Developed and Emerging Markets
Markets took a leg lower in March despite increased calls to end global monetary easing, supported by a run of improving economic data. An up-tick in inflationary readings has soon switched investor complacency to investor concern as a rapid return to inflation could have negative effects. Many look to the US as the worlds leading economy, at the forefront of post-crisis normalisation. This is true of the Federal Reserve although political protectionism threatens positive development. Uncertainty regarding trade tariffs and potential trade wars between the US and China, in tandem with a unity of tighter financial conditions and fears of an aggressive ending to stimulus has triggered a sell-off in risk assets and a flight to quality. Global equity faltered and a large focus was also placed on the Technology sector following a succession of negative events. Investors questioned the future prospects of growth if strict regulations were to be placed on leading tech corporate entities. Government bond yields rose in anticipation of the US Federal Reserve raising rates and corporate credit spreads widened. Safe-haven purchases to the end of the month gave negative bond returns some reprieve.
Investors sought protection in safe-haven currencies through the month. A rate increase by the US Federal Reserve could not provide support for the US Dollar which traded negatively against a basket of leading global denominations. Emerging Market currencies gained in the wake of US President Donald Trump relaxing his protectionist trade tariffs towards key NAFTA menbers. EMFX also received a boost from a muted/negative US Dollar environment.
Energy and other commodities
Crude oil breached recent highs intra-month as Brent soared to over $70 US Dollars. OPEC members were reported to maintain their deal on reduced supply for the remainder of 2018. Industrial metals were a major casualty as a result of trade tariffs and rhetoric from the US. Precious metals outperformed on a relative basis but could not prevent overall negative price action. Agriculture prices could not be supported by the surge in Cocoa prices during the month as the sub-sector also closed negative within the month.
Global Bond Markets
Global Bond markets posted a mixed performance through the month of March. This has helped stall the deceleration of fixed income assets, which has been an overwhelming theme during the first quarter of this year.
Sovereign yields trended higher on positive readings of economic data, with the US in particular focus. The US Federal Reserve continues to be at the forefront of major central banks implementing less accommodative monetary policy, as it’s domestic economy indicates growth and expansion. A Federal Funds Rate increase in March was much anticipated by investors, although guidance delivered raised questions as to whether the US will see further rate increases, at a quicker pace. Current US Treasury 2-year Notes trade at their yield’s highs unseen since mid-2008, whilst 10-year Notes continue to yield below 3%. In Europe, the theme continued although with less vigour. This is in part due to the European Central Bank which reaffirmed its commitment to slow and cautious changes to the ongoing stimulus program. President Mario Draghi confirmed a delay to rate increases until “well past” the maturity of its extraordinary bond purchases. He also commented on subdued inflationary measures, which have yet to demonstrate a more convincing upward trend. The Bank of Japan communicated their wish to consider an exit strategy to loose monetary policy in 2019, should inflation reach 2%. For the time being, they will continue with their sizable asset support and note that it is too soon to unwind. The Bank of England’s decision to keep rate moves on hold this month has boosted prospects of a rate increase in May.
Global credit spreads have widened across both Investment Grade and High Yield universes. Investment grade markets have underperformed their lesser rated equivalents as they are more closely tied to a move in rates than “Junk” bonds, which are determined by the performance of the underlying corporate. Record sizes of recent debt issuance has weighed heavy on credit markets this month which has also caused strain on Issuers themselves. Investors continue to seek structures offering a greater credit spread equivalent, to compensate for the risk of higher sovereign yields. Emerging Markets have been a favourable sub-region for allocators who have outperformed versus higher quality, hard currency developed markets.
Global Equity Markets
Investors were adjusting to the White House’s protectionist agenda and the fallout from Facebook’s data harvesting scandal. The “standard” market response to uncertainty unfolded once more and risk assets such as equities were duly sold to be redirected to supposedly “low-risk” and “inflation-hedge” asset classes such as Treasuries and Gold.
Year-to-date regional return divergence has been accentuated with the US still holding up reasonably well against some of their European counterparts. In Europe, Germany, U.K. and Switzerland are leading the negative return contribution league table. Meanwhile, developed Asia is split between a weak Japanese and still positive Hong Kong and Singapore stock markets. Once more, the return in the Emerging Market region is showing resilience as it is driven by its risk diversity in terms of different economic stages. Large economies such as Brazil, Russia, South Korea, Taiwan and China contributed positively and helped to counterbalance the negative return impacts by smaller-sized representatives such as Poland, Indonesia and the Philippines.
Global sectors in developed countries did not offer any retreat in terms of return and/or diversification as nine out of eleven sectors show negative readings as of now. Most notable is the (still) positive year-to-date return of the Information Technology sector, considering the meltdown of the FANG-plus index (i.e. mainly Facebook, Amazon, Netflix and Google and six other large IT-related companies). The biggest negative contributors were led by Consumer Discretionary, Energy and Telecommunications.
Positive Emerging Market sector returns were driven by commodity-, financial- and technology-based export-oriented countries such as Russia (Energy), China (Financials and Energy), South Korea and Taiwan (Information Technology).
Capital markets will continue to be in flux in the near term given uncertainty about the inflation and interest rate outlook as well as fresh policy risks, including the recent US protectionist measures. The threat of a US-led trade war has now moved to the forefront of investor worries as protectionist policies could threaten the global economic expansion. We expect markets to be choppy in the coming months as the macro tailwinds from 2017 fade and/or begin to reverse.
The rise in bond yields and equity prices is on temporary hold: growth momentum will slow a notch and protectionist concerns may keep some investors cautious, yet the cyclical buildup of inflation pressures will persist. Given the positive prospects for corporate earnings, stock prices and bond yields should ultimately undergo another up-leg over the next 6-12 months.
A combination of wider credit spreads and higher rates has forced valuations lower across the asset class. The overhang from new issuance will challenge the primary market and corporates will need to provide a premium to attract investors. Political and fiscal uncertainties may keep the “long-end” anchored for some time and thus we see yield curves flatten further in the short-term. We are selective within Emerging Markets given the ongoing growth and subdued inflationary backdrop, and we favour “quality” High Yield debt and the lower-end of Investment Grade as they offer some compensation and relative value, in the face of benchmark yields trending higher. We continue with a bias to shorter duration overall.
Earnings will remain a tailwind, but equities will need more clarity on the interest rate outlook before moving higher again, which we expect. The recent US outperformance phase might fade and we still favor Emerging Markets and developed Asian markets, stay neutral against Europe and will de-risk the US equity exposure.
The risk to further US Dollar weakness remains tilted to the downside. We would favor the Euro and selected commodity-importing Emerging Market currencies.
We see further downside on industrial metals should the US-led trade war topic persist and oil prices are likely to come under short-term pressure in Q2 as US output ramps up.
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