Equities fall sharply but highly-rated bonds rally.
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December proved a torrid month for equities with markets across the globe experiencing sharp falls. By contrast global bond markets enjoyed their best performance in over a year as safe havens returned to favour amid political and economic uncertainty.
A combination of events, mostly centred on the US, unnerved equity markets in December. They included: President Trump’s criticism of the Federal Reserve’s policy of raising interest rates and reports that Trump wanted to fire Jerome Powell, the head of the US central bank; a partial US government shutdown, leaving around 25 per cent of the US federal government with no funding, as Congress and Mr Trump failed to reach an agreement over a budget bill in December; and the continuing trade dispute between the US and China. All of these factors exacerbated concerns about the outlook for global growth and earnings as central banks rein in the extraordinary monetary policies adopted in the wake of the global financial crisis.
The MSCI World index returned -7.8 per cent in local currencies, which equated to a -7.4 per cent return in sterling terms. Over the course of 2018, the index returned -6.8 per cent in local currencies or -2.5 per cent in sterling terms. All of the major regions lost ground with Japan among the worst performers, the MSCI Japan Index returning -14.8 per cent in Japanese yen terms.
Disappointment over the structural reforms promised by Prime Minister Shinzo Abe, along with a weak economy that barely escaped recession early last year and concern that the yen hasn’t declined enough to prop up exports, explains Japan’s lacklustre performance. Japan’s economy is also highly sensitive to global trade so fears of a global slowdown and a trade war has further sapped demand for the country’s equities.
The US fared relatively well in December compared to other global markets but the MSCI USA Index still delivered a return of -4.5 per cent in US dollar terms. US equities, as well as in the UK and the euro zone, experienced their worst annual performance since 2008. Healthcare was the best-performing sector in the US, helped by strong drug pipelines and an ageing population, while banks and technology were among the worst.
Meanwhile, concerns over global growth and a range of political woes from Brexit to the Italian budget weighed on European equities in December. Banks and automakers were among the worst performers. A regulatory raid on Deutsche Bank, which took place at the end of November, and disappointment over the European Central Bank’s decision to prolong unchanged interest rates affected banks in December, while uncertainty over potential US tariffs on imported vehicles hurt autos.
The MSCI Emerging Markets Index returned -2.5 per cent in local currency terms over the month, bringing the annual return to -9.7 per cent. The Far East was among the worst performers, with China falling sharply, reflecting trade tensions with the US as well as domestic economic concerns.
Higher interest rates in the US with the outlook of more to come, as well as the prospect of the ECB ending its bond-buying programme by the end of the year, pressured global bond markets for much of 2018. But the equity rout in December enhanced the appeal of the most highly-rated fixed income assets.
The yield on 10-year US treasury bonds ended the year at a 10-month low of 2.68 per cent, having reached a seven-year high of 3.26 per cent in early November. That helped the overall US government bond market to a 1.9 per cent gain in December (NB. yields move inversely to price). Higher-rated European and Asian government debt, as well as US municipal bonds also rallied and ended 2018 in positive territory. But emerging markets bonds, US corporate bonds, as well as US and European high yield, remained in negative territory for the year as a whole.