A decline in global trade pushed our proprietary leading economic indicator into very negative territory.
December 2019 Market Commentary
In December, global equity markets rallied for the fourth month in a row. Within the U.S., equity markets reached all-time highs and large cap marginally outperformed small cap, rising +3.0% versus +2.9%. U.S. equity volatility, as measured by the VIX Index, increased +9.2% to 13.8 – this level is substantially below its long-term average of 19.2. Abroad, emerging markets significantly outperformed developed stocks, rising +5.8% versus +1.4%.
The US dollar (USD) declined -2.0% during the month and was the worst performer out of the G10 currencies. The USD was weighed down by a more dovish Federal Reserve (Fed), progress on the U.S. and China “phase one” trade deal and weakness in domestic economic data. Progress on the “phase one” trade deal boosted risk-on sentiment, leading safe-haven currencies like the USD to decline. U.S. ISM manufacturing data declined to 48.1 versus a 49.2 expectation.
The U.S. ten-year yield seesawed during December, as it initially fell to 1.7% after the U.S. manufacturing sector gauge showed a contraction. The ten-year yield rebounded from a strong U.S. jobs reading; U.S. non-farm payrolls data showed an increase of 266k versus the 180k forecast. The ten-year yield rose fourteen basis points over the month and ended at 1.9%, the highest end of month reading since July.
The price of crude oil rose +10.7% on the back of reduced supply and improving global demand. Crude oil was supported by OPEC and Russia agreeing to cut oil production and by a larger amount than the market had anticipated. Additionally, U.S. inventory fell by a larger amount than forecasted.
In the U.K., the GBP rose +2.5% against the USD. Boris Johnson’s conservative party won the general election, which led the GBP to initially rally. Economic data out of the U.K. was mixed during the month, as weakness came from manufacturing data and retail sales both contracting. However, the labor market data did beat expectations and Q3 GDP was revised up to +0.4% quarter over quarter from +0.3%. The U.K. ten-year Gilts yield ended the month at 0.8%.
Short-Term Market Outlook
Our proprietary leading economic indicator declined significantly month-over-month and has shifted to very negative territory. This was driven by a decline in global trade.
Our outlook for U.S. stocks versus investment grade bonds is currently in neutral territory, compared to a preference for U.S. stocks last month. The decline in the strength of the signal was driven by the decline in the QS leading economic indicator and a rise in the ten-year yield.
In U.S. fixed income, we believe that high yield will outperform investment grade bonds over the near term. Within the model, the narrowing of the spread between high yield and investment grade more than offset the rise in equity volatility.
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 supporting international-developed markets is at its strongest level in several years.
European stocks are expected to perform similarly to 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. Bonds are supported by the recent change in European government yields and a negative reading of European Leading Indicators.
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 12/31/19, unless otherwise noted. Global Equities represented by the MSCI ACWI Gross Total Return Local Index; U.S. Equities represented by the S&P 500 Total Return Index; Emerging Market Equities represented by the MSCI EM Gross Total Return Local Index; developed markets represented by the MSCI World Index; the U.S. Dollar (USD) represented by the Bloomberg Dollar Spot Index; and the British pound (GBP) represented by the Bloomberg GBP 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%).
The British pound (GBP) is the currency of United Kingdom.
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.
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 U.S. Federal Reserve, or “Fed,” is responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
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.
Gilts are bonds that are issued by the British government.
The Group of Ten (G-10 or G10) refers to the group of countries that agreed to participate in the General Arrangements to Borrow (GAB), an agreement to provide the International Monetary Fund (IMF) with additional funds to increase its lending ability.
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.
The Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI) for the US manufacturing sector measures sentiment based on survey data collected from a representative panel of manufacturing and services firms. PMI levels greater than 50 indicate expansion; below 50, contraction.
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.
The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its member countries.
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.