Over the past 12 months we have witnessed a remarkable shift in the state of the world, with Donald Trump’s election and Brexit headlining a series of developments that has the potential to affect market sentiment for years to come. In order to appreciate the change, we only need to rewind the clock to February 2016.
There were Chinese debt concerns, an earnings recession in large parts of the world, rising default rates, the threat of deflation and the oil price was less than $30. We now have an oil price comfortably above $50, China seems healthy, default rates are rapidly decreasing, and robust earnings growth and inflation expectations are growing by the day.
If we take the liberty to look at the leader-board over this period, we can see the turn of health in action. In fact, global shares increased by approximately 18% in US dollar terms and as much as 33% in pound sterling terms. Emerging markets and developed markets have both contributed positively, with commodity-linked markets such as Brazil and Russia performing particularly strongly.
Fixed Income Fares More Poorly
On the other side of the equation, fixed income markets were a tale of two stories. Initially, a strong price rally and prolonged period of lower bond yields saw double-digit returns for most major markets. However, this reversed following the Trump election victory as bond yields rose under the expectation of fiscal stimulus and higher inflation. The global aggregate performance was just over 2% in US dollars, with the strongest contribution from high yield and emerging market debt.
While some investors are getting optimistic about the state of the world, pragmatists such as ourselves retain a healthy amount of scepticism. The problem going forward is that stellar short-term performance reduces our long-term return expectations. Just as it gets harder to lose additional weight as we get fitter, it gets harder to sustain strong market performance under valuation pressures. This is especially true in an environment that has used strong stimulus to get it where it is.
The only rational answer is to further enhance the focus on the best mix of assets, with a disciplined approach that maximises reward for risk in a long-term context.
In the words of William Arthur Ward: “The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”
January: All About Trump
What an interesting month. If one had to guess how many executive orders Donald Trump could trigger between his inauguration on the January 20 and the end of the month, most would have assumed one, three or five. Instead, we saw no less than 17 executive orders from Donald Trump which if sustained would amount to 564 executive orders per year. It is a true case of a man on a mission.
The clearest expression of these developments was a weakening of the US dollar, taking many investors by surprise. It also marked the worst January for the US dollar in a decade, as it fell by 2-5% against the major currencies.
Among equity markets, it was mildly positive overall, with the broad MSCI All Country World index rising by just under 3% in US dollar terms over the month. However, this conceals some reasonably significant shifts in selected markets. Driving the underlying divergence was a broad emerging market rally, outperforming developed markets by 5% over the month. The Brazilian and Chinese markets were particular outliers, rising strongly after a weak period in late 2016.
Fixed income was generally subdued overall, with the global aggregate index rising by just over 1% in US dollar terms, although was slightly down in euro and sterling terms. Once again, this covered significant underlying divergence, with emerging market debt the strongest performer despite ongoing concerns over potential trade barriers by the Trump administration. To the downside, there was further pressure on U.K. gilts, with added anxieties following Theresa May’s ‘Clean-Brexit’ speech.
Going forward, we advocate that investors retain perspective and discipline. The uncertain backdrop described above is likely to persist for some time and we continue to witness valuation pressures among many of the key markets. On this basis, a repeatable investment process must combine with a level head to ensure portfolios deliver to their long-term objective. This means the avoidance of short-term bets and the adherence of a valuation discipline that maximises reward for risk.
