Equity markets have gone almost nowhere year to date. Emerging markets have done the best, gaining about 5%, and Japan the worst, down about 7%. Europe was also down but by a smaller amount, and the U.S. S&P 500 has returned about 2% year to date. However, that relative calm belies some powerful volatility.
The Fed indicated that two interest rate rises were likely in 2016, instead of the previous four
Rough Start to 2016
From the beginning of 2016 to February 11, almost all major equity markets and commodity markets received a beating ranging from 7% to 11% declines. Equity markets were driven down by worries about collapsing energy prices and the potential impact on oil companies, their lenders, and financial market participants more generally.
More worries and better recognition of China's slowing growth prospects did not help. U.S. economic data released in early 2016 was mixed, though an artificially weak initial print of fourth-quarter GDP growth, later revised higher to 1.4%, fuelled the bear case. The weak GDP report seemed to suggest that falling energy prices and a slowing China were beginning to hinder growth, even in the United States.
Energy Price Rumours Halt Market Decline
Some of those worries came to an end in mid-February, when some economic reports for January showed better data in the U.S. and Europe. Rumours of an energy producers' meeting to curb output stopped the decline in energy prices. The day energy prices bottomed was just a day or two ahead of the equity market trough, which was February 11.
This stabilisation in energy prices, better economic news, and increasing rumours of central bank easing sparked a major rally in equity and commodity markets between mid-February and mid-March ranging from 7% to 16%, erasing most of the earlier equity losses.
Investors Buy Stocks on Central Bank Action
As typical, markets correctly anticipated that early 2016 economic and stock market weakness would trigger a lot of central bank actions. It didn't hurt that a lot of central bankers began whispering about more easing in February. In fact, by the time the European Central Bank instituted another wave of monetary easing on March 10 and the U.S. Federal Reserve decided to not hike interest rates on March 16, with Fed governors indicating that two rate rises were likely in 2016, instead of the previous expectation of three or four increases, markets had already had their rally.
Since levelling off around March 18, most equity markets have done little. Terrorist activities in Europe and worries about the potential exit of the United Kingdom from the European Union have caused modest losses in Europe over the past month, while emerging markets have gained about 3% as purchasing manager data out of China finally managed to show improvement in March, as it did the U.S. and Europe. The U.S. hasn't done quite as well, as recent worries about consumption growth, slowing auto sales, and the potential for a sub-1% growth rate for the first quarter held back U.S. equities over the past month.
Central Bank Easing Make Bonds a Star Performer
Bond yields around the world have generally eased throughout 2016, driving high total returns for bonds so far this year. The 10-year U.S. Treasury yield has fallen from 2.2% at the end of 2015 to just 1.8% recently even in the aftermath of the Fed's first rate increase in December and promises to raise rates further in 2016. German bond rates have also continued to decline in 2016. Both the two-year and five-year German bonds carry negative yields, and even the 10-year German bond yields a miserly 0.1%.
Most bond funds have returned 3%-4% year to date, with even high-yield and emerging-market bonds doing well. Much of that return was earned just in the past month. Emerging-market bonds have been the best performers, returning more than 5% year to date.
A combination of central bank easing, fewer worries about catastrophic financial damage from falling energy prices, and better news out of China have helped even risky bonds do well. Those strong-performing bonds – year to date and monthly – include U.S. high-yield bonds that did so poorly early in 2016.
