NNIP: Manoeuvres in the dark

Asset class performance

Equities and real estate were the top performers in March and for the year to date. The biggest driver was undoubtedly the dovish shift of the ECB and the Fed, which has pushed bond yields to their lowest levels in more than a year and sparked a renewed search for yield. The yield curve flattened and even inverted in the US, rekindling talk of its predictive powers as a recession indicator. The defensive turn in the market was also driven by the Brexit soap opera, for which there is still no clear outcome, in addition to weakening macro data. Trade discussions have not yet reached a final conclusion, with both parties signalling some progress.

Equities

On a regional basis, the US market outperformed, helped by some currency appreciation. The Eurozone was the laggard. Indeed, from a historical perspective, more dovish central banks tend to drive investors towards growth regions and sectors, and away from value. The Eurozone suffered an extra hit as bond yields fell into negative territory, hurting the banking sector. Despite all the Brexit uncertainty, UK equities fared well. The depreciation of the British pound is of course beneficial for the big UK exporters, which make up the majority of the UK market.

From a sector point of view, March was the mirror image of February. Defensive sectors and bond proxies (utilities and real estate) did well, whereas cyclical sectors as a group underperformed. Nevertheless only one sector (financials) ended in the red. This is linked to the interest-rate developments. The rise in the oil price supported the commodity cyclicals.

Fixed Income

Safe government bonds fell sharply again in March on the back of growth worries and dovish central banks. This decline sent 10-year Bund yields back below zero. In total, the US 10-year yield dropped by 31 bps in March and the 10-year Bund yield fell by 25 bps. In Europe, the fall in the 10-year nominal yield was caused by both a decline in the real yield and the long-term inflation expectations premium. This is different for the US, where the long-term inflation expectations premium has risen of late, due to rising oil prices and the Fed’s signal that it is more prepared to tolerate an inflation overshoot. Thus, the decline in US nominal yields results entirely from falling real yields. Hence, inflation-linked bonds outperformed nominal bonds in the US.

Fixed income spreads continued to benefit from the search-for-yield environment. Spread levels in developed markets (investment-grade and high-yield) fell further. Spreads in emerging market debt widened moderately. In total return terms, the performance of all fixed income spread categories was strong, due to declining safe government bond yields, solid carry and (for some categories) falling spread levels. The total return performance since the start of the year has been very strong for fixed income spreads, based on the combination of these three drivers (falling safe government bond yields, falling spread levels and decent carry).

Commodities

Commodities continued to move sideways in March. The energy segment outperformed on market tightening, courtesy of the OPEC+ production cut. Agriculture was the underperformer once again, although this time it was joined by industrial metals, as no breakthrough in the US-China negotiations materialized during the month.

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