Market Analysis Mar 2019

During Q1, US equities mounted a strong comeback following a challenging conclusion to 2018. The Federal Reserve's announcement of plans to adjust interest rate hikes to accommodate declining economic momentum, alongside the resolution of the US government shutdown, greatly contributed to these gains, particularly in January. However, as the quarter progressed, the Fed embraced a more dovish stance in light of slower economic growth. The Q4 GDP was revised downward from the initial 2.6% reading to 2.2%, and the potential resolution of US-China trade tensions seemed more feasible.

By the close of March, investors displayed heightened caution as they balanced the Federal Reserve's accommodating tone with its broader implications for economic growth. The Fed adjusted its expectations for US growth and inflation, and it scaled back projections for interest rate hikes, with the "dot plot" now indicating no rate hikes in 2019 and just one in 2020. The adjusted growth outlook caused the Treasury yield curve to invert, a historical precursor to a pre-recessionary environment.

Despite the cooled sentiment by quarter's end, equity gains were widespread for the entirety of the quarter. The IT sector, which encountered challenges in Q4, particularly excelled, while healthcare witnessed more tempered gains due to uncertainty surrounding potential regulatory changes. The Fed's comments on rate trajectory also hampered gains in the financial sector.

Eurozone equities bounced back in Q1 after a weak finish to 2018, thanks to central banks' departure from stricter monetary policies. The European Central Bank (ECB) announced that interest rates would remain at current levels at least until the end of 2019, and the US Federal Reserve also indicated a lack of interest rate rises for the year. Furthermore, optimism surrounding global trade improved as the US postponed planned tariff hikes on Chinese goods.

The market displayed mixed performance across sectors. While industrials and information technology fared well, traditionally secure sectors like consumer staples and real estate also ranked among the top performers. Although banks initially benefited from reports of a new ECB program to support lending, the details unveiled in March were less impressive, and continued low interest rates may impact net interest margins.

Despite the prevailing positive sentiment in the market, concerns lingered over economic growth. The eurozone's economy expanded by a mere 0.2% in Q4 2018, with Germany registering no growth and Italy slipping into a recession. Forward-looking indicators signaled further fragility, particularly in the manufacturing sectors. The flash manufacturing purchasing managers' index declined to 47.6 in March from February's final reading of 49.3, indicating contraction.

In Q1, UK equities followed the global trend, rallying after a lackluster Q4 2018. Companies exhibiting strong and defensible earnings growth outperformed, considering the uncertain global economic outlook. The UK's relatively small technology sector and select consumer goods companies, including large-cap tobacco and beverage groups, particularly shone.

Areas with domestic focus that were previously undervalued staged a robust resurgence after the extension of the Brexit deadline beyond March 2019, fostering hope for averting a disorderly exit from the EU. Despite a broader economic slowdown, UK employment growth remained robust, with nominal wages continuing to rise while inflation remained muted.

In Q4 2018, the UK's economy decelerated due to Brexit uncertainty impacting business investment. The Office for National Statistics reported that GDP growth tapered from 0.7% in Q3 2018 to 0.2% in Q4. The UK economy expanded at a rate of 1.4% in 2018, marking its slowest pace in several years. The Organisation for Economic Co-operation and Development (OECD) projected UK economic growth to slow to 0.8% in 2019 under the assumption of an orderly Brexit, while the Bank of England lowered its 2019 GDP growth projection from 1.7% to 1.2%.

During the initial quarter of 2019, global equity markets rebounded from the substantial losses of the previous year's conclusion. Nevertheless, the Japanese equity market's return of 7.7% was relatively subdued in comparison to other developed markets. The Japanese currency depreciated against other major currencies, retracing a portion of the sharp movements observed in late 2018 and early 2019.

Interest rate trends underwent reevaluation during the quarter, leading to intermittent volatility after the US yield curve inverted. A more subdued global interest rate environment renewed investor favor towards stable growth and bond-like proxies within the equity market, while sectors related to finance lagged behind.

The corporate results season for the quarter concluded in mid-February with a predominantly negative interpretation, slightly skewed towards downside surprises. However, share price reactions remained muted, suggesting much of the setback had already been factored in. Negative surprises primarily stemmed from a more pronounced-than-anticipated slowdown in the external environment, particularly in China, affecting sectors like automotive and technology. Elevated labor costs further contributed to mounting pressure in distribution, food, and retail sectors. Corporate earnings revisions for the fiscal year maintained a negative trajectory throughout March.

March witnessed Japanese economic data largely aligning with expectations. Headline inflation slightly exceeded forecasts, and the Bank of Japan's quarterly Tankan survey indicated deterioration in conditions for large manufacturers, as anticipated.

Asia ex Japan equities rebounded significantly from the preceding quarter's sell-off, though global growth concerns persisted. Chinese and Hong Kong markets emerged as frontrunners, buoyed by easing trade tensions, MSCI's elevation of the weighting of China-listed shares in its benchmark indices, and expectations of supportive policies to counteract the economic slowdown. Indian markets encountered pressure due to geopolitical tensions with Pakistan but rallied on optimism surrounding the return of the current coalition government to power in upcoming elections. South Korean stocks underperformed, primarily due to the abrupt termination of the US-North Korea summit and apprehensions concerning corporate earnings. In contrast, ASEAN markets lagged behind the broader region.

Throughout Q1, both higher-risk assets and government bonds performed favorably, capitalizing on a robust recovery after the significant declines of late 2018. A pivot towards a more dovish monetary policy, particularly by major central banks, significantly impacted the markets. Apprehensions had arisen about the potential tightening of monetary policy in the US, yet both the Fed and ECB conveyed that interest rates would remain stable in 2019, coupled with revised downward growth and inflation forecasts. US 10-year Treasury yields plummeted by 30 basis points over the quarter, reaching their lowest level since late 2017. Additionally, in an intriguing occurrence, the three-month Treasury bill yield exceeded that of the 10-year bonds in March, indicating escalating investor caution surrounding prospects for economic growth.

In the European bond markets, 10-year Bund yields experienced a drop exceeding 30 basis points and sank below zero towards the end of March, marking the first such occurrence since October 2016. European economic data further weakened over the quarter, particularly in the manufacturing sector.

Corporate bonds witnessed a robust quarter, recouping the losses endured in Q4 2018. High-yield credit outperformed investment grade, with both surpassing government bond markets. Emerging market bonds also enjoyed a positive quarter, with US dollar-denominated debt outperforming local currency bonds due to weakening certain EM currencies.

Convertible bonds enjoyed a significant tailwind, as evidenced by the 6.6% surge in the Thomson Reuters Global Focus index. Interestingly, during a period of escalating markets and amplified risk appetite, investors did not seek out convertibles, resulting in a slight depreciation in their valuations.