Financial markets were shaken out of their comfort zone in early February as global equity markets were severely impacted by a sudden spike of volatility and by fast-rising bond yields. Even if these factors were the main reasons for the turbulence of the markets, it is fair to affirm that equity markets were ripe for a correction as they had become extremely overbought and had been boosted by massive inflows during January.
Global equity markets got off to a spectacular start in 2018 as investors poured into equity funds at a record pace. In contrast, government bond markets have remained under pressure with yield curves gradually shifting higher and also steepening. The end-2017 weakness of the U.S. dollar against most currencies accelerated throughout January, reflected by a monthly drop of 3.3% for the dollar index.
2017 was a good year for the global economy and an outstanding one for equity markets
The global economy enjoyed its strongest rate of growth since 2011 with the most noteworthy aspect being that growth was broad-based and expectations were upgraded during the year. Geopolitical tensions, at times quite threatening, failed to dampen high levels of business and consumer confidence and had only a short-lived impact on capital markets. Concerns about European political events did not materialize as populist parties failed to create an upset in several general elections. Also, Emmanuel Macron’s spectacular rise to power in France was considered to be a major boost for the future stability of the European Union.
Equity markets had an unusually smooth ride throughout 2017 with strong and widespread corporate profitability and ample liquidity underpinning higher equity prices; volatility was consistently close to record lows and no major shocks were observed. Bond markets could be described as having been a little choppier but remained within relatively tight ranges. Surprisingly, the euro turned out to be the strongest major currency, on the back of a much more stable political landscape than expected in Europe.
November turned out to be quite eventful, especially when compared to the relatively quiet previous months. The performances of equity markets across the world were far from being homogeneous; US equities hit new records, emerging markets ended flat and European equities lost ground, due to the impact of an appreciating euro. Short-lived stress was observed in both the US and European high-yield bond markets whereas Chinese assets were affected by authorities’ efforts to limit levels of debt. Finally, the high-flying technology sector was impacted by a late-month sell-off. Profit-taking and a switch into sectors seen benefiting the most from the potential reduction in the US corporate tax rate were behind this correction of tech stocks..
October was another strong month for global equity markets as the MSCI World Index gained 2.5% in local currencies. The ongoing rally was primarily sustained by positive economic data, robust third quarter corporate earnings and a dovish European Central Bank. Rising expectations for US tax cuts and a general election victory by Japan PM Abe also contributed to the supportive environment for risk assets. The US dollar extended its September rebound and appreciated versus all the other major currencies. Bond yields edged lower in the Eurozone while the yield on 10-year Treasuries ended the month only four basis points higher than at the end of September.
The trends observed during September were not necessarily those anticipated by many seasoned market investors and commentators. A rise of volatility and a correction of equity markets had often been put forward but the end result was a good performance of equity markets and volatility close to record lows. Bond yields trended higher while the US dollar finally managed to regain some composure as it rebounded against most currencies. Within the equity asset class, European equities clearly outperformed, for the first time since April. Emerging market equities were impacted by some profit-taking and the recovery of the dollar. The dollar was also a headwind for gold as were the rising real interest rates.
Global equities managed to end August virtually unchanged even though it was quite a volatile month for financial markets. Sovereign debt performed well as key central bankers refrained from discussing any changes to their monetary policies whereas gold benefited from safe haven demand and lower real interest rates. The euro reached new year-highs against other major currencies and peaked close to a parity of 1.21 versus the dollar before retreating somewhat. Finally, oil prices dropped as severe flooding in Texas restricted refining capacity, resulting in lower demand for crude oil.
The euro was the star performer during a month of July which also saw global equity markets record additional gains. Developed sovereign debt markets regained their composure following the late-June/early-July correction while the US dollar continued to depreciate against most of its peers. The equities of emerging markets outperformed once again as they recorded a 4.4% gain in local currency terms. In contrast, the appreciation of the euro prevented equities of the Eurozone from making any significant gains.
In this mid-year publication, we review our January expectations and analyse some current key economic indicators before outlining the asset allocation that we recommend for the second half of the year.
We had increased our equity allocation at the beginning of the year
On the back of our positive macro-economic and equity outlook for 2017, we positioned the portfolios dynamically by increasing the allocation towards the equity asset class. We had also expressed our confidence that equity prices should be supported by an acceleration of global earnings’ growth and, so far, this has effectively proven to be the case.
We had reaffirmed our strong conviction on emerging markets and our early-year global equity exposure was well diversified into the different regions. We have since increased our allocations towards European and also emerging markets equities. Hedge funds were an area of concern following a disappointing 2016 performance, but the different funds to which we are exposed have performed much better so far this year and contributed to the strong performance of portfolios.
May was another positive month for global equity markets whereas the dollar remained under pressure and government yields declined. US equity indexes ended the month at record levels, emerging markets continued to outperform while European equity markets took a breather following a period of strength. As largely expected, the centrist candidate Emmanuel Macron was elected French president and it was a case of “sell on the news” as European equities peaked immediately following the second round’s outcome.
The month of April got off to a difficult start for risk assets before ending on a very positive note. Following a strong first quarter for equities, investors turned more cautious in view of rising U.S. tensions with North Korea, Syria and Russia, and concerns about the French presidential elections. Gold, Treasuries, Bunds and the yen were well bid while volatility spiked as the VIX Index reached levels last observed after Trump’s election last November. However, these trends were quickly reversed and volatility collapsed to a ten-year low. Better-than expected first-quarter earnings reports and the first-round results of the French elections were the main drivers for strong equity gains during the last week of the month.
The modest percentage changes recorded by certain asset classes during March fail to tell the whole story. In particular, significant movements were observed during the month within the bond and FX markets. For example, the 10-year US Treasury yield climbed from 2.39% to 2.63% on March 13 before retreating back to its start-of-month level. This was largely due to the Federal Reserve appearing as less hawkish following its March decision to hike rates by 0.25% to a new 0.75% - 1% range. 10-year Bunds followed a similar path as they spiked from 0.21% to 0.48% to end the month at 0.33% as investors reacted to the minutes of the latest ECB meeting. The dollar also experienced a rollercoaster ride as it consistently lost support until recovering at the tail-end of the month.
The trends observed in February were clearly entrenched, with global equity prices moving higher, bond yields declining and the dollar recovering some of its early year losses against other majors.
Equity markets continue to be driven by an improving economic environment, higher inflation expectations and anticipations of supportive policies by the Trump administration. Despite concerns about the timing and implementation of these new US policies and rising political risks in Europe, the levels of volatility have remained close to record lows. This is reflected by the reading of the CBOE Volatility Index which is currently about 25 percent below its five-year average.
Markets are having a bit of a rest after quite a steep climb at the end of 2016.
However, many trends observed since the beginning of the year have been in contrast with consensus expectations; emerging market equities have distinctly outperformed, the dollar has lost ground and gold has had a solid month on the back of a weaker dollar and stable US bond yields.
The most significant of all the market moves that took place during the past month was the rise of yields on euro-region bonds.
2017 has started on a positive note for our portfolios, thanks not only to the contributions from equities but also from our fixed-income allocation, which has been largely immune from the rising yields observed in Europe.
The markets had a very poor start in 2016 due to concerns about China’s economy and weak commodity prices, before moving slightly higher until early summer. The June 23rd UK referendum, resulting in Brexit, was an unexpected shock which triggered another correction of equities and a collapse of Sterling. However, equity markets erased their losses within weeks before entering into a period of stability. Surprisingly the unexpected victory of Donald Trump triggered only a very short-lived bid for safe-haven assets, as risk assets recovered almost instantly and ended the year on a bullish note.
2016 will most likely also be remembered as the year when a 35-year bond rally finally came to an end.