Markets were again plagued by volatility in May, largely due to heightened political risk. The US administration’s approach to global trade, North Korea and Iran remain uncertain, while Italy’s new populist government added to market concerns. Risk-off sentiment contributed to a significant rise in the value of the US dollar, which strengthened 2% vs. a basket of major currencies.
Despite the noise, the macro backdrop is still relatively supportive. The ongoing strength of global growth was evident in corporate earnings reports. Moreover, inflation remains benign, and so any interest rate normalisation looks set to be gradual. Therefore, despite significant intra-month swings, developed world equity markets rose over the month by more than 1% and broad fixed income markets were down around 1%.
US data was strong across the board. April consumer confidence is still close to the 17-year high reached in February, and the flash manufacturing purchasing managers’ index (PMI)—the key business survey—increased in May, indicating an acceleration in the pace of activity into the second quarter. The tailwind to growth from tax reform and the energy sector should more than offset any drag to consumption caused by higher gasoline prices.
What has been unusual about recent events is not the volatility of the S&P 500, the unusual part is that the bond market has performed poorly at the same time. In fact, over the last 20 years there have only been four instances where the S&P 500 and the bond market both fell by more than 1% over a 3 month period….we just experienced one of those periods (February through April, the S&P 500 was down 5.8% and the bond market was down 1.1%). The only other times this occurred over the last 20 years was once in 2004 and twice in 2008.
Overall, the calm markets of 2017, which saw both bond and stock prices drifting gently upwards on a monthly basis, seem firmly behind us. Geopolitical risk is likely to continue to be felt most keenly in currency markets. We continue to believe that over the long term a combination of a large trade deficit and rising government debt should weigh on the value of the dollar. But in the near term, geopolitical risk is likely to coincide with dollar strength. Looking through the noise, we still expect a benign growth environment—characterised by above-trend growth, relatively low inflation and accommodative global monetary policy—to be supportive for earnings growth and equity markets. But a more unpredictable US administration and the re-emergence of political risk in Europe serve for caution in the degree of risk taken at this stage in the cycle.
We encourage you to tune out the markets (whatever they decide to do) and enjoy your summer. Rest assured, we will be here listening nonetheless…noise and all…focused on keeping your plans on track.