Risk assets delivered strong performance in February. Sentiment remained positive as clarity regarding future U.S. policy rates and a potential end to the balance sheet roll-off emerged with the apparent Fed shift to a more dovish stance. Meanwhile, some progress was made in trade negotiations between the U.S. and China during the month. In light of the positive developments, energy prices rebounded sharply and inflation expectations rose modestly, positively impacting a number of real assets. Treasury yields drifted higher and the U.S. dollar (USD) rose against almost all currencies. Nonetheless, the impact of rates and currency did not detract from a renewal in the reflation trade, which boosted risk assets.
Equity markets rose with the U.S. outpacing broad non-U.S. developed and emerging markets (EM) equities. The 3.2% rise in the S&P 500 helped the benchmark achieve its best two-month start to a calendar year since 1987. Non-U.S. developed market equities rose 3.5% in local terms and EM equities gained a more modest 1.1%, each trailing U.S. markets. In contrast, the 13.8% increase in China’s Shanghai Composite Index outpaced all other indices. The Shanghai market rallied nearly 6% the day after President Donald Trump announced he would delay an increase in tariffs on $200 billion of Chinese goods set to take effect March 1st.
China’s domestic equity markets currently account for only a small portion of the MSCI EM Index’s China allocation and less than 1% of the total benchmark. However, this exposure will increase meaningfully as MSCI announced at month end that it would more than quadruple the China A share allocation—from approximately 0.7% to 3.3%—in three phases over the course of 2019. Total China exposure in the EM Index is expected to increase from just over 30% to roughly 33%. Other major index providers, FTSE and S&P, will be adding China A share exposure to their EM-specific benchmarks in 2019.
Energy-related assets posted strong returns as crude oil prices moved 6.4% higher, bringing YTD gains to more than 26%. This marks the best start to the year since 1984, but follows 2018 when the commodity declined 21%. Macro and fundamental factors provided a tailwind. Reported progress toward a resolution in the Chinese and U.S. trade war as well the Federal Reserve’s more dovish monetary stance improved the market’s outlook for Chinese and global demand. In terms of fundamentals, OPEC and Russian production cuts and U.S. sanctions on Iran and Venezuela helped limit supply and offset continued growth in U.S. production according to the Energy Information Agency (EIA).
Speculative investors and hedge funds have also reportedly continued to build bullish positions after bearish bets pushed spot prices sharply lower in the fourth quarter of 2018. Higher prices have flowed through to energy equities. Outside of energy in the resources space, industrial metals and related equities also moved higher as the macro outlook improved and supply and demand tightened.
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