Equities continue to fall while bonds have caught a bid as investors seek safety despite some respite from trade frictions following the Trump-Xi dinner, and lower yields from a more dovish Federal Reserve. December has historically been a strong month for risk assets, but it may not be the case this year.
The S&P/ASX 200 is now underwater for the year and has lost 6% in the past four weeks. Meanwhile, the S&P 500 is down 2.73% and is also negative for the year, meaning that every major equity market has negative returns for the year. The Euro STOXX is down over 7.5% as well, with cash now the best performing asset class for the year.
US and Australian 10-year bond yields both fell 0.3% to 2.85% and 2.45% respectively as investors fled risky assets. This has caused the spread between the two and ten-year bond yields to narrow, raising further concerns for investors as a flat yield curve signals an imminent recession in two years.
The Australian Dollar has weakened again and is now trading at 72 US cents.
On the political front, there was no respite for equity bulls despite some progress on the trade front as Xi and Trump agreed to a 90-day truce in order to work out their differences on trade. Instead, the jailing of an important Chinese executive from Huawei threw doubt onto the possibility of a trade resolution. Even a dovish speech from Jerome Powell that sent yields tumbling was not able to calm investors as sentiment soured.
On the economic front, domestic data disappointed as GDP came in way below expectations. The Reserve Bank of Australia kept rates unchanged again and continue to be unlikely to move in the next few months.
US data remains encouraging as activity indicators were strong again and employment figures remain strong despite missing estimates. Unemployment continues to tick lower on another month of solid job gains and wages rose 3.1% from a year ago.
On the other hand, European data has been largely disappointing as unemployment ticked up and GDP missed estimates. Activity indicators were encouraging though as they ticked up from the previous month.
Chinese activity indicators were mixed but still broadly pointed to continued expansion suggesting that recent stimulatory measures may be working their way through the system. Inflation figures disappointed, leaving room for China to potentially stimulate more, though debt levels remain the primary concern for investors and authorities.
Cash is king in 2018
It all started so well in January and early February as equities and other risk assets continued from 2017, rallying strongly as volatility was non-existent. Then it all unravelled in mid-February as equities experienced a sharp correction and volatility spiked, setting the tone for the rest of the year. The US rate hikes had been well broadcasted in 2017, and so had the trade tensions and Brexit woes. The difference was that the market could no longer shrug off such issues as the worries of tomorrow, rates are higher, deadlines are closer and tariffs had become a reality. Global economic growth slowed as a result.
Despite strong profit growth globally, equities fell. The US market, with earnings growth of over 20%, managed to hold a rally until October, but other markets were posting negative returns several months before then. The MSCI World index is down about 1.5% so far this year. US markets fared best, posting slight losses, while Europe is off more than 8%, Japan is off 9% and China is in a bear market with a drop over 21%. The S&P/ASX 200 was not an exception, falling 2.5% year-to-date at the time of writing. The Reserve Bank of Australia has held rates at a lowly 1.5% for the whole year and is likely to continue to hold for some time yet, but stocks faced pressure from Royal Commissions into aged care and financials, tightening lending standards and a property downturn.
Global bonds did not fare much better, posting negative returns since early in the year as global yields were led higher by the US Federal Reserve’s rate hikes. To date, the global benchmark is down close to 2% but Australian bonds are up over 3% as investors continue to dial back expectations of a potential rate hike.
Commodities are lower for the year as global growth slows. Oil prices have fallen over 20% as shale oil supply exceeded expectations, forcing OPEC and Russia to commit to further production cuts.
To date, the best performing asset class of 2018 has been cash as all other asset classes posted losses.
Global growth was downgraded by the International Monetary Fund for the first time in two years. Tariffs between the world’s two biggest economies, the US and China, had weighed on global trade, threatening to upend long-established supply chains and keeping corporate spending in check. Combined with idiosyncratic issues, global growth became unsynchronised with the US the only bright spot.
However, a global recession in 2019 is unlikely as economic data continues to point to decent growth despite weakening over the year. Monetary policy remains highly accommodative in Europe and Japan, while China has eased this year and still has room to ease further if necessary.
Aside from the US and China tensions that risk an ‘economic Cold War’, Europe was the primary source for political tension. Brexit remains a total uncertainty just less than four months from its deadline as the terms of Britain’s exit continues to be debated, and the European ruling that Brexit can be reversed. Furthermore, Italy elected a populist government that is seeking to disregard the European Union’s budget rules. In the US, the probe into Russia’s election meddling continues despite Trump’s ire. Domestically, Australia has yet another Prime Minister just months away from elections that could see a Labour government come to power looking to implement policies that would be negative for investment markets (removal of franking credit cash refunds and negative gearing).
In all, 2018 has been a challenging time for investors. The good news is that bond yields are now higher and equity valuations are lower thanks to strong profit growth and falling equity prices. With a global recession unlikely, 2019 may be more forgiving to investors. Volatility is likely to remain elevated as quantitative easing continues to be wound back but the reality is that 2017 was the outlier and 2018 has been more normal. In the face of higher volatility, diversification is likely to be key to protecting portfolios moving forward.
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