The first quarter of 2017 passed without any major disruptions. Financial market volatility was the lowest for a decade and investment performance reflected this after a quarter of strong gains. Supporting this were a series of strong data releases globally – including upbeat corporate profitability announcements as well as cheerful surveys of economic confidence. This more than offset the potential headwinds of political uncertainty and delicate central bank tightening.
The U.K. also commenced its official divorce from the European Union by invoking Article 50, while European contagion risk temporarily settled following the failure of the populist movement in the Dutch elections.
This positivity has prompted action from some central banks, with the Federal Reserve hiking rates in the U.S. for the third time since the financial crisis. China also joined the tightening camp, with a similar hike at the end of the quarter.
Given this favourable backdrop, it should not be a surprise that risk assets performed best over the first quarter, with equities comfortably outperforming bonds. Emerging market equities topped the table, posting near-double digit gains, while developed markets also produced healthy mid-single digit returns. Underlying the strong gains were a muddying of the ‘value revival’ seen during the second half of 2016, with energy companies dropping following a 9% fall in crude oil prices, while technology and healthcare rallied strongly. Currency-wise, the major development was a rebound from emerging market currencies, although the US dollar stayed broadly in line with the pound sterling and the euro.
Which Bonds Bucked the Trend?
While fixed income markets generally underperformed equities, modest gains were recorded following a reasonable January and February. Some of this was offset, however, as the U.S. market saw bond yields stabilise as the ‘Trump bump’ lost energy, while in Europe there was a subtle shift towards higher bond yields in politically sensitive economies. The standout was once again emerging market local debt, which rose 7% over the quarter.
Looking forward, many participants are citing the separation between political uncertainty and market volatility as a noteworthy development. While this is undoubtedly important in the lead up to the French elections, we would suggest investors instead focus on what is knowable, implying an increased focus on the sustainability of asset price gains relative to their ‘fair value’. This valuation-driven philosophy leads us to favour cautious positioning as valuations for equities and bonds remain stretched.
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