[ANALYSIS] Goldilocks markets show 2017 was no year to be a bear
A year ago, the consensus view of the world economy and markets coming into 2017 was for a Goldilocks mix of strong growth, decent corporate profits, low volatility, a gradual drift higher in bond yields, and a continued “melt up” in stocks.
If anything, 2017 has proved even more resilient than many had hoped for. World stocks rose 20%, global growth was its strongest since 2010, market volatility fell to its lowest on record and “junk” bond yields hit all-time lows.
It didn’t pay to be a contrarian in 2017.
Just ask Scottish hedge fund manager Hugh Hendry, who closed his fund Eclectica Asset Management after losing 9.4% in the first eight months of 2017 and 4% loss in 2016. He had sold Italian government bonds as part of a wider bet on the break-up of the European Union.
Equity hedge funds with a short-selling bias have been the worst-performing hedge funds this year, down 9.22% January-October, according to data from industry tracker Hedge Fund Research. The wider equity hedge fund total index is up around 11 percent and the S&P 500 is up 18%.
At the start of the year, “secular stagnation”, “political risk” and “weak recovery” were the Cassandras’ popular tropes, but they quietly faded from the wider market discourse as, frankly, global growth and markets boomed.
Continued central bank largesse and a surprisingly rosy economic backdrop, particularly in Europe, anchored market volatility, which provided the springboard for the global and cross-asset rally.
A year ago, Reuters outlined some of the most contrarian market predictions for the year ahead, covering specific trades and broader political and economic risks that could throw markets a curveball.
Unsurprisingly, most of them failed to materialise. But a few did come up trumps.
One was the UBS call for the euro to rise. At the time, the politics didn’t auger well - Europe’s electoral calendar was loaded, populism was on the rise and there was widespread concern that anti-euro parties such as France’s Front National would gain power.
The euro opened the year only a few cents above parity with the dollar and the consensus was that it would struggle to rebound much, if at all.
Swiss bank UBS predicted a rise to $1.20, a level that was breached in August. Right now, the euro is up 13% on the dollar this year, well on course for its best year since 2003.
DOLLAR THE NEW VIX
Another was HSBC rate strategist Steven Major’s prediction that 10-year US bond yields would rise to 2.5% in the first quarter, then fall as low as 1.35%. Well, sort of.
The yield rose to what turned out to be a high for the year of 2.6% in March then came close to breaking below 2% in September.
The following chart from Deutsche Bank’s Torsten Slok shows how consistently wrong analysts have got their US bond yield forecasts down the years. Major’s 1.35% call (which would have been a new low) proved a stretch, but he got closer than most.
Tighter Fed policy was expected to deliver a stronger dollar and higher US bond yields, an unpalatable cocktail for emerging markets. Unsurprisingly, most analysts were bearish on emerging markets at the start of the year.
That’s not how it played out. With the dollar on track for its worst year since 2003 and the US yield curve its flattest in a decade, emerging markets have boomed.
Emerging-market stocks are up 30% and on course for their best year since 2009, local currency debt is up 13% and dollar-denominated EM bonds are up 9%.
The Bank for International Settlements has been a leading voice arguing that the dollar has replaced the VIX index of implied volatility on Wall Street as the best barometer of global investor risk appetite and financial market leverage.
“When the dollar is strong, risk appetite is weak. Given the dollar’s role as barometer of global appetite for leverage, there may be no winners from a stronger dollar,” said Hyun Song Shin, head of research at the BIS, in a speech last November.
Luckily for emerging markets and world markets more broadly, the dollar is down 9% so far this year.
One indicator of how much of a consensus year 2017 has been is the surge of inflows at passive investment vehicles exchange-traded funds (ETFs), which track the ups and downs of major equity indices.
Assets under ETF management are expected to have grown by more than a quarter this year to $4.4 trillion from $3.5 trillion last year, according to a recent report by Ernst & Young Global.