Despite a sluggish start to 2016, with the MSCI AC World Index shedding 2.4% in January, global equities quickly gathered momentum and have continued their upward trend, with the index delivering 19.2% so far this year in GBP terms (as at 31 August).
This follows a meagre 3% return in 2015 for global equities and double digit returns over the two previous years, giving an annualised three-year return of 12.8%. Historically, however, four consecutive positive years of equity returns is not a considerable feat: there were five consecutive years between 2003 and 2007 and nine years between 1991 and 1999.
This outcome seemed unlikely at the start of the year when investors were concerned by the prospects of a US slowdown, the implications of further commodity price falls, anxiety over growth in developed markets and heightened fears over the signs of financial market distress, particularly in corporate credit and the financial sector.
Against this backdrop of uncertainty, the probability of a global recession increased.
Surprisingly, markets rallied despite the fear of the unknown, namely the EU referendum and US elections. In addition, post-Brexit theatrics, the rally in gold, Italian banking challenges, plummeting sterling, profit margin concerns, federal elections and negative bond yields, are all still looming.
Don’t bank on it
The long-term economic malaise of low inflation and low economic growth across most of the western world is creating an erroneous belief in the rescue capabilities of the big four central banks.
Efforts by these institutions progressed further recently with the Bank of England reigniting its stimulus programme, sending markets higher despite uncertainty over the efficacy of these programmes. It raises an interesting dilemma, as it is creating further disharmony in fixed income markets.
The strong gains seen so far this year were supported by US stocks, up 21.3% in sterling terms, as at 31 August, as well as emerging market equities, up 28.9% over the same period. European stocks also continued to show considerable strength, with the MSCI Europe Index rising 11.6%, with UK and Japanese equity markets close behind.
Strength in numbers
The strength in US equities continued to gather pace in 2016 and we saw a fresh record high in the Nasdaq, Dow Jones and S&P 500 in early August, thanks to rising oil prices and upbeat US job data growth.
This came despite a combination of abnormally low earnings yields, low dividend yields and unsupportive profit margins, raising questions on how much more multiple expansion there will be before US equities run out of steam.
Since the financial crisis began in 2008, the total size of the US economy has increased by 28.6% while the stock market has grown by 196.5%.
Brexit bailout
In the UK, post-Brexit frailty and the re- sulting fall in the sterling have acted as a catalyst for outperformance in UK blue chips, which investors have sought for their perceived safety.
From an asset allocation perspective, it became apparent from conversations with global equity fund managers that they were tempering exposure to UK equities in the lead-up to the referendum.
However, to the end of August, the average fund in each of Morningstar’s four global equity categories (three style-based categories and a flex-cap category) was overweight in UK equities relative to the MSCI ACWI, reflecting some comfort with UK equities.
