The start of 2016 began in sobering fashion, with a broad sell off in risk assets accompanied by very pessimistic market assessments from various commentators. Heavy January declines were driven by falling oil prices, China’s worsening economic situation and its effect on global industrial commodity markets, and concerns over the backdrop of rising US interest rates. China’s authorities’ poorly communicated move to devalue the renminbi also negatively impacted investor sentiment.
We have long held the view that central banks will continue to respond to economic challenges with supportive measures. This view was vindicated in February as a co-ordinated shift towards more accommodative policy helped global equity indices stabilise. This included cautious rhetoric from members of the US Federal Reserve (Fed) and European Central Bank (ECB), as well as the surprise implementation of negative interest rates in Japan.
Although headline global equity indices stabilised, the performance of their underlying industry sectors diverged. Financials lagged in the face of multiple headwinds, including lower rate expectations weighing on earnings growth projections and concerns over corporate defaults in the resource sectors and emerging markets. The proliferation of negative interest rate policies also led to broader questions over regulators’ treatment of banks and how future policies may hinder their profitability. Meanwhile, uncertainty over the Brexit referendum impacted sentiment towards UK and European financials, and weighed on the pound. Likewise, the healthcare sector underperformed, primarily on valuation grounds, after posting the strongest performance in 2015.
More positively, the Chinese government moved to increase its fiscal spending to stimulate growth, providing some support to industrial commodity prices. Oil prices also bounced following news that some of the major oil-producing countries were prepared to freeze production. These developments led to a rally in emerging market equities and the region finished as the strongest performer over the quarter as a whole.
Following February’s bounce, global equities rallied further in March as a number of central banks announced large stimulus measures. The ECB was most aggressive, expanding the size and widening the scope of its Quantitative Easing programme to include purchases of non-bank investment grade corporate bonds. It also announced supplementary measures to encourage credit lending, including a reduction of its central bank deposit rate further into negative territory and mechanisms to offset the adverse effect of this policy on bank profitability. These measures exceeded consensus expectations and bolstered market confidence despite scepticism that the ECB may be close to reaching the limit of its ability to support the eurozone economy.
Later in March, the US Federal Reserve also surprised investors by tempering its interest rate rise projections more than anticipated, better aligning its expectations with those of the market. It attributed the shift to global economic pressures but reiterated that the path of interest rates would be data dependent, perhaps with one eye on the US election later in the year.
Despite central bank actions supporting broad risk sentiment and inflation expectations in the US rising, government bonds outperformed developed market equities over the quarter. In particular, longer-dated issues made the large gains as global growth expectations fell. However, the emerging market debt and corporate bond markets were the strongest performers amid the aforementioned macroeconomic developments and a weakening of the US dollar.
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