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Bleak midwinter

02 January 2019

Stocks worldwide slid in the last three months of the year, as growth and trade risks unnerved investors, reports CIO Chris Ralph.

For developed world equities in 2018, it was the fourth quarter that really counted.

In the US, the S&P 500 rose some 9% across the first three quarters, but a fall of some 14% in the fourth left it down for the year.1 The Topix index in Japan ended the first three quarters unchanged, only to lose almost 18% in the fourth. Europe’s Eurostoxx 50 and the UK’s FTSE 100 indices both lost some ground in the first nine months of the year, but it was the final quarter that hurt, knocking more than 10% off the value of each index.2

As if on cue, volatility on the S&P 500 started to rise materially on 1 October and has remained elevated ever since. The VIX, which measures volatility across S&P 500 stocks, spiked to 36 in mid-December and ended the year around 25 – its historical average is just 20.3 Undoubtedly, there were significant moments in the fourth quarter that weighed on stocks.

Among those moments, geopolitics, diplomacy and trade loomed especially large. A Saudi journalist was murdered in the Saudi embassy in Turkey at the start of October and Russia detained three Ukrainian ships in the Sea of Azov in November. Both incidents sparked international condemnation, but Riyadh and Moscow arguably felt the shift in the oil price more keenly, as a barrel of Brent crude dropped from $86 at the start of October to below $55 at year-end, reflecting fears of oversupply, the rise of shale oil, and worries over global growth.4

The price drop offers some relief to China, the world’s largest oil importer,5 after a fraught year in which growth slowed and the Shanghai Composite index fell an eye-watering 25%.The fourth quarter accounted for almost half of the losses, as China felt the weight of US trade sanctions, which had by year-end been placed on $250 billion of Chinese exports.

Yet trade tensions only accounted for some of the falls; after all, while China was the target of US sanctions, other emerging markets had a bad year too, knocked by a rising dollar and by specific crises in Turkey, Argentina and Brazil. The MSCI Emerging Markets index lost almost 10% in the first three months of the year, only to lose almost as much again in the final quarter.7

Although global tensions played their part in buffeting markets, investors still had growth and corporate earnings in their sights. The trends were broadly positive. Global growth should come in at just over 3% for the year, while third quarter growth in the US was 3.4% (annualised).8 Wage growth was also notable in the US, as were corporate earnings, which enjoyed the boost provided by Donald Trump’s 2017 corporate tax cuts.

Yet extended periods of growth can unnerve investors, sparking fears that the best has already been and gone. The US is currently enjoying its second-longest run of economic growth in recorded history, while the current S&P 500 bull run is its second-longest – or, by some calculations, its longest.9

In recent years, it has been the technology majors that have driven index gains, as their earnings and market share continue to creep upwards. The S&P 500 Information Technology gained more than 50% in just two years over 2016-17. Last year, despite a Facebook data-privacy scandal in March, that surge continued, adding another 18% over the first three quarters as Apple and then Amazon became the first listed companies to be valued at a trillion dollars.10 But these 2018 gains were forfeited in the final quarter as worries over regulation and business growth – iPhone sales began to plateau – led some investors to lock in their substantial gains.

Market participants also feared that strong economic growth would spur inflation, leading central banks to tighten policy. (Policy tightening, in turn, tends to slow growth.) The Federal Reserve raised rates four times in 2018 as expected – against just once for the Bank of England – but was sounding more dovish by December. 2018 was also the year when markets started to feel the effects of quantitative tightening, as the Fed began to sell bonds back to the market. The ECB is some way behind but did end its asset purchases – of €30 billion a month – in December.11

Politics was never far from market movements. A December government shutdown in the US continues to stretch nerves, but political discord was perhaps greater in Europe. Angela Merkel was left so weakened by state elections that she set her departure for 2021 while several weekends of ‘gilets jaunes’ riots in France persuaded Macron’s government to roll back some new policies. Italy tested Brussels’ patience with an expansionist budget before watering it down.

The UK arguably had the worst time of them all. Although the public finances are much improved, Philip Hammond delivered an unremarkable Budget. The Christmas season only added to the sense of woe afflicting the UK High Street, but the greatest troubles were in Westminster, where Theresa May delayed the parliamentary vote on her Brexit plan in the hope of winning round some 100 MPs by mid-January. The sense of disorder was palpable. So much so, in fact, that when MPs were likened to clowns and parliament to a circus, the media was criticised for the comparison – by the UK’s former chief clown.


Source: FTSE International Limited ("FTSE") © FTSE 2016. "FTSE ®" is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any libaility for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE's express written consent.

© S&P Dow Jones LLC 20[16]. All rights reserved.

Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

1-4 Bloomberg, accessed 31 December 2018
5 US EIA, accessed 31 December 2018
6-8 Bloomberg, accessed 31 December 2018
9 Reuters, accessed 31 December 2018
10 Bloomberg, accessed 31 December 2018
11 Reuters, accessed 31 December 2018

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