Monthly markets review - January 2018
- Widespread positive macroeconomic data continued to drive global equities firmly higher in January. Government bond yields rose, reflecting higher growth and inflation expectations.
- US equities enjoyed a strong advance as economic momentum remained robust.
- Eurozone equities posted gains; the region’s economic expansion led to some suggestions that the European Central Bank (ECB) could soon end its ultra-loose monetary policy.
- The FTSE All-Share index fell in January. Large caps and overseas-focused parts of the market performed poorly as sterling strengthened against a weaker dollar.
- Japanese equities made gains for the month; investors mainly focused on the short-term implications of the Bank of Japan’s dealing in the bond market.
- Emerging market equities posted a robust return with continued strength in global growth and trade, as well as US dollar weakness, supporting performance.
- Government bond yields rose significantly, reflecting higher growth and inflation expectations after the US tax reform bill passed in December. Corporate bonds performed well.
Please note any past performance mentioned in this document is not a guide to future performance and may not be repeated.
US equities were stronger over the month after the latest batch of economic data indicated that momentum remained strong into year-end. Retail sales were robust and inflation continued to climb, as the effects of last year’s hurricane disruption faded and energy prices rose. Employment figures also remained healthy, with unemployment unaltered at 4.1%.
Perhaps most significantly, signs are emerging of long-awaited improvement in wage growth. Average hourly earnings increased 2.5% year-on-year in December after a similarly strong November number; data released in early February confirmed a further pick-up in wage growth during January. The updates prompted investors to consider the implications for bond markets. Expectations that the Federal Reserve would continue to tighten policy at its current pace solidified, but the prospect of more aggressive rate hikes emerged. The dollar fell over the month, particularly following comments from Treasury secretary Mnuchin that a weaker US currency is good for US trade.
As a consequence, the market made significant advances overall but enthusiasm faded in the final days of the month. More cyclical areas of the S&P 500 – consumer discretionary, technology and financial names - were the best performers. Rate-sensitive areas such as utilities, real estate and telecoms were softer.
Eurozone equities registered gains in January with the MSCI EMU index returning 3.2%. The region’s economic expansion gathered further momentum and cyclical (economically-sensitive) stocks led the gains. The financials and consumer discretionary sectors were the best performers while utilities and real estate were the main laggards with negative returns.
Preliminary GDP data for the eurozone showed growth of 0.6% in the fourth quarter. This took the annual growth rate to 2.5%, the fastest since 2007. Inflation slowed to 1.3% from 1.4% amid a lower contribution from energy prices. Other data painted a positive picture: German industrial production showed a pick-up while the eurozone unemployment rate dipped to 8.7%. Forward-looking indicators also remained robust with the flash composite purchasing managers’ index (PMI) for January reaching the highest reading in almost 12 years.
Minutes from the European Central Bank’s December meeting discussed the bloc’s “expansion” rather than “recovery”. The change of tone raised the prospect that the ECB could bring its ultra-loose monetary policy stance to an end sooner than markets had expected. This possibility saw bond yields rise and the euro strengthen. Banks are a prime beneficiary of higher bond yields and the sector performed well over the month. By contrast, bond proxies (stocks perceived to offer low risk income) such as consumer staples and utilities performed poorly.
On the political front, Germany’s social democrat SPD agreed to start formal coalition talks with Angela’s Merkel’s CDU/CSU bloc. Martin Schulz, the SPD leader, has promised to put any final coalition agreement to a vote of the party base.
The FTSE All-Share index fell 1.9% over January. Large caps (i.e. those companies with a large market capitalisation) and overseas-focused parts of the market performed poorly as sterling strengthened against a weaker dollar. Sterling was also supported by expectations that the Bank of England could increase base rates faster than previously anticipated.
In addition, large cap defensive areas of the market were negatively impacted as gilt yields rose in line with a broad-based sell-off in bonds. Despite the negative top-line performance, the underlying trends remained in favour of cyclical areas of the market amid further evidence of a sustained recovery in the global economy.
Reflecting the preference for economically-sensitive areas, financials outperformed and the mining sector bucked the market falls, performing well amid better-than-expected Chinese macroeconomic data. Mid cap areas of the market underperformed, driven by a number of stock-specific disappointments.
It was revealed that UK consumer prices index had fallen back from 3.1% in November to 3.0% in December. While growth edged higher in the fourth quarter of 2017, annual GDP growth decelerated to its lowest rate since 2012, according to preliminary estimates released by the Office for National Statistics.
The strong gains made at the start of January partly ebbed away later in the month but the market still recorded a total return of 1.1%. In currency moves, the yen strengthened against the US dollar but the sterling/yen rate moved in the opposite direction. Sector performance was very mixed. The market was led by strong gains in real estate stocks and some financial subsectors sub-sectors, but relatively defensive areas such as pharmaceuticals and land transportation also performed well. The weakest areas of the market were air transport and construction.
Investors were mainly focused on the short-term implications of the Bank of Japan’s dealing in the bond market. The recent reductions in bond purchases by Japan’s central bank had raised some concerns. In reality this simply reflects the priority on a day-to-day basis being given to targeting either a specific yield, or targeting a specific volume of purchases. When viewed this way, the reduced purchase amounts don’t suggest any material change in policy.
Economic data released in January was generally in-line with improving expectations. Core inflation remained flat, although headline numbers showed the overall consumer price index has edged up to 1.0%. We see anecdotal evidence of the gradual return of positive pricing power for some companies.
Corporate news centred on the early stages of the reporting season for the quarter to December. Initial indications show a continuation of the strong profit growth seen so far this fiscal year as Japanese companies benefit from domestic reflation and a stronger global environment.
Asia (ex Japan)
The MSCI Asia ex Japan Index registered a robust 7.6% return in January. China registered a strong return with technology sector stocks and banks supporting gains. Macroeconomic data was more resilient than expected with GDP growth accelerating to 6.9% year-on-year in 2017. The Caixin manufacturing PMI index increased to 51.5 while industrial production growth ticked up to 6.2% year-on-year in December.
Elsewhere, Thailand and Malaysia also recorded strong gains and outperformed. Hong Kong registered a positive return but modestly lagged the wider rally. Indonesia was the regional laggard, in part due to weakness from Telekom Indonesia.
Emerging market (EM) equities posted a robust return with continued strength in global growth and trade, as well as US dollar weakness, supporting performance. Strong net capital inflows to EM equities were also beneficial. The MSCI Emerging Markets Index increased in value and outperformed the MSCI World.
China registered a strong return with technology sector stocks and banks supporting gains. Macroeconomic data was more resilient than expected with GDP growth accelerating to 6.9% year-on-year in 2017. Brazilian equities also rallied sharply as former president, Luiz Inácio Lula da Silva, saw his criminal conviction upheld. Although he can appeal, the outcome increases the chances that the left-wing candidate, who currently leads opinion polls, is prohibited from participating in October’s presidential elections.
Elsewhere, Russia recorded a strong gain and outperformed, with energy sector names leading the market higher. A pick-up in the price of Brent crude outpaced the rouble’s appreciation against the dollar, resulting in higher rouble oil prices which are positive for sector earnings.
In contrast, South Africa posted a positive return but underperformed, having rallied strongly in December on positive political developments. Indonesia and India, which were already trading on high valuations, also lagged the index. The Philippines recorded a negative return and was the weakest index market, in part owing to peso weakness as the trade deficit widened.
Government bond yields rose significantly over the month, reflecting higher growth and inflation expectations as macroeconomic data continued to surprise positively and on the back of the US tax reform bill passed in December. Ten-year yields in major developed markets finished about 30 basis points (bps) higher. US 10-year rates were up from 2.41% to 2.72%, with five and two-year yields keeping pace. In Europe, 10-year Bund yields increased from 0.43% to 0.70%, and French 10-year yields from 0.78% to 0.97%. Ten-year gilt yields rose from 1.19% to 1.51%.
The US dollar weakened amid continued strengthening economic activity outside the US and comments from US officials on trade. In particular, officials reprised previous comments on China’s overvalued currency and the potential benefits of a weaker US dollar.
European data was strong. Germany’s economy grew 2.2% in 2017, the largest annual expansion for six years, while eurozone growth reached a 10-year high. Strong data, coupled with news of a breakthrough in coalition talks in Germany, helped the euro to reach a three-year high versus the dollar. Conditions were supportive for peripheral bond markets. Spanish 10-year yields fell from 1.54% to 1.43% as it issued a new 10-year bond, seeking to raise €10 billion but drawing orders of €43 billion. This came even against a backdrop of ongoing uncertainty in the Catalonia region. Italy issued a €9 billion 20-year bond attracting €31 billion in orders.
Corporate bonds outperformed government equivalents amid a healthy environment for risk. The BofA Merrill Lynch Global index of investment grade credit returned -0.7%, while the high yield index rose 0.6% (both in local currency terms). In emerging markets, local currency-denominated bonds returns 4.5% as the US dollar weakened. Both hard currency and corporates were little changed.
Global stockmarkets continued their upward trajectory in January 2018. The synchronised global economic upswing with growth rates of more than 3% remains intact; if anything, economists are upgrading their growth forecasts. In the US, the results of the corporate tax reform have led analysts to slightly adjust their revenue models, indicating a bit more room for already high-flying stocks. Convertibles benefited from this tailwind and the typical benchmark for balanced convertible strategies, the Thomson Reuters Global Focus index, was up by 2% this month.
The Bloomberg Commodities index increased in value, supported by a strong gain from the energy component. Brent crude was up 3% while coal (+3.5%) and natural gas (+1.4%) prices also rose. Opec’s compliance towards production cuts and US dollar weakness proved supportive. The agricultural component recorded a solid gain. Grain prices, notably corn and soybeans, increased, partly due to concern over worsening weather conditions in Argentina. The industrial metals component registered a slightly positive return while precious metals were stronger, with gold and silver up 2.8% and 1.8% respectively.
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
 Cyclical stocks are those whose business performance and share prices are directly related to the economic or business cycle. Defensives are those whose business performance is not highly correlated with the larger economic cycle - these companies are often seen as good investments when the economy sours.
 The eurozone purchasing managers’ index is produced by IHS Markit and based on survey data from around 5,000 companies based in the euro area manufacturing and service sectors. A reading above 50 indicates expansion.
 The Caixin China report is based on responses from over 500 manufacturing companies in China. A reading above 50 indicates expansion.
 Investment grade bonds are the highest quality bonds as determined by a credit ratings agency. High yield bonds are more speculative, with a credit rating below investment grade.
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