In the aftermath of October’s equity collapse, a nearly-two standard deviation outcome, November produced modestly positive equity returns of 1.5% after a late-month rally. The rally was spurred by dovish Federal Reserve Board (Fed) commentary on November 28, benign U.S. economic news and hopes for a temporary U.S./China trade truce. Despite the positive returns, risk assets failed to stabilize, with volatility remaining at elevated levels.
Category: Market Perspectives
The realization that the Fed was serious about maintaining its path of ongoing rate hikes amidst increasing concerns over growth that was peaking in the U.S. and slowing overseas proved deadly for both equities and Treasuries in October.
Global equities finished the month modestly higher at +0.2%. Unexpectedly strong U.S. growth numbers (but without growing inflation pressures) allowed U.S. equities to hold their value despite a sharp pick-up in interest rates.
August featured a more nuanced and collectivized Goldilocks story—investors judged the porridge on offer in emerging markets and Europe not to their liking, but not so distasteful as to go on a general hunger strike. Instead, as a group, they just ate more of their favorite brand.
Investors successfully compartmentalized favorable US economic and earnings reports from a seemingly growing list of macro-risks, while a thaw in European Union (EU)/US trade talks provided hope that trade wars would not go global, producing a modest bounce in international equities.
June market action was very much a function of geography, with US markets little changed, but less benign results seen elsewhere depending on the proximity to increasing trade tensions. China and other emerging markets were at the epicenter. While giving the appearance that the US is “winning” the trade war, the strength in the dollar and US asset prices was primarily due to exceptionally strong second quarter growth. Commodities were a real wild card, depending on the mix of double-digit West Texas Intermediate oil gains or trade-war-inflicted losses in grains and industrial metals. While central bank actions were not unimportant, they were overshadowed by geopolitical developments.
Despite starting with the worst first day of the second quarter since the Great Depression, global equities ended the volatile month modestly higher. The combination of plateauing overseas growth and higher Treasury rates contributed to dollar strength that boosted European equities, but not emerging markets. Overseas developed markets outperformed the US by nearly 2%, but emerging market equities finished modestly in the red. News flow over the month included increasing Russia sanctions, US labor costs, tariff threat uncertainty, as well as airstrikes in Syria and potential new Iran sanctions (which fueled a 6% rally in crude oil).
Following February’s market gyrations, which saw inflation fears exacerbated by the unwinding of ill-fated short-volatility strategies, March promised to be a month of rest and recovery as global growth was plateauing at a high level and the monthly employment report presented a remarkable combination of strong employment growth, higher workforce participation and little sign of wage pressures. In addition, North Korea tensions eased while NAFTA and South Korean trade talks advanced smartly.
Following January’s equity melt-up, February saw the sharpest equity reversal in seven years as “warmer” economic reports and the enactment of additional fiscal stimulus triggered U.S. inflation fears. The unwinding of various flavors of short volatility strategies—risk parity, commodity trading advisors (CTAs), short volatility exchange traded funds (ETFs), and targeted volatility insurance products—contributed to the speed of the decline, as the VIX (equity volatility index) reached its highest levels since 2015. Global equities fell 4% uniformly across segments; bonds were unable to serve as a portfolio anchor, losing 1%, as it is hard for a hedge to be effective when it is the catalyst for the equity market decline. The dollar ended higher after a volatile month, while weak energy prices weighed on the commodity complex.
Prospects for a further acceleration in economic growth, combined with capital expenditures and corporate earnings supercharged by tax reform, drove outsized market gains in January, as equity investors extrapolated inflation-free above-trend growth into the future. Fixed income investors had a different perspective on inflation, with the increase in yields and fall in price wiping out a full year’s return for many owners of Treasuries. Higher yielding bonds significantly outperformed their investment grade peers. A continued fall in the dollar bifurcated the world bond market and supported commodity prices.