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.
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.
