JANUARY EQUITY MARKET REVIEW: The Fed capitulates leading to a strong market rally

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1 Page 1 JANUARY EQUITY MARKET REVIEW: The Fed capitulates leading to a strong market rally January 2019 The World in five bullet points After an extremely volatile December, which saw steep declines in equities worldwide, 2019 got off to a very strong start with some indices recording their best January for decades. All but one (India) of the markets in the MSCI All Country World index returned a positive figure with a key driver being the US Fed s comments that will likely see interest rate hikes put on hold. This triggered the US dollar to pull back, in turn pushing Emerging Markets higher. Higher commodity prices and a toning down of political rhetoric around the world also helped sentiment. The catalyst for the bounce back in equities was the US Federal Reserve dropping its reference to expecting further gradual increases in the base federal funds rate while the balance sheet reduction programme was no longer on auto pilot, meaning it would pay more attention to data going forward. Both comments led to economists to call for a slowdown, a halt or even to a cut in interest rates later this year. Meanwhile Fed Fund futures now point to a flat outlook for rates this year. The UK government suffered a humiliating parliamentary defeat when its agreement with the EU to leave the bloc at the end of March was defeated by 230 MPs, the largest such defeat for a sitting UK government since the 1930s. Prime Minister Theresa May then survived a vote of no confidence in her government and was subsequently told by MPs to go back to Brussels to ask for concessions from the EU. The EU promptly said no to a reopening of the agreement but said it may renegotiate part of the political declaration as a concession. By the end of the month, no solution had been proposed that would likely see passage. The US government closed for much of the month as an impasse between Congress and the White House over cash for a security wall on the country s southern border reached an impasse. A temporary funding package was eventually signed but no permanent solution appears close. Analysts predicted the hit to GDP would be small at just 0.2%. A tailings dam owned by Vale in Brazil collapsed, killing more than 300 people and leaving a trail of destruction in the country s biggest mining state. The disaster happened just over three years after a similar disaster in nearby Mariana at a dam owned by Vale and BHP. But this time it had an immediate effect on Vale s share price which plunged 25% on the next trading day in Brazil. Iron ore prices also subsequently spiked as traders speculated iron ore production from Vale would be disrupted. Fig.1. Regional Equity Indices Performance, US$ % Fig.2. Asia Equity Indices Performance, US$ % Equity Markets Global equity markets returned their best start to their year in decades in January as a sense of risk on returned to stocks following December s dismal month. Emerging Markets outperformed Developed Markets as the US dollar eased back slightly with Latin America and EMEA outperforming Asian indices. Here, China and Korea led the region higher as trade-exposed and technology stocks bounced back strongly, but this also lead to south east Asian markets to underperform. India was the only index in the MSCI Global family to see a loss as investors there worried over the upcoming budget ahead of this year s election. In the Developed Markets, the US again outperformed Europe with the former driven by the Federal Reserve s dovish comments on interest rates, which will now likely see rates on hold with some now betting that it may even cut at some point this year. Europe was dragged back by sluggish economic data out of Germany (see below), and while political troubles in the UK grabbed the headlines, the subsequent weaker pound meant the dollar earners gave the MSCI UK index a 7% return. Source: Eastspring Investments. Chart data from Thomson Reuters Datastream as at 31 January For representative

2 Macro Briefing Page 2 Asia s markets were driven higher by a calming of trade tensions between the US and China. This helped push the MSCI China index up 11.1% while Korea gained 10.3%, going some way to reverse the 19% and 21% losses respectively seen for the calendar year Supportive measures by Beijing helped equities with a 100 basis points cut to the Reserve Ratio Requirement (RRR) and a relaxation of loans criteria for banks helping to increase liquidity. A a return of foreign inflows into funds also boosted demand throughout the region. India markets underperformed every other country market by losing 2%. Economic figures continued to point to a slowdown but the likely culprit for the weakness was the higher oil price and nerves ahead of the budget with the elections looming later this year. A mixed set of corporate earnings did little to improve sentiment. Latin America was again pulled higher by Brazil which saw its new president taking office with an ambitious economic agenda that incudes a long-anticipated pension reform plan. Chile also helped post a 25 basis point rate rise as did Columbia on higher oil prices and news of corporate tax cuts. EMEA benefitted from a higher oil price that gave Russia a 14% rise, while South Africa and Turkey gained from a weaker dollar with the latter getting a boost from the dovish US interest rate comments. Fig 3. Bond Indices Performance, USD % Fig 4. Commodities Performance in USD (%) BAML US High Yield JPM EMBI Global JPM Asia Credit ML US Investment Grade JPM GBI US 30Y Treasuries US 10Y Treasuries Source: Thomson Reuters Datastream Fixed Income Global bond markets generally fared well in January amid more benign expectation of interest rates. In the US, mixed economic data and a more dovish policy shift of the Federal Reserve led to further declines in US Treasury yields. As a result, the 10-year US Treasury yield fell 5 basis points to end the month at 2.63%. At the January FOMC meeting, the Fed kept policy rate unchanged, while dropping reference to further gradual increases in its rate guidance as it shifts to a more patient and datawatching mode. It also added that it would consider adjusting the reduction of its balance sheet if conditions warrant. In this environment, Asian interest rates fell in tandem, resulting in positive returns for most domestic bond markets. In January, further monetary policy easing was seen in China as it cut reserve requirement ratio for banks by 100 bps. The dovish shift in Fed s stance also sparked a risk-on sentiment which supported performance of Asian credits. This is reflected by a broad tightening in credit spreads, particularly in the non-investment grade sector. Investor sentiment for the non-investment grade sector was also bolstered by easing measures and liquidity injection by the Chinese government. Commodities Commodity prices surged over the month in line with the modest easing of the US dollar, and the spike higher in equity markets. Brent crude had its best January in more than 30 years with a 23.5% gain while gasoline, copper, aluminium and even gold saw gains. Oil prices were driven higher as sentiment in the US economy recovered on the Federal Reserve s decision to put rates on hold but a collapse in output from Venezuela and Iran helped prices, as did a voluntary production cut from Saudi Arabia. Iron ore prices spiked to levels not seen for almost two years after the mining dam accident in Brazil raised questions about production disruption from Vale s other iron ore mines in the region. Spot iron ore prices jumped $11 to $87 in the few days post the collapse after Vale said it would close some mines temporarily as it decommissioned several other similarly designed dams. Other metal prices advanced as the US dollar faltered slightly. Even gold, which is traditionally a safe haven commodity and jumped notably in December, recorded a modest gain for the month. Other industrial metals such as copper and aluminium moved in narrow ranges for much of the month before accelerating into the close, with traders wary of developments on the US- Sino trade talks. Among the soft commodities, wheat prices fell amid evidence of a surge in exports from Russia, while soybean futures also fell over the month as demand for US soybeans fell amid with the ongoing trade dispute, and South American producers upped supply. Source: Eastspring Investments. Chart data from Thomson Reuters Datastream as at 31 January For representative

3 Macro Briefing Page 3 Currencies After a strong performance in 2018, the US dollar began 2019 by weakening thanks to a change in the Federal Reserve Bank s rhetoric (see Fixed Income above). This came after a significant sell-off in equity markets and tighter monetary conditions in the US during December. The Canadian dollar, New Zealand dollar and British pound were the key outperformers in January. The first two gained because of the improvement in risk appetite and oil price while the British pound strengthened on the back of Brexit developments. The market has turned more constructive on the outcome and nearly priced out a hard Brexit outcome. US dollar weakness has been most evident versus emerging markets currencies. After a beleaguered 2018, most emerging market currencies have strengthened so far this year with the South African rand, Russian ruble and Brazilian real all gaining more than 6% against the greenback. Patience from the Fed means markets are less concerned about tighter funding conditions for these emerging markets. Further, in Brazil, the new government introduced its long-awaited economic agenda although details have not been officially announced yet. In Asia, India has been the main outlier, declining nearly 2%. Concerns about a larger fiscal deficit ahead of the presidential elections later this year has come into focus. Meanwhile, Thai baht and the Indonesian rupiah have gained more than 3%. The baht may be a low yielding currency but it does have a very high current account surplus. As for Indonesian rupiah, fundamentals remain positive and the renewed Fed stance means Bank Indonesia may become less concerned about outflows. Also in Asia, the Chinese renminbi has also had a strong start to the year, gaining 2.5%. The resumption of trade talks mitigated concerns that relations would worsen between the world s largest economies but the deadline for these talks is 1 March when new tariffs are introduced. While it may be extended, the ongoing discussion provided some support to the markets. In addition, expectations are high that the Chinese government will announce more fiscal stimulus in the coming months. Fig 5. Currencies Performance versus USD (%) Fig 6. Central Banks Interest Rate (%) Economics US jobs data at the beginning of the month were much better than anticipated with 312,000 jobs being added while previous months were revised higher. But the unemployment rate crept higher too as the labour pool increased amid the government shutdown. In the negative column, ISM manufacturing data sunk to a two-year low, shedding 5.2 points, while the forwardlooking New Orders Index fell 11 points.. Japan s Industrial Production fell 1.9% in December in a further sign of a slowdown in the industrial sector. In the positive column, retail sales were higher than expected with a 0.9% yoy rise in December but the BoJ was unmoved by the economic data points and kept its short-term benchmark rate at -0.1%, and lowered its inflation outlook for the year. Europe saw Germany s industrial production data disappoint. Italy finally approved a budget proposal following a number of European Commission-recommended revisions but the economy fell into a technical recession when GDP growth was negative for the second month running. UK economic data including manufacturing output numbers were in general positive but all eyes were on the political developments in Westminster which saw the government lose its key Brexit vote. China s central bank lowered its RRR in response to the lacklustre economic data that included the PMI index showing factory activity shrinking for the first time in two years. Q GDP growth came in at 6.4%, in line with expectations but below Q3 s figure, factory activity contracted for the first time in two years, and exports for December contracted. In response, Beijing cut the RRR rate by 100 basis points and announced $125bn of rail projects, effectively providing a fiscal stimulus programme for the sector. It also expanded monetary easing adding a record Rmb570bn to the banking system. Elsewhere, Korea s employment growth slowed although yoy figures and seasonally adjusted numbers were slightly ahead of expectations. Taiwan s Manufacturing PMI fell to its lowest level in three years at just 47.7 led by a drop in new export orders. South Africa s inflation slowed to 4.5% yoy in December, lower than the 5.2% seen in November. Turkey s inflation figure rose to 20.3% in December, slightly below expectations, but the central bank held interest rates steady at 24%. Source: Eastspring Investments. Chart data from Thomson Reuters Datastream as at 31 January For representative

4 Macro Briefing Page 4 Fig 8. Key Bond Yields (%) Source: Eastspring Investments. Chart data from Thomson Reuters Datastream as at 31 December For representative

5 Macro Briefing Page 5 MSCI monthly, quarterly and year-to-date data Jan 2018 Q4 Dec-18 Q3 Q2 Q World Developed World United States Europe Japan Emerging Markets Asia Pac Ex Japan Asia Ex Japan Latin America Brazil EMEA Dec 2018 Q4 Nov Q3 Q2 Q Australia New Zealand Hong Kong China Korea Taiwan Thailand Malaysia Singapore Indonesia India Philippines Dec 2018 Q4 Nov Q3 Q2 Q Mexico Chile Hungary Poland Czech Republic Russia Turkey South Africa Qatar Saudi Arabia United Kingdom Germany France Netherlands Austria Italy Spain Source: Thomson-Reuters Datastream, MSCI. All data Total Returns, in US dollar terms, as of 31 January 2019

6 Macro Briefing Page 6 KEY TERMS CA Current Account CBR Central Bank of Russia COPOM Central Bank of Brazil CPI Consumer Price Index DM Developed Markets ECI Employment Cost Index EM Emerging Markets EM Currencies MSCI Emerging Markets Currency Index EM Equities MSCI Emerging Markets Index EM Local Currency Bonds JP Morgan Emerging Local Currency Bond Index EM USD Bonds JP Morgan Emerging Market Bond Index EMU European Monetary Union EU European Union Fed The Federal Reserve Board of the United States FOMC Federal Open Market Committee GDP Gross Domestic Product Global Developed Equities MSCI Developed Markets Index Global Equities MSCI All Country World Index Global Government Bonds Citigroup World Government Bond Index IP Industrial Production M2 M2 Money mom Month on month PBoC Peoples Bank of China qoq Quarter on quarter Repo Repossession SDRs Special Drawing Rights SELIC Sistema Especial de Liquidação e CU.S.todia (SELIC) (Special Clearance and Escrow System) Tankan Japan Large Business Sentiment Survey TSF Total Social Financing UK United Kingdom yoy Year on year REPRESENTATIVE INDICIES Aluminum S&P GSCI Aluminum Index Asia Local Bond (ALBI) HSBC Asia Local Bond Index Brent Oil Cash settlement price for the InterContinental Exchange (ICE) Brent Future based on ICE Futures Brent index Commodities Datastream Commodities Index Copper S&P GSCI Copper Index EMU 10 Year Datastream EMU 10 Year Global Emerging Bond JPM Global Emerging Bond Index Gold S&P GSCI Gold Index Japan 10 Year Datastream Japan 10 Year JACI JP Morgan Asia Credit Index MSCI Dev World MSCI Developed Markets Index MSCI EM MSCI Emerging Markets Index MSCI Europe MSCI Europe Index MSCI Japan MSCI Japan Index MSCI Latam MSCI Latin America Index MSCI Russia MSCI Russia Index MSCI U.S. MSCI U.S. Index MSCI World MSCI All Country World Index Steel (HRC) TSI Hot Rolled Coil Index UK 10 Year Datastream UK 10 Year U.S. 10 Year Treasuries Datastream U.S. 10 Year Treasuries U.S. 30 Year Treasuries Datastream U.S. 30 Year Treasuries U.S. High Yield BAML U.S. High Yield Constrained II U.S. Investment Grade BAML Corporate Master DXY U.S. Dollar Index Zinc S&P GSCI Zinc Index Source: Eastspring Investments

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