This blog aims to give a relatively concise overview of financial markets in 2018 using a selection of charts I tweeted throughout the year. While this probably aggravates the already pronounced calendar-year thinking of investors, it also offers potential insights to the, at times erratic, behavior of financial markets. Expect a non-comprehensive and subjective coverage of 2018, but hopefully also one that is fun to read…
In January bitcoin still dominated the financial headlines. Only this time it was no longer related to the fact that bitcoin made new highs almost every day. After a massive run up, to almost USD 20 000 in December 2017, the cryptocurrency started what has now become one of most epic downturns in history.
Meanwhile, the euro continued its ascent in which it rose to 1.25 against the US Dollar, or up more than 20% since the beginning of 2017. In January, investors were still thinking about some kind of convergence in monetary policy between the Fed and the ECB. The ever-widening gap in interest rates, however, would prove differently, sending the euro down again later in the year.
Expectations surrounding a normalization of monetary policy in the Eurozone were visible outside currency markets as well. Germany’s 10-year bond yield rose to 0.60% as 2018 would surely reflect a decisive turning point in bond markets, right? With hindsight the answer, yet again, has to be ‘it didn’t’.
Apart from the sell off in equities, some other more exotic developments occurred as well. Due to size and velocity of the rise in the VIX index, the NAVs of a number of short volatility ETFs were wiped out completely. Most of these ETFs were terminated ultimately, underpinning that short volatility strategies are like picking up pennies in front of a steamroller.
In March, FANG stocks and their ‘colleagues’ in the FANG+ Index determined market sentiment, which was pretty horrible at best. FANG+ stocks fell more than 11% in less than 10 trading days as worries about their, in some case, lofty valuations grew.
On the economic front, which was looking pretty ok, the wait for faster wage growth continued. Even though the US labor market strengthened each month, as it would do so throughout the year, wages continued to lag, intensifying the discussion among economists if the Phillips curve had broken down. Recent wage growth numbers show that the curve was probably lagged not broken.
April provided the first signs that economic growth was becoming less synchronized. Especially in the Eurozone, circumstances deteriorated quickly with the Citi economic surprise index falling to its lowest level since 2012. By this time, the trade war between China and the US had really started with the first round(s) of tariffs being implemented. Coinciding with what would have a been a soft patch in the economy any way, the decline in macro numbers and the escalation of the trade war probably accumulated into the negative Q3 GDP growth number in Germany. On top of some car sectors specific issues of course.
Equity markets bottomed in April, yet the Bofa Merrill Lynch’s monthly Fund Manager Survey for April showed fund managers had gone long cash and underweight equities. Given the fact that the S&P 500 Index would rise another 8% until October, these fund managers are either very good at forecasting longer-term equity movements, or heavily influenced by the poor stock market returns that just occurred, making them too negative about future stock market performance. I’ll let you answer that question for yourself.
May saw two new risks emerge that would shape a large part of 2018. First, cracks in some of the smaller and weaker emerging countries started to emerge. It was Argentina’s central bank, which raised its reference rate by almost 10% to 40% to halt the decline of the Argentine Peso. Argentina, however, would not remain on its own.
The other risk came from Europe, obviously. Europe has realized an impressive track record of politics hampering financial markets, and 2018 has been no exception. Italy’s new government, a mixture of two very different parties, was always a risk for Italian political stability. But slowing GDP growth, something Italy can’t afford given its massive pile of government debt, and the upcoming budget round within the EU already send Italian bond yields firmly higher.
Turkey took over the headlines in June. Like Argentina, its currency collapsed too. Different from Argentina however, Turkey’s central bank refrained from intervention, a decision that surely seemed to reflect some political interference. In July, President Erdogan would name his son-in-law economy chief. When Moody’s (finally) lowered Turkey’s credit rating things really started to look ugly. With relatively large amounts of foreign debt in Turkey’s financial system, the fall of the Turkish lira put a massive strain of Turkish banks. Emerging currencies as a group sold off as well, pushing their value down more than 10% against the US Dollar since February.
June also brought the first bear market within the major stock markets. China was the ‘lucky’ one with company earnings pressured because of lower growth and the seemingly unwillingness of the Chinese government to stimulate growth. While this would change later in the year, China’s possibilities remain limited given the massive amount of corporate debt in the Chinese financial system.
The China – US trade war was now in full swing, resulting in China’s first current account deficit in 25 years. More importantly, countries and companies all over the world started preparing for a prolonged dispute that would negatively impact trade and growth. A classic example that politics unfortunately do matter.
Facebook probably won’t look back at July with that much joy either. It now, undesirably, tops the list with the largest one-day market cap losses in big cap stocks, after reporting worse than expected sales and user numbers. The stock slumped 19%.
Turkey ‘gets’ two charts in the 2018 overview. In August investors fled the country, sending the USDTRY exchange rate through 7, almost halving the value of the Turkish Lira against the US dollar relative to the beginning of the year. Turkey’s central bank finally gave in and raised its repo rate to 24% later on. Since then things have stabilized somewhat but remain shaky at best. Also, the currency remains heavily depressed in value, it is down roughly 60% since 2010, suggesting an accident can still happen.
We have reached September, a difficult month for equities most of the time, but not on this occasion. Emerging currencies, however, hit new lows on Argentina and Turkey, and declining sentiment towards emerging markets in general.
By now, the ongoing monetary tightening of the Federal Reserve also started to weigh on financial markets. Chairman Powell suggested the Fed was still some distance away from the neutral rate, even though the reduction of the balance sheet continued. The ‘r* debate’ gets a bit out of hand, as we can tell later on, but the effect of tightening is becoming more apparent. Powell would send markets tumbling in October after suggesting the tightening was far from over, although he tried to correct this in November.
In October, Angela Merkel announced she will not be running for a firth term as Germany’s chancellor. While less relevant for markets, she deserves a spot in the 2018 review. During the month, however, investors are far more focused on Italy, which has submitted a budget deficit proposal of 2.4% of GDP using a number of pretty unrealistic assumptions. The likely rejection by the EU steers Italy’s 10-year bond yield up to an impressive 3.75%, not that far from levels that would create direct solvency problems for Italian banks.
Meanwhile, Chinese stocks are down almost 30% from their high earlier in the year. The Chinese government has increased stimulus, but by no means comparable to the stimulus started in 2015, and signs of any uptick remain elusive.
Chinese stocks close at their lowest level of the year. Shanghai Composite Index down 28% from its high in January.… twitter.com/i/web/status/1…
November brings a new bear market. In oil this time. Slower economic growth, rising supply and OPEC that is struggling to determine the direction of oil prices send oil into bear market territory. It remains ‘interesting’ to this day that just over a month before the bear market started many investors were expecting oil prices to top USD 100 once again. Commodities are a very difficult asset class to forecast, and the massive reversal of oil prices confirms this in my view.
Bitcoin is still alive in November, but it too has entered an undesirable list, that of biggest bubbles of all time. While I don’t know if this is the end of bitcoin, I tend to think not, it surely is the end of many other cryptocurrency projects. The total market cap of all cryptocurrencies has fallen to from above USD 800 billion to just over USD 100 billion now. It’s the combination of the size of the collapse and the emergence of a new ‘asset class’, that makes this ‘bubble’ one to remember.
The collapse of equity markets in December, usually a pretty investor-friendly month, obviously doesn’t qualify under: ‘saving the best for last’. The S&P 500 Index, by far the strongest of the global equity markets during the last 10 years, also entered a bear market. Many emerging and European markets went already before that. Recession scares, overdoing it by the Fed, China growth worries, trade wars, Brexit fears, they all accumulated into making it at one of worst December months in history.
equities were not alone in the carnage. As a result of the meltdowns in many financial markets in December, 2018 has turned out to be a year in which basically all major asset classes realized a negative return. If anything, 2018 was a year in which earning a decent return was very, very hard using traditional investment strategies.
So now what? The pressure on most asset classes surely has something to do with the reduction in global liquidity by central banks. 2019 promises little relief on that front as the ECB and other central banks seek some kind of normalization. It was always likely that markets would struggle with this development. However, at this point a US recession still doesn’t look imminent. Parts of the yield curve haven’t inverted, and other leading indicators point towards slower, but positive growth. Under these conditions earnings should be able to grow just a little bit more, making equities not all that expensive given current valuations. It seems that risky assets, and especially equities, have some room to rise before we reach the actual end of this cycle. Let’s hope I can put this in next year’s review as well.