For much of January little changed as equities drifted higher although, for once, bond prices were following suit. Late month emerging market-led angst and disappointing data reports from the US and China, however, caused a complete turnaround such that, by month end, bonds had significantly outperformed equities and enjoyed their best start to a year since 2008. In some ways this was no great surprise, equities were overdue a setback and bonds were oversold, and indeed, UK government bonds recouped some 5% of their recent losses against equities. Investment grade corporate bonds performed in line with governments but with higher quality issues outperforming. Most commodities followed equities lower, with the exception of gold, and the only other asset producing strong gains was UK commercial property.
This was a month where quality outperformed
US Federal Reserve bond tapering continued on schedule, being reduced by another $10 billion at the recent FOMC meeting. In contrast, ECB President Draghi noted further monetary stimulus was possible and the BOJ is still expected to expand its balance sheet further in Q2.
In EM, four of the “fragile five” raised interest rates as currencies bond and equity markets came under pressure with the Turkish central bank at last deciding a grand gesture was required.
Mixed US reports punctured recent economic optimism and, together with a late month flight to safety trade, generated sustained bond buying and bond/equity switching. Very weak US non-farm payrolls began that process with yields falling 10 basis points on the day and, over the month as whole, 10-year treasury yields declined 34 basis points. Naturally, UK gilts and German bunds followed suit matching the scale of the fall. Such a sizeable fall in yields enabled main fixed income markets across all maturities to more than recoup the losses sustained in December.
January was another good month for the EU peripheral bond markets, particularly Portugal, continuing a trend in place for much of the past six months or so. Spreads also declined dramatically with all countries back to levels last seen in 2010.
Even though a strong month for bonds overall, corporate bond returns just matched those from governments in the UK while, in the US, high yield underperformed both investment grade and governments. This was a month where quality outperformed and nowhere was this more evident than in the losses sustained in emerging market debt which remained at the centre of investor/trader concerns.
The upward trend in developed world equities continued into the early part of the New Year. It was certainly more of a struggle for equities to move higher but by January 22, the MSCI All Countries World Index had reached a new high for the bull market. The rise was led by Europe and the UK as the S&P 500 trended sideways with its advance interrupted by some disappointing economic data and an earnings season that had begun a little limply. AP/EM had eased modestly buffeted by ongoing currency issues but also specific weakness in China and Brazil which had both fallen some 6%.
On the January 23, weaker than expected Chinese economic data provided the catalyst for a more sizeable sell off that reverberated around bond and currency markets as well as equities. Safe haven assets came back with a vengeance as investors turned much more risk averse and profit-taking set in. VIX closed the month at 18.4, up from a 10/1 low of 12.1, its highest level since October.
There is no doubt the developed markets had looked vulnerable for some time, given overly bullish sentiment, the scale of prior returns and the more limited upside to target levels. TOPIX fell the most in index terms, but only as the yen strengthened, and sterling returns were similar to other developed markets. China has become the “hot spot” for many, with macro bears out in force, and its stock markets were amongst the worst performers over the month. As would be expected, “defensive sectors strongly outperformed “cyclicals”, while, more surprisingly, large cap stocks underperformed both mid and small caps.
Following a sizeable sell-off in Q4 the yen rallied sharply during January, albeit the bulk of the 3% of so gain against the dollar occurred over just two days as financial markets hit turbulence towards month end. Elsewhere, in the currency markets, the other major crosses were little changed and with limited volatility.
