December concluded the worst year since the Global Financial Crisis (GFC) for most major developed markets following an increase in US interest rates, slowing global growth, protracted political uncertainty in Europe and fruitless negotation in trade talks between the US and China. Conversely, January proved more fruitful with a ‘relief rally’ rivalling that of the post-1987 crash recovery.
The performance of the main US equity market (S&P 500) marked the worst December for the index since 1931, as well as its first negative year since 2008. The Fed persisted with interest rate hikes by a further 0.25% in December, the Federal Funds target rate now stands at 2.25-2.50%. This was well sign-posted in the run-up to the Federal Open Market Committee (FOMC) meeting, however, against an increasingly uncertain backdrop, was still poorly received by investors. They then made a 180-degree turn in January with one of the most dovish meetings in recent times providing some much needed reason for optimism and respite for equity markets.
The announcement of trade talks between Presidents Xi Jinping and Donald Trump instigated a relief rally which began in late December. This was seen as positive news by investors despite providing few clues as to the final outcome of these talks. Our positive view on US equities was rewarded as we held on through the volatility of December to benefit from the gains made in January.
Source: Data provided by FactSet, 2 months to 31/01/2019
Despite the increase in short-term rates, the yield on US 10 year Treasuries went down to 2.7% from 3.2% in December and has remained steady throughout January. This initial move reflected the uncertainty in markets and a rush to ‘safe haven’ asset classes, such as fixed income, away from equity markets. The FOMC turned more dovish in January as they revised their forward projections of both growth and inflation down, which in turn led to a period of strength for the S&P in January. The Fed has now pencilled in only two further rate increases in 2019, down from a maximum of four previously. Our US Dollar position stood up well against market volatility, however, we continue to review this this currency exposure in light of a recent strong run and less upside in US interest rates going forward.
Whilst the UK market struggled also, it was one of the better defended areas in December. There was a distinct lack of clarity surrounding Brexit which had neither positive nor negative consequences. However, poor sales over Christmas – especially on the high street – weighed on the Retail sector with an increasing number of consumers opting to shop online from the comfort of their own homes. Paradigmatic of this was HMV’s decision during December to call in administrators for the second time in six years, jeopardising 2,200 staff at 125 stores. The recovery for UK stocks during January was weaker than most markets as Brexit deadline day draws ever closer. Our exposure to UK equity is focused more on quality growth than cyclical sectors such as retail, which we believe stands us in good stead as the economy shows signs of weakness amidst political uncertainty.
The ‘risk-off’ sentiment was mirrored in currency markets with the Japanese Yen and Swiss Franc benefitting from elevated levels of equity market volatility during December, before giving up gains as volatility reverted back to lower levels.
Source: Data provided by FactSet, 1 month to 31/12/2018
Closer to home, Sterling was flat during December, albeit touching lows of 1.26 vs. the US Dollar intra-month as a result of Brexit-related jitters before rallying to the end of January with markets optimistic of a conclusion to Brexit negotiations. Our currency exposure remains well diversified and structurally underweight GBP until the future path of Brexit becomes clearer.