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Market Report

Global equity markets fell over the last year, with the MSCI AC World Index falling by 9.5% in local currency terms. Global equities performed well in the first three quarters of the period, recording the best annual equity market gain in a decade in 2019 as trade war concerns faded with the eventual agreement of a “phase one” US-China trade deal. However, Covid-19 bought an end to the decade-long bull market in Q1 2020, as the virus outbreak in China escalated into a global pandemic. Whilst unprecedented fiscal and monetary stimulus provided support to markets, the MSCI AC World index still recorded its worst quarter since the 2008 Global Financial Crisis with a -19.9% return in local currency terms in Q1 2020. With much of the global economy shuttered going into Q2 2020, a deep global recession appears to be inevitable.

The US Federal Reserve (Fed) implemented three 0.25% rate cuts over the second half of 2019, bringing the Federal Funds Rate target down to 1.50%-1.75%. The Fed then announced two emergency rate cuts in Q1 2020 in a bid to mitigate the severe economic impacts of Covid-19, lowering the Fed Funds Rate target by a total of 1.50% to 0.00%-0.25%. The Fed also relaunched quantitative easing, pledging to buy potentially unlimited amounts of treasuries, corporate bonds, and other credit assets.

Following the Fed’s lead, the Bank of England (BoE) cut its base rate by 0.65% to an all-time low of 0.10% in Q1 2020. Meanwhile, the European Central Bank (ECB) cut its deposit rate by 0.1% to -0.5% in September 2019 but, with limited room to cut rates further, kept interest rates unchanged in Q1 2020 amidst the coronavirus outbreak. The BoE joined the ECB in launching new asset purchase programme in Q1 2020.

Brent Crude oil prices fell sharply by 66.7% to US$23 a barrel over the last twelve months. Weakening global economic growth and heightened trade tensions kept a lid on crude oil prices over 2019 but almost all of the decline occurred in Q1 2020. Over that quarter, oil prices fell by 65.5% in USD terms as demand for fuel fell due to social distancing measures to reduce the spread of Covid-19 whilst Saudi Arabia ramped up production after it failed to agree a plan with Russia to cut oil supply.

Sterling ended a highly volatile twelve-month period 1.7% lower on a trade-weighted basis. Sterling was driven by Brexit developments for most of 2019. Whilst fears of an acrimonious “No Deal” Brexit kept pressure on sterling over 2019, sterling rallied after Prime Minister Boris Johnson agreed a Withdrawal Agreement with the European Union and his Conservative Party won a sizeable majority in the UK general election, paving the way for the Brexit Withdrawal Agreement to be ratified. Sterling fell sharply in Q1 2020, briefly hitting a 30-year low of $1.15/£ against the US dollar amidst safe haven dollar inflows and a deteriorating UK coronavirus situation.

UK gilt yields fell in tandem with global government bond yields as monetary easing measures by major central banks took interest rates to near zero. Meanwhile, increased demand for government bonds from investors seeking “safe haven” assets amidst an equity market sell-off and from central banks implementing quantitative easing measures also drove prices up and yields down further. Investment grade credit spreads (the difference between corporate and government bond yields) rose over the year to end at their highest level since 2012. Credit spreads widened in Q1 2020, a reflection of the risk asset sell-off which tormented equity markets over the quarter, as concerns over future corporate earnings and existing corporate leverage resurfaced.

UK commercial property returned 0.1%, supported by a steady income return of 5.4% which offset the 5.0% fall in capital values. The coronavirus outbreak intensified pressure on the already struggling retail sector, delivering a total return of -9.7% over the period.

The graph below summarises the index returns on the main asset classes/regions for the year to 31 March 2020. Returns are shown in sterling terms and local currency

 

Further details on the performance of specific asset classes over the period are provided below.

 

Equities

UK equities fell sharply over the year, returning -18.5%. UK equities rose over Q2 2019 despite lacklustre UK economic data releases and this continued over Q3 2019, although equity market momentum weakened. UK equities continued to rise over Q4 2019, but lagged other markets, suggesting that some Brexit-related fears still prevented UK stocks from fully participating in the strong global equity rally. However, in Q1 2020, UK equities underperformed other regions with a return of -25.1%. The FTSE 100 index briefly fell below 5,000, its lowest level since 2011, before recovering some of the losses towards the end of March. The UK equity market’s heavy exposure to commodities (Oil & Gas and Basic Materials sectors) suffered from the collapsing oil price over Q1 2020 caused by a disagreement between OPEC and Russia over oil production and lower global demand for commodities due to the virus.

US equities outperformed other markets over the year, returning -7.0% in local currency terms. Performance was strong in Q2 2019 as US equities rallied strongly late in the quarter as the Fed moved to a more dovish stance and trade concerns retreated slightly. Positive performance continued for the remainder of 2019, as more defensive stocks performed well in the third quarter with Consumer Staples and Utilities posting near double-digit returns, and Q4 performance was driven by valuation multiple expansion, leading US equities to all-time highs. US equities fell sharply over Q1 2020, despite reaching all-time highs in mid-February, as the market subsequently fell more than 20% below its peak in just over three weeks, recording the fastest bear market in history.

European equities were buoyed by improving investor risk appetite over Q2 2019, despite being buffeted by the global slowdown and rising trade concerns. Defensive stocks in Europe outperformed their more cyclical counterparts in the third quarter, with the latter hit by data releases pointing to signs of further economic weakness particularly in the manufacturing sector. Over Q4 2019, a slight improvement in European economic data, combined with expectations of a trade deal between the US and China, led European equities higher. However, as with other markets, this was reserved in Q1 2020 as Europe was amongst the worst impacted by the coronavirus outbreak with the region accounting for the majority of the world’s confirmed cases as at the end of March. The relatively limited scope for fiscal and monetary stimulus in the region compared to elsewhere was a drag on investor sentiment. The Europe ex UK index fell 10.7% over the year in local currency terms.

Japanese equities returned -9.2% in local currency terms over the year. Japanese equities struggled over the second quarter of 2019 and were the only major equity market to fall in local currency terms. However, they bounced back in Q3 and Q4 following better than expected economic releases and greater optimism for some respite in the US-China trade war. The region was the best performing over Q1 2020 as the Covid-19 outbreak appeared to be relatively contained in Japan. The lower corporate leverage amongst Japanese companies also helped to limit drawdowns. 

Emerging Market equities returned -12.7% in local currency terms over the past year. Trade concerns hurt emerging markets and especially exporting countries in Q2 and this continued to depress emerging markets over Q3. Emerging market stocks recovered strongly in the fourth quarter with the highest local currency return among major equity markets. Alongside the thawing of trade tensions, reflationary policies in China (lowering of reserve requirement ratios and greater fiscal expansion) helped Chinese equities surge. Emerging markets suffered similar returns to other regions in Q1 2020, as whilst the coronavirus outbreak hit China hard when it first spread out from Wuhan, Chinese equities were boosted by signs of recovery from the outbreak later on.

 

Bonds

UK fixed gilts returned 9.9%, whilst UK index-linked gilts returned 2.2% as yields fell across both curves. Over Q2 and Q3, gilt yields were influenced by the downtrend in global bond yields on the back of the easier monetary stance of central banks and weaker global growth. However, yields rose over the fourth quarter, although this was reversed in Q1 2020.

Index-linked gilts outperformed fixed interest gilts over Q2 and Q3 2019, despite the fall in breakeven inflation (a market-based measure for expected inflation, calculated as the yield of a fixed interest bond minus the yield of an inflation linked bond of the same maturity) which meant real yield movements were generally more muted. However, index-linked gilts underperformed fixed interest gilts in Q1 2020, driven by falling breakeven inflation especially pronounced at shorter durations.

Corporate bond spreads (the difference between the yields on non-government bonds and equivalent maturity government bonds) fell across all credit grades, although the move was most notable among lower quality corporate bonds in the second quarter of 2019. However, concerns over UK credit escalated over the third quarter with investment grade credit spreads widening slightly before reversing the following quarter. In Q1 2020, UK investment grade corporate bond spreads reached their highest levels since 2012, with lower quality credit spreads widening by more than their higher-quality counterparts. This reflected increased downgrade risks, as a number of lower-rated companies were downgraded out of investment grade status over March, with more expected in the coming weeks.

 

 

Property

The MSCI UK Monthly Property Index was broadly flat over the year, returning 0.1%. Tough market conditions meant capital values fell. These lower values were, however, more than offset by stable income returns. There was no discernible change in either market rents or vacancy rates over Q2 and Q3 2019, but rental growth became negative over Q4. In the first quarter of 2020, overall performance was negative, as vacancy rates increased and rental growth continued to be negative.

 

Infrastructure
 

For the better half of 2019, institutional investors have continued to embrace the potential of equity investment in core private infrastructure assets: diversification, inflation protection and yield returns. Due to favourable diversifying effects of the asset class there continues to be a lot of interest in illiquid opportunities such as infrastructure. As with all illiquid asset classes, valuations need to be treated with an element of caution and the true performance of these assets is known once assets are realised.