- December 2018 was the worst December performance for US equity markets in 50 years, with S&P 500 down 9.2% in the month. Global equities followed suit.
- The US Federal Reserve (the Fed), in a unanimous decision, continued its path of raising interest rates.
- Oil prices continued a precipitous slide downwards and fell more than 40% over the fourth quarter.
- Trade wars escalated between the US and China and political instability reigned around the outcome of Brexit in the UK.
- US Treasury yields fell dramatically as safe haven assets outperformed in the aftermath of an equity crash. 10-year bond yields fell from 3.0% to 2.7% by month end.
In the usually quiet December period, global markets were hit hard by growing fears of recession, and then the Fed, despite an already weak market, continued on their hawkish path by raising rates again. Whilst this was expected given their previous communications, what was disappointing to markets was the lack of a change in the language to a softer, more dovish tone. Their statement pointed to “some further gradual increases” in the outlook for 2019.
The end may be in sight for the Fed’s rate hiking cycle and this will likely see positive sentiment swinging towards the other major currencies, with the US dollar strength beginning to dissipate. This will present opportunities for non-US dollar and potentially emerging market assets. Whilst global growth might slow, a negative feedback loop may reinforce this. We would argue that valuations across most equity markets are improving and creating investment opportunities
Inflation is remaining close to target levels, so we do not expect dramatic shifts in monetary policy away from what we have already seen. Having said that, liquidity remains in a contraction phase, and countries who are overleveraged will remain at risk. Corporate earnings are still fairly healthy, but as the global economy slows, we expect this to be less supportive of valuations over time.
US bond yields rallied on the back of the equity market crash, with 10-year bond yields falling all the way from above 3% at the start of December to end the year at 2.7%. Very few analysts would have penciled in a yield below 3% at the start of the year, but this move is purely a safe haven play. Expectations for continuously rising yields will now most likely be pared back.
On balance, a number of new developments are at play, with the oil price in particular being key. US Treasuries appear fully priced and we are in the process of re-evaluating both exposure and duration levels. Regional differences in monetary policy suggest that asset allocation shifts between regions may well prove to be a positive strategy going forward. Cash has been king in 2018, but it is likely that a rebound from the negative year could bring some light to the gloom in markets.