Economic Commentary – March 2019

March 21st, 2019, by Martyn Torevell

A positive start to the year

After the sharp falls in the final quarter of 2018 global equity markets have rebounded strongly since the start of the year. At the end of February the US S&P 500 index was up 11.4% (in US Dollars) whilst the MSCI indices for Europe ex UK and Asia-Pacific ex Japan (in local currencies) had risen by 10.7% and 9.7% respectively.

UK investors have seen these gains offset by the recent strength of Sterling. Despite concerns over Brexit the Pound hit a 21 month high against the Euro at the end of February, and has risen against the Dollar and Yen since the start of the year. These foreign exchange movements have reduced the year to date returns for UK investors to 6.6% for the S&P 500, 6.3% for the MSCI World and around 5% for European and Asia-Pacific stock market indices. The strength of Sterling also weighed on the overseas earnings of the FTSE 100 index of the UK’s leading companies which generated a return of just over 6.0%. The broader FTSE All-share index rose by 6.6%.

The recovery in share prices in January and February has been sufficient to offset most if not all of the sharp losses incurred by global stock markets in December. The FTSE 100 index is now showing a modest positive return of 2.3% over the last quarter and the S&P 500 index (which was down by 15% in late December) is showing a positive return of 1.3% in Dollar terms (although currency movements translate this into a loss of 2.9% in Sterling). Whilst global stock markets remain lower than they were last summer, UK and American market indices are now showing gains over the last 12 months despite the recent turmoil. Other global equity markets have not recovered as strongly and European, Asia-Pacific, Japanese and Emerging Market indices are showing losses over the last 12 months in both local currency and Sterling terms.

Whilst equity markets have seen increased levels of volatility, global debt markets continue to show signs of significant distortion. Over the course of last year we saw yields on global government debt drift upwards with a corresponding fall in prices; the benchmark US Treasury yield rose from 2.4% at the beginning of 2018 to 3.2% in November (a five year high). We saw this move a healthy readjustment to more “normal” and sustainable levels of yield and US government bond prices fell back to more reasonable price levels.

December’s volatility saw a sharp increase in demand for these perceived “safe haven” assets (as well as other government bonds, gold and Japanese Yen) and yields fell with the 10 year US Treasury yield ending the year at 2.7%. Yields on most government bonds have followed a similar trajectory; Swiss and Japanese 10 year bond yields have fallen back below zero (guaranteeing a negative return for investors who hold the assets to maturity) and the UK equivalent Treasury Stock yields just 1.2% despite uncertainty over Brexit.

Over time we expect these yields to rise and prices to fall as the extraordinary period of loose monetary conditions following the Global Financial Crisis comes to an end. Corporate credit markets offer higher yields but with additional risks. There are disturbing signs that the quality of covenants accepted by investors of corporate debt is reducing as fixed interest investors place more importance on current income levels rather than any protection against default.

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