Global equity markets remained in an ebullient mood in February, with the MSCI World index producing a US dollar total return of 5.9%. In the US, the S&P 500 broke through a series of record highs (although it has subsequently given up a little ground in March) while in the UK the FTSE 100 finally eclipsed its previous all-time closing high of 6930 (set in late 1999), finishing the month at 6946.7. European, Japanese, Asian and emerging market (EM) equities also made strong progress in local currency terms.
In contrast to the strength seen in equity markets, US and UK government bonds had a difficult month, with the yield on the benchmark US 10-year treasury climbing from 1.64% at the end of January to 1.99% at the end of February. The broad UK gilt market registered a sterling total return loss of -4.2%, with long gilts (-7.6%) performing particularly poorly. European core bond markets were largely insulated from these moves, with the 10-year bund yield finishing the month at 0.3%. At the time of writing, yields on a number of short-dated European government bonds are negative, and Swiss government bonds offer negative yields out to 10 years.
In equity markets, we are positive on all the major regions except the US, where we have a neutral weighting in our asset allocation model, and emerging markets, which we continue to underweight. In our view, the US is undoubtedly the strongest of the developed world economies and is home to a range of world leaders across a range of sectors, and we continue to find interesting long-term stock-level opportunities in areas with exciting growth potential, such as immunology. For the broader market, however, valuations are less compelling and we continue to believe that a strengthening dollar is likely to provide a headwind for US multinationals.
EM equities trade at a significant discount to developed markets and there are good opportunities in the countries that are beneficiaries of lower oil prices and where the respective governments have committed to business-friendly reforms. Unfortunately, commodity-exporting EMs, such as Brazil, remain under pressure, and similarly the low oil price is a headache for a range of EM oil exporters with knock-on adverse effects for their currencies.
In Asia ex Japan, valuations are attractive versus other markets and in Japan itself we expect a weaker yen to provide a significant tailwind for corporate earnings this year. UK equities have been the focus of some of our asset allocation meetings over the past month, and despite the broader re-rating of the market, our UK team continues to find companies that are committed to boosting shareholder returns. The UK also remains an M&A target, due to the relative ease of the takeover process, and the market’s high dividend yield is still attractive in a global context.
In bond markets, we see an increasing disconnect between the US and UK, where yields should move higher, and Europe, where the ECB began intervening in secondary markets on 9 March. Previous episodes of QE have been a case of ‘buy the rumour, sell the fact’ when it came to rates markets, but for Europe we think that the sheer scale of the ECB purchases will be positive for markets from here. This appears to be borne out by price action; as I write, 10-year bund yields have declined further to just 0.2%. A second-order effect of the ECB’s policy is that many non-euro corporate issuers are tapping European bond markets due to the very cheap financing that is available; one estimate suggests that of the €37.8 billion of investment grade non-financial issuance that was seen in February, some €30.8 billion of this was from companies that are incorporated outside the eurozone!
For bond markets more broadly, the next major catalyst could come in the form of the Fed; any change in its language is likely to be seen as laying the ground for a rate rise, although the strong dollar and low oil prices suggest that the broad CPI readings are likely to remain subdued, meaning there is no obvious rush to raise rates. The recent strength in labour markets will provide food for thought for the Fed however, and we will be watching developments closely in the coming weeks.
Column by Mark Burgess, CIO at Threadneedle Investments
