Currency Index fell by 6.2%, notably the Turkish lira and Argentinian peso both fell by 25% (Figure 1). The Venezuelan bolivar devalued by 95%, however, Venezuela is known for being a basket case due to their low international debt and hardly having any impact on the financial stability of the global economy. However, the collapse of oil production has played a key role in putting upward pressure on Brent Crude. This volatility has dragged down emerging market bonds, with local currency bonds down 6%. Hard currency emerging market debt has fallen 3.1%, and subsequently resulted in a 7.3% fall YTD. Emerging equity markets fell sharply, the fall of 2.7% in the global index masking much bigger falls in Latin America, Russia, South Africa and Turkey. From the January peak emerging equity markets are down 16% and several are in bear market territory with falls of over 20%.