Review of Markets over January 2018 - J.P. Morgan Asset Management

Review of Markets over January 2018

Contributors Nandini Ramakrishnan, Global Markets Insights Strategy Team

Global markets were certainly not plagued with the January blues. The major equity markets continued their ascent, led by emerging Asia and the US. Growing confidence among central banks that the strong recovery will bring inflation back towards targets caused most government bond prices to weaken, notably US Treasuries.

Exhibit 1: Asset class and style returns (local currency)

Source: Barclays, Bloomberg, FactSet, FTSE, MSCI, J.P. Morgan Asset Management. REITs: FTSE NAREIT All REITs; Cmdty: Bloomberg UBS Commodity Index; Global Agg: Barclays Global Aggregate; Growth: MSCI World Growth; Value: MSCI World Value; Small cap: MSCI World Small Cap. All indices are total return in local currency. Data as of 31 January 2018.

The most notable market move over the month was the US dollar exchange rate. The dollar declined broadly through the course of last year, as global growth outside of the US strengthened. This decline accelerated in the first month of this year, helped by comments from US Treasury Secretary Steven Mnuchin that a weaker US dollar would be good for the US economy.The dollar is now at a three-year low against the euro, with the currency pair now at 1.24 (US dollars per euro).

The currency move is partly attributable to the eurozone recovery, which continues to strengthen; consumer confidence and the composite purchasing managers’ index business survey are close to record highs. Investors are now closely watching the European Central Bank’s (ECB’s) monetary policy language, awaiting any hints of future plans to withdraw stimulus. So far the Governing Council has committed to continue asset purchases until September and not begin raising rates until “well after” the asset purchase programme ends. In what appeared to be an attempt to counter the upward pressure on the euro, ECB president Mario Draghi highlighted at the 25 January meeting that there were still risks that inflation would not return to target. The rise in the euro has been marked against the dollar, but in trade-weighted terms the increase is more modest (only up 0.7% in January). As a result, the share prices of exporters have continued to rally.

Exhibit 2: World stock market returns (local currency)

Source: FactSet, FTSE, MSCI, Standard & Poor's, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency. Data as of 31 January 2018.

As we move into February, the European earnings season will go into full swing. Given the strength of the economic backdrop earnings expectations are relatively modest. Eurozone (MSCI EMU) consensus expects earnings growth to be around 10% this year, which is lower than the 13% achieved last year. If those expectations are reached or exceeded we would expect further positive returns.

Markets are mindful of the Italian election on 4 March, but the most populist parties have recently toned down their rhetoric towards a referendum on the country’s membership of the single currency. The most likely scenario appears to be a fragmented result and a minority government. While this would not be sufficient to deliver the reforms Italy needs, such a result is unlikely to rattle broader European markets.

In the UK, a number of factors conspired to push sterling to the highest level since the country’s decision to leave the European Union (EU). In the final three months of 2017 GDP grew by 0.5% on the quarter and the labour market strengthened. Additionally, further progress was made in the Brexit negotiations. There were signs of consensus between London and Brussels for a transition period, which would begin in March 2019, and would allow businesses to adapt to any change in the trading relationship between the UK and the EU. The gain in sterling weighed on the FTSE 100 given 70% of its companies’ revenues are generated from abroad.

The US macroeconomic picture remained broadly strong, but there was some mixed data: the Institute for Supply Management’s business surveys pointed to robust activity in manufacturing and a slight easing in non-manufacturing activity. Fourth-quarter 2017 real GDP growth missed expectations slightly at 2.6% (seasonally-adjusted annualised rate), but the US jobs report for December showed another robust increase with 148,000 new non-farm jobs created in the month. The unemployment rate remained at 4.1%. As has been the theme for much of the past few years, low unemployment is still not feeding into higher wage growth. At this point in an economic expansion, with the unemployment rate low by historical standards, we would expect wage growth to be accelerating. Instead, it remains low at 2.5%. US core inflation came in above expectations but is still subdued at 1.8%. Certainly one of the most important questions for markets in 2018 is when, or if, inflation returns in a more concerted fashion. The Federal Reserve, Bank of England and ECB all expect inflation to gradually pick up towards their 2% targets and have thus committed to reduce monetary stimulus very gradually.

Such a gradual unwind may put some downward pressure on government bond prices but is unlikely to challenge equity markets. In January, US Treasury prices fell and the 10-year yield ended the month at 2.7% but the S&P 500 roared ahead with prices up 5.6%.

Exhibit 3: Fixed income sector returns

Source: Barclays, BofA/Merrill Lynch, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. IL: Barclays Global Inflation-Linked; Euro Treas: Barclays Euro Aggregate Government - Treasury; US Treas: Barclays US Aggregate Government - Treasury; Global IG: Barclays Global Aggregate - Corporates; US HY: BofA/Merrill Lynch US HY Constrained; Euro HY: BofA/Merrill Lynch Euro Non-Financial HY Constrained; EM Debt: J.P. Morgan EMBI+. All indices are total return in local currency. Data as of 31 January 2018.

The US Treasury market was not the only government bond market to be jostled. When the Bank of Japan (BoJ) announced it would buy fewer longer-dated bonds, 20-year and 40-year Japanese Government Bond yields increased, although they are still well below last year's highs. Towards the end of the month, BoJ Governor Kuroda repeatedly dismissed the notion of removing monetary support anytime soon. As we have stressed, the role of BoJ policy in depressing global government bond yields should not be underestimated. Although the stronger yen may be tricky for Japanese exporters, in recent months the TOPIX has been able to rally despite the currency strength. A key theme for the Japanese equity market in 2018 will be how companies perform in a higher yen environment.

Exhibit 4: Fixed income government bond returns

Source: FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. All indices are J.P. Morgan GBIs (Government Bond Indices). All indices are total return in local currency. Data as of 31 January 2018.

In the fourth quarter of 2017, China’s economy grew slightly above consensus at 6.8% year on year. Retail sales disappointed slightly and industrial production was stable. One of the best performing equity markets in January was emerging market equity—heavily driven by emerging Asia. A number of factors are supportive of activity and stocks in emerging markets, including a weaker US dollar, stronger commodity demand and prices, and an expansion in global business investment. All of which are supportive of emerging market technology producers.

Overall, markets are moving broadly in line with the key themes we identified for this year in the 2018 Investment Outlook ‘It ain’t over till the central banks sing’: Risk assets are benefiting from a synchronised global recovery, and inflation is picking up moderately. Central banks feel comfortable easing off the accelerator, but are not close to moving to the brake.

Exhibit 5: Index Returns for January 2018

Source: MSCI, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management; Data as of 31 January 2018.

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