At the start of 2018, financial markets were brimming with confidence. The previous year had been a cake-walk for equities, with volatility at record lows and valuations rising steadily.
The US corporate tax cuts were acting as a tailwind and stock markets kicked off the year impressively. Then, on January 29, the US market had a modest correction which snowballed over the following days. By February 9 US stocks had fallen by 12% and the world’s exchange-listed companies had been marked down by over $5tn.
Many experts found it difficult to pinpoint the cause — stretched valuations, concerns about inflation, profit taking, increased funding costs were just a few of the theories put forward but we can only speculate on what actually caused the sellers to sell.
One thing was clear, however; after a historically long vacation, volatility had returned to stock markets. Over the following months global equities continued to be undermined by an escalating trade war.
A further bout of volatility was triggered in May, when the new Italian government was formed. Many investors were uncomfortable with the coalition’s anti-establishment credentials and when the new Italian leaders baited European authorities with their plans to increase the budget deficit, the writing was on the wall. Between May and October, Italian equities and bonds fell by 25% and 15% respectively.
When it comes to emerging markets, volatility tends to get amplified and because a large percentage of emerging market debt is denominated in US dollars, emerging economies are very sensitive to dollar strength.
The axe continued to fall in the fourth quarter when, other than low-risk sovereign bonds, there were few places of refuge. Some of the headline makers included oil — which fell 39% on over-supply concerns — GE shares, and Bitcoin, which continued its spectacular decline after being spurned by venture capitalists.
The vast majority of asset classes and investment sectors are showing negative returns this year. This year was a snowball in the face for financial markets and a reminder that complacency, leverage and algorithms can be a dangerous cocktail. Looking ahead to 2019, there is a selection of themes, both old and new, to watch out for.
Firstly, if you’re fed up hearing about Brexit, it’s bad news I’m afraid. Negotiations are set to intensify in January and if the British parliament can’t ratify a deal, the UK government will either need to agree a no-deal exit or seek an extension to Article 50.
Secondly, trade wars. The Chinese retaliation to the Trump tariffs has been quite effective. By bringing the trade war to the farming communities of the US, they have hit the US president where it hurts. This has forced Mr Trump to the negotiation table and enabled a 90-day truce. Overall, it’s a step in the right direction, but US trade policy can change in the time it takes to send a tweet, and with the US-China truce due to run until the beginning of March, President Trump may shift his attention to Europe.
Which brings us to the question of fiscal expansion in Europe and China. Most forecasters are expecting global growth to slow in 2019. Those who aren’t will be pinning their hopes on the proposed fiscal expansions in Europe and China. Final budget plans are not yet available. If they’re something in the region of 0.5% of GDP in Europe and 1% of GDP in China growth concerns may prove to be overblown.
In 2019 we will see new leaders appointed to the European Parliament, the Commission, the Leader’s Council and the ECB. The changes may coincide with periods of transition for European fiscal policy.
Volatility may take some lengthy holidays, but it always returns.
Ronan Costello is head of Euro Money Markets at Bank of Ireland Global Markets.