Highlights from last month

2018 began with a bang as markets continued to set fresh records. In what some dubbed a “melt-up” ‒ the self-perpetuating rally that often precedes a sell-off ‒ the gains in equities were impressive: Global stocks rose 5.6%, the third best January since the inception of the MSCI AC World Index in 1987, and emerging market equities5 surged 8.3%. Even more notable, though, was the length of the broader rally: Both the S&P 500 and MSCI World Indexes entered their longest periods without a correction of more than 5%. The risk rally was not confined to the bottom of the corporate capital structure: High yield credit spreads11 tightened over 20 bps, Brent crude rose above $70 per barrel for the first time since December 2014, emerging market currencies soared against the U.S. dollar, and U.S. inflation expectations hit a multi-year high. Developed market currencies also rallied against the U.S. dollar, and yields rose across many developed economies, weighing on safe-haven assets. Positive economic data helped stoke the market exuberance, already invigorated by the prospects of stronger global growth and fiscal stimulus in the U.S.

A U.S. government shutdown and the potential for a trade war did little to curb the market rally. The U.S. government shut down for the first time since 2013 as battles over immigration blocked a funding bill. The standoff was short-lived though: Senate Majority Leader Mitch McConnell brokered a deal within three days to provide stopgap funding through 8 February with a promise to address protection for “dreamers” (undocumented immigrants brought to the U.S. as children). With the shutdown behind him, President Donald Trump attended the World Economic Forum in Davos, where Treasury Secretary Steven Mnuchin’s endorsement of a weaker dollar renewed concerns over protectionism. This came just days after the U.S. administration announced its first (largely symbolic) import tariffs ‒ on washing machines and solar panels ‒ and amid growing worries that the U.S. might withdraw from NAFTA as the sixth round of negotiations continued. In Iran, civil unrest escalated with ongoing anti-government protests, and the state of its nuclear deal remained tenuous as President Trump threatened to restore sanctions unless his European counterparts fixed concerns with the agreement. Meanwhile on the Korean peninsula, tensions appeared to thaw somewhat as North Korea agreed to participate at the Winter Olympics in PyeongChang in February.

Fundamentals continued to underpin the global growth narrative. In the U.S., generally positive growth coupled with steady inflation data appeared to keep the Federal Reserve on a path to another rate hike in March. Americans demonstrated an increased willingness to use their credit cards in recent months: Consumer credit surged above expectations to its highest level in 16 years. Business activity remained firmly in expansionary territory as the ISM manufacturing survey pointed to a sustained recovery in the factory sector, fueled by a boost in new order activity and higher prices paid for inputs. Initial jobless claims dipped to their lowest level in 45 years, despite a smaller-than-expected gain in new jobs, while the unemployment rate was unchanged. However, retail sales lagged after a strong report in December, and the initial reading of fourth-quarter GDP came in below expectations. Elsewhere, the rise in core inflation in Europe, while still below the European Central Bank’s (ECB) target, supported an optimistic near-term outlook for the European economy. Despite this backdrop, ECB President Mario Draghi pushed back against suggestions that the ECB could begin to raise rates this year.

In a league of its own
While the S&P 500’s 22% rally in 2017 (and 16% annualized return over the past five years) is impressive, January’s single month return of nearly 6% was in a league of its own. Yet the U.S. was in good company: The MSCI World jumped 5% in January, and the MSCI EM Index soared over 8% – emerging markets’ best start to the year since 2012. What’s more, both the S&P 500 and MSCI World Indexes entered their longest period without a correction of more than 5% (foreshadowing for February?). As risk markets surged, bond prices fell and yields rose in response to fading central bank stimulus, prospects for higher inflation, and increased fiscal stimulus in the U.S. In contrast, the U.S. dollar fell sharply in January on a pickup in global growth expectations and after Treasury Secretary Steven Mnuchin endorsed a weaker dollar at the World Economic Forum in Davos.