Global equities raced to fresh record highs in January, with the rally led by the all-important US market, as optimism over the outlook for both the global economy and corporate earnings mounted.
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Key points
- Shares plunge after hitting fresh highs in January
- Equity markets spooked by surge in government bond yields
- Volatility surges amid fears inflation is resurfacing
- Brighter global economic outlook should help stabilise markets
The MSCI World index returned 3.79 per cent in local currencies, although that was the equivalent of a much more modest gain of 0.17 per cent in sterling terms as the pound climbed sharply against the majority of other currencies.
Among the leading markets, US shares were buoyed by economic data, which generally surpassed expectations, and company results, which on the whole beat analysts’ forecasts. The benchmark S&P 500 index leapt 5.73 per cent in local currency terms.
Emerging market equities were in even ruder health, as investors continued to be attracted to what are widely regarded as low valuations relative to those available in developed markets. The MSCI emerging markets index surged, returning 6.78 per cent on the month in local currency terms, continuing the healthy outperformance seen over the past year.
The UK was a rare area of weakness, with the FTSE All-Share Index returning -1.93 per cent. Shares of the country’s major exporters were adversely impacted by the strength of sterling while signs of fragility in the economy further undermined sentiment.
It was a different picture in global debt markets with government bond prices falling as expectations mounted that the era of extraordinary monetary stimulus is drawing to a close.
However, in recent days the picture has turned altogether uglier with stock markets selling off sharply in belated response to an appreciable rise in government bond yields. On February 5 the Dow Jones Industrial Average plunged 1175 points – the biggest one-day decline in its history. The fall sent shudders through markets around the world.
The sell off in stocks was prompted by the sharp rise in US government bond yields. That resulted from fears inflation could be about to return after data suggested the long-running tightening of the labour market may have finally begun to feed through into higher wage growth.
At the start of February the US ten-year government bond yield hit a four-year high of 2.83 per cent, having begun the year at 2.43 per cent. Higher bond yields tend to undermine equities by raising borrowing costs for companies and making the dividends paid by them look relatively less attractive.
Looking forward, it is important investors retain some perspective and do not panic. Shares were due a correction having gone up in a virtual straight line over the preceding 15 months. We believe the prospects for equities remain broadly positive. While volatility may persist for a while longer, the outlook for the global economy looks brighter than it has done since the financial crisis of 2008. Our expectation is that unless government bond yields rise significantly further, once volatility has begun to subside, investors who have been sitting on the sidelines will use the sell-off as an opportunity to pick up shares at more attractive levels.
Nevertheless, the events of recent days serve as a useful reminder to investors that equities remain inherently risky investments and the direction of travel is not guaranteed. They also illustrate that when the current cycle does eventually turn, the sell off could be dramatic.
