Global equity markets experienced their steepest monthly loss (-7.2%) in December since February 2009 – the last steep market loss as the global economy pulled out of the financial crisis that began the prior year. Equity market losses were pervasive across geography, sector, and market cap. Emerging markets suffered the least of major regional indexes, declining 2.5% during the month. International developed countries fared worse, losing 5.8% while U.S. stocks lost 9.0% (and even worse in small-cap, down 11.9%). These monthly declines were in spite of a huge single-day gain on December 26 – U.S. stocks surged 5.0% – the largest single day gain since March 23, 2009 (7.1%).
A confluence of factors drove equity markets to their worst month of the decade, and momentum was poised for losses given volatility throughout the year and steep global equity market declines in October followed by a tepid recovery in November. Early in the month, a truce in the trade war between the U.S. and China was announced but investors seemed skeptical of a long-term solution. This was exacerbated by President Trump tweeting on December 4, “A deal between the two countries would get done if possible. But if not possible remember ... I am a Tariff Man.”
In the middle of the month, the U.S. Federal Reserve announced a quarter point rate hike – its fourth rate hike of 2018. While this was largely expected by the markets, the Fed’s “dot plot” suggested two rate hikes are likely in 2019 – a change from the expectation of 3 hikes in their projections from September 2018. Later in the month, the ECB announced its expectations of decelerating global economic growth in 2019, based on higher borrowing costs and the cumulative impact of a trade war between the U.S. and China – the world’s two largest economies by GDP. Volatility was further exacerbated by news of a partial shutdown of the U.S. government driven by disagreement regarding funding for President Trump’s desire for a Mexican border wall. At the end of the month, the shutdown had entered its ninth day with little signs of progress made to reach a successful resolution.
Risk-off assets finally played the role of portfolio stop gap in the month, as most fixed income assets appreciated in value. Globally, investment grade bonds appreciated 2.0%, and in the U.S., they gained 1.8%. Even as recently as November 2018, global bonds had declined in value at the same times as equities. Gold saw its strongest monthly gain since June 2016, rising 5.0%.
Short-Term Market Outlook
Our economic outlook is in slightly negative territory at the end of December – a rebound from a far more negative position at the end of November. A decline in building permits and a pullback in manufacturing data are the primary drivers of this month’s position. The improvement versus the prior month was largely due to a recovery in global trade data.
QS Leading Economic Indicator
This assessment of leading indicators is subsequently the largest drag on our outlook of global stocks versus bonds, which modestly favors equities. Valuation between the two assets favors equities and this strengthened throughout Q4 2018 as U.S. government bond rates declined (peaking at 3.24% in November and ending the month at 2.68%). This trend in interest rates, signaling a decline in borrowing costs, also favors equites in our tactical model. The factors favoring fixed income included a pullback in our measurement of leverage in the U.S. economy as well as our economic indicators in negative territory, as described above.
Asset Class Preferences
Asset Class Preferences are based on QS Investors proprietary quantitative factor models. These rules-based financial models use a combination of indicators that analyze asset valuations, investor sentiment, and the broad economy.
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*Global Equities represented by the MSCI ACWI Gross Total Return Local Index; Emerging Market Equities represented by the MSCI EM Gross Total Return Local Index; International Equities represented by the MSCI EAFE Gross Total Return Local Index; U.S. Equities represented by the S&P 500 Total Return Index; U.S. Small Cap Equities represented by Russell 2000 Total Return Index; Italy Equities represented by MSCI Italy Index (MXIT Index); Spain Equities represented by MSCI Spain Index (MXES Index); Greece Equities represented by MSCI Greece Index (MXGR Index). China Equities represented by MSCI China Net Total Return Local Index; U.S. Dollar (USD)represented by the Bloomberg Dollar Spot Index; Global Fixed Income represented by the Bloomberg Barclays Global Agg Total Return Index Value Unhedged USD; U.S. Fixed Income represented by the Bloomberg Barclays U.S. Agg Total Return Index Value Unhedged USD; Emerging Market Fixed Income represented by J.P. Morgan EMBI Global Core USD Index.
QSCR18334 (January 2019)