Our proprietary leading economic indicator suggests that international developed market stocks are positioned to outperform versus their U.S. counterparts.
January 2020 Market Commentary
In January, global equity markets fell for the first time in five months - largely driven by the coronavirus outbreak, which led investors to a “risk off” sentiment. Within the U.S., large caps outperformed small caps, returning -0.0% versus -3.2%. U.S. equity volatility, as measured by the VIX Index, increased +36.7% to 18.8 – this level is in-line with the long-term average of 19.2. Abroad, developed stocks outperformed emerging markets, returning -1.2% versus -3.3%.
In January, risk-off currencies (USD, CHF and JPY) outperformed their risk-on counterparts. Over the month, geopolitical tensions and the coronavirus led to concerns around global growth. The USD rose +0.9% and was supported at the beginning of the month by a U.S. drone strike killing an Iranian general. On the last day of the month, the USD weakened after the Chicago PMI reading fell to 42.9 versus a 48.9 forecast.
The U.S. ten-year yield fell forty-one basis points and ended the month at +1.5%. The significant drop was driven by geopolitical tensions, the coronavirus outbreak and a weaker than expected non-farm payrolls report. The month ended with the spread between the three-month and ten-year yield inverting.
The price of crude oil declined -15.6% after rising +10.7% in December. China is the world’s largest importer of crude oil, and the outlook for demand drastically declined due to the coronavirus. Crude oil received marginal support from supply falling in Libya due to a blockade in the country’s export terminal.
Gold prices rose +3.9% and reached a several year high over the month. Gold retained it’s “safe haven” status as geopolitical tensions and coronavirus concerns were top of mind. The U.S. and China signed the “phase one” trade deal during the month, however this had minimal impact on the markets as it had been announced in December of last year. The U.S. agreed to suspend additional tariffs and reduce the existing tariffs on $110bn of Chinese imports from 15% to 7.5%.
Short-Term Market Outlook
Our proprietary leading economic indicator declined month-over-month and remains in negative territory. This was driven by continued weakness in global trade and manufacturing.
Our outlook for U.S. stocks versus investment grade bonds remains in neutral territory. The weakness in the QS leading economic indicator has been offset by valuations (equity earnings yield compared to ten-year treasury yield) and the decline in treasury yields.
In U.S. fixed income, we believe that high yield should underperform investment grade bonds over the near term. Within the model, the widening of the spread between these assets and a rise in equity volatility have tilted our model towards investment grade bonds.
We believe that U.S. stocks are positioned to underperform versus their international-developed market counterparts. This view is supported by valuation, which compares the forward price to earnings ratio in the U.S. versus their international counterparts. Options market data also shows greater demand for price protection in the U.S. versus international-developed markets. The options market data (where we measure the demand for put options versus call options) supporting international-developed markets is at its strongest level in several years.
European stocks are expected to outperform European bonds in our model. Valuation, as measured by comparing European equities earnings yield to the ten-year government yield, and equity price momentum continues to support stocks. European leading economic indicators now prefer European stocks for the first time in nearly two years.
Asset Class Preferences are based on QS Investors proprietary quantitative factor models. These rules-based financial models use a combination of indicators that analyze asset valuations, investor sentiment, and the broad economy.
All data source Bloomberg, as of 1/31/20, unless otherwise noted. Global Equities represented by the MSCI ACWI Gross Total Return Local Index; Emerging Market Equities represented by the MSCI EM Gross Total Return Local Index; Developed Market Equities represented by the MSCI EAFE Gross Total Return Local Index; U.S. Large Cap Equities represented by the S&P 500 Total Return Index; U.S. Small Cap Equities represented by Russell 2000 Total Return Index; U.S. Dollar (USD) represented by the Bloomberg Dollar Spot Index; Swiss franc (CHF) represented by the Swiss Franc Spot Index; Japanese yen (JPY) represented by the Japan Yen Spot Index.
QS Leading Economic Indicator Index is a proprietary composite of economic data that QS Investors believes are significant in determining financial and economic conditions in the U.S. Past performance or any prediction or forecast is not indicative of future results. QS Leading Economic Indicator Index inception date is 1/2/1970.
A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
CHF is an abbreviation for Switzerland’s currency, the Swiss franc.
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.
The Chicago Purchasing Managers' Index (PMI) determines the economic health of the manufacturing sector in Chicago region. A reading above 50 indicates expansion of the manufacturing sector; a reading below indicates contraction.
Developed markets (DM) refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.
The earnings yield is the earnings per share for the most recent 12-month period divided by the current market price per share.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
The forward P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.
High yield bonds have below investment-grade ratings (BB, B, CCC for example) are considered low credit quality and have a higher risk of default.
Investment-grade bonds are those rated Aaa, Aa, A and Baa by Moody's Investors Service and AAA, AA, A and BBB by Standard & Poor's Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.
JPY is an abbreviation for Japan’s currency, the Japanese yen.
Nonfarm payroll employment is a compiled name for goods, construction and manufacturing companies in the US. It does not include farm workers, private household employees, or non-profit organization employees.
USD is an abbreviation for the U.S. dollar.
U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.