What does the chart show?
 
The chart shows the calendar year performance of an index that tracks US dollar-denominated sovereign debt for every year since 1978, as well as the year-to-date (YTD) performance for this year. Historically the performance of US debt has fluctuated significantly around an average return of 7% per annum but has the potential to produce excellent returns. In 1982, the index returned 27.97% throughout the year. In 2009 the index had its worst full calendar year performance, falling 3.72%. These statistics help put into context the astonishing performance of US Sovereign debt this year. US treasuries have fallen 11.9% so far this year which, if they end the year unchanged, would be the worst year for bonds for almost a century when bonds fell by 15% in 1931.   

 Why is this important?

 This year has been a difficult one in markets with seemingly no hiding place for investors. Equities have fallen with bonds as the typically negative correlation between the two asset classes has deteriorated in the high inflationary environment. Real assets have declined in value on rising interest rates despite the higher inflation helping them at the margins. Even commodities, which started the year with record levels of performance, have fallen back to just above-average levels. However extraordinarily difficult this year has felt for investors, it is important that it be remembered as just that, extraordinary. Price fluctuations are driven by short-term shocks that produce an emotional response in markets. Although this year has been difficult, as shown by the above chart, we can also see that a more measured, long-term approach has historically proved to be beneficial to investors. If we look to the future, the sharp downturns in certain markets have also provided opportunities to invest in high-quality securities at below-average prices as some investors overreact to negative sentiment. These kinds of value opportunities have been less prevalent in recent years as asset prices have become inflated above their fair values but now provide a good reason to be optimistic about the future.  

What does the chart show?
 This chart shows the average returns of the major US equity indexes in the last week before Christmas and the first week after Christmas, alongside the average weekly performance of the indexes since 1985. The data suggests that in the weeks before and after Christmas, US markets regularly perform better than they do compared to other weeks of the year. The NASDAQ performs especially strongly, returning 0.7% and 0.87% on average in the first week before and after Christmas respectively. Compared to the average weekly performance of 0.31%, this is a significant outperformance. The S&P 500 and Dow Jones Industrial Average (DIJA) also outperform their weekly averages both before and after Christmas.

 Why is this important?

 The tendency for markets to rise during the Christmas period is a widely observed phenomenon known as the ‘Santa Claus rally’. Explanations for what causes this rally can range significantly. One explanation is that investor optimism fuelled by Christmas spirit leads to the buying of stocks. Another is that over the holiday period lower market activity from institutions reduces liquidity and causes higher levels of volatility, even though that could also lead to higher-than-average losses. Whatever the explanation, short-term fluctuations in market prices can be caused by a number of factors that are virtually impossible to predict. At first glance, the Santa Claus rally may seem like an amusing quirk that opportunistic traders can use to make a quick return, but the normal risks are just as prevalent during the holiday period. Despite abnormally high average returns during the weeks before and after Christmas, stocks actually fell 40% during the observed periods. The Santa Claus rally can therefore be seen as a seasonal reminder to investors: Short-term bets on market movements are not a sustainable investment strategy. Having a well-diversified portfolio with a longer-term outlook can help investors ride short-term market fluctuations and enjoy more sustainable returns, meaning more enjoyable Christmases for years to come. 

What does the chart show?
 
The chart shows the US Dollar value of negative nominal-yielding bonds in developed markets. Debt that yields less than 0% means that investors should lose money if they hold it to maturity. Yet at its peak in December 2020 the value of developed market negative yielding debt was over $18 trillion, largely made up of ultra-low yielding government bonds which were the result of the loose monetary policy seen in places, such as Japan and the Eurozone. Since then, the dollar value of negative-yielding debt has fallen sharply to under $2 trillion. Over the past year, central banks have tightened monetary policy in response to inflation and so yields have risen dramatically, which has reduced the amount of negative-yielding debt to its lowest levels since 2015.

 Why is this important?

 In recent months, any indication that central banks may begin to pivot away from their current hawkish policies has been followed by sharp rallies in equity and bond markets. In both October and July of this year, global equity markets returned over 7% driven by expectations of pivots in central bank strategy. Low rates and quantitative easing have been largely responsible for the strong performance in equity markets over the past decade, and investors are eager to not miss out on another bull-market run. However, these same policies have been blamed for the high inflation that central banks are so keen to bring under control and so they will be unwilling to return to the excesses that caused these issues. It is important to consider that before 2014, negative-yielding debt was virtually unheard of and only came about as a result of excessively loose monetary policy. With around $2 trillion of negative-yielding debt remaining, symptoms of these policies remain, and so further tightening may still be necessary before there is a true return to ‘normal’. A pivot in policy is unlikely to be a return to loose monetary policy, but instead a pause in rate hikes at a level closer to the historic average base rates. For the Federal Reserve, this would be 4.61%, a far cry from the 0.25% rate that held for so long. The era of easy money coming to an end may be unpleasant for some, but for those who know where to look, opportunities are emerging across all asset classes.

What does the chart show?
 
This chart shows quarter-on-quarter German GDP growth alongside the results of the IFO German Business Sentiment survey. The IFO Business Sentiment survey not only provides insight into how German businesses feel about the current economic climate but also their expectations towards the future climate. A score of above 100 suggests that businesses expect an increase in economic activity, while a score under 100 suggests that businesses expect a contraction. Historically, business sentiment surveys such as these have closely aligned with the level of change in economic activity and so are used as leading indicators for where an economy may be headed in the future. However, in Germany a significant disconnect has emerged between business sentiment and economic growth. The results of the latest sentiment survey came in at 84.4, a level not seen since the 2008 financial crisis. Despite this, German GDP growth remained positive last quarter with the economy growing 0.3% in Q3.

 Why is this important? 

If the historic alignment between sentiment and activity continues, then this dramatic separation can mean one of two things. The first scenario is that German businesses are in a negative sentiment ‘bubble’. Although global economic activity is widely expected to cool and so some negative sentiment is to be expected, the combination of the war in Ukraine, record levels of inflation and slowing economic activity may be combining to give businesses an excessive sense of pessimism. The outlook is undeniably bleak, but all hope is not lost. Although still high, gas prices have fallen significantly from their August peak as storage levels have risen and there are signs that inflation may be easing in other areas. Consumers face a challenging environment but have emerged from the pandemic in a healthier financial state than before. A level of sentiment worse than it was during the pandemic may therefore be unjustified. However, if German business expectations are accurate, which historically they have been, the German economy faces a meltdown of epic proportions. The ECB has failed to act decisively to tackle the record levels of inflation in the Eurozone, and there are few signs of the Ukraine-Russia conflict ending as we head into winter when gas demand is highest. Levels of consumer spending, which recently have largely driven growth in Germany, are likely to tighten as the cost of living rises and German businesses will suffer as a result. Many global economies are asking themselves if a recession will happen at some point. For Germany, a better question may instead be how bad their recession is going to be.

What does the chart show?
 
This chart shows the DXY US dollar strength index (in red) and the Goldman Sachs US Financial Conditions Index (in blue) for 2022. The DXY Index measures the strength of the Dollar against a basket of other major currencies. The GSUSFCI Index measures the financial condition of the US economy using a basket of components, such as corporate bond spreads, equity market levels, and the yield curve. The index has been suggested as a guide to inform the Federal Reserve’s (Fed) policy decisions. The easier policy is needed when trying to encourage growth, but increased tightness is necessary to keep inflation under control. A strong dollar has a tightening impact on growth and can ease inflationary pressures. Throughout the year, the strength of the dollar and the tightness of financial conditions have steadily increased as the Fed has been aiming to bring inflation under control. However, both indexes have recently seen sharp declines.

 Why is this important?

 With signs suggesting that inflation in the US has peaked and with some leading indicators showing signs of cooling economic activity, global markets are expecting a pivot in the Fed’s policy to a less hawkish stance. Although inflation remains high, Fed policy has a lagging effect on economic activity, and so, despite certain economic indicators, such as labor markets and GDP growth, still showing signs of strength, there are many who believe that the Fed’s dramatic rate rises throughout the year have already pushed the economy into a recession at some point next year. An easing of financial conditions will therefore be necessary as the Fed attempts to pull off a ‘soft-landing’, and the sharp reversals in the upward trends of the DXY and GSUSFC Indexes show that markets believe that will happen. However, Chairman Jerome Powell and the Fed have surprised markets several times this year with their policy decisions. With the conviction of a pivot as strong as this, the next Federal Open Market Committee meeting could heavily disappoint. 

What does the chart show?
 
This chart shows a breakdown of quarterly US Gross Domestic Product (GDP) growth (in annualised terms) into its key contributors: personal consumption, investment, government spending, and the net value of exports minus imports. All activity within an economy can be assigned to one of these groups, and the quarterly change in their levels produces the result for quarterly GDP growth. Following two successive quarters of negative growth, which many believe constitutes a recession, the economy grew at an annualised pace of 2.6% in the third quarter of 2022. This growth was largely driven by an increase in the level of exports and a fall in the level of imports. Government spending increased slightly, as did consumption. Levels of investment shrunk for the second quarter in a row. 

 Why is this important?

 Although at first glance a rebound into positive territory for GDP growth may allay fears over an upcoming recession in the US, if we take off the mask there are signs that the future may be a bit more painful. The shrinking trade deficit that helped drive growth in Q3 is widely seen as a one-off event. The strength of the dollar means foreign goods are now cheaper and imports are expected to rise with exports falling. Although consumers emerged from the pandemic in relatively healthy financial positions, inflation and rising interest rates have dampened consumer sentiment with the rate of growth of consumption falling steadily. The fall in investment may be a clearer sign of what lies ahead. Investment levels can be used as an indicator of sentiment among businesses and sharply rising interest rates have caused investment levels to decline for two quarters in a row, suggesting that businesses are becoming more nervous about a future slowdown in economic activity. We believe that the strength of the dollar and a cooling global economy are likely to hurt the US trade balance, and if investment and consumption continue their downward trend then the risk of a decline in GDP followed by a recession in 2023, appears increasingly likely.

What does the chart show?
 
This chart shows the year-to-date (YTD) Returns of trend-following strategies versus global equities and global bonds. Trend-following strategies attempt to exploit the direction that markets are moving, with a variety of investment time horizons ranging from intraday to many weeks, or even months. During bull runs, when markets are making positive returns, these strategies will position themselves long, but during market downturns, these markets will switch to short positions and will therefore make positive returns, even when asset prices are falling. As such, these strategies rely on an ability to accurately time market movements, which historically has proved very difficult to do and can, therefore, pose extremely high risks to those that attempt to do so. However, trend-following strategies can be rewarding for those that get them right. YTD trend following strategies have returned 36%, a significantly better return than the return of -20% of global bonds and equities. These returns have been driven by clear trends in steadily falling stocks and bonds, and the steady rise in the strength of the dollar.

 Why is this important?

 One of the key aspects of building an optimal portfolio is managing risk through the diversification of assets. Over the past 20 years, the negative correlation between stock and bond returns and the generally positive returns across both asset classes has given rise to the 60/40 stock/bond portfolio. However, this correlation has been shown to become positive during periods of high market uncertainty, especially when inflation is high, which minimises attempts to diversify away risk. This has meant that YTD, a standard 60/40 portfolio has been one of the poorest performing strategies. Further diversification is, therefore, necessary to properly manage risk. Exposure to trend-following strategies can provide a further level of diversification to a portfolio, adding the ability to make gains, even when all traditional assets are falling. Although these strategies can be more volatile and can undergo long periods of volatility or negative returns, especially when markets do not show clear trends in any direction and rather move sideways, these strategies can help control drawdowns when other asset classes fall in value. Diversification is key for helping limit volatility and manage risk. Understanding which asset classes and strategies properly diversify a portfolio can therefore be important for providing steadier returns over the long run.

What does the chart show?
 
This chart shows the median five-year annualised return of stocks at a given Cyclically Adjusted Price-to-Earnings ratio (CAPE) for an equally weighted universe of all UK stocks with a market cap over £100m, over the past 30 years. The CAPE ratio is a valuation tool that measures a company’s share price relative to its earnings per share over an extended period of time. There is a clear relationship between CAPE ratios and subsequent five-year returns, with a lower CAPE ratio being a good indicator of an undervalued market with opportunities for returns. At the beginning of the year, the CAPE ratio for this universe of stocks stood at 22.6x, one of the highest on record. UK markets have suffered this year with the FTSE All-Share down over 7% in GBP terms. This fall in share prices has brought the median CAPE ratio down to just 14.3x, which is not far from being the lowest we have seen in a long time.  

 Why is this important? 

In recent years loose monetary policy, excess liquidity and near-zero interest rates have pushed stock valuations considerably higher. In many cases share prices have risen far beyond levels that could reasonably reflect the fair values of companies. This has meant that investing using a value-based approach has been harder as well-valued companies with good opportunities for future growth have become rarer and rarer. However, the economic headwinds and uncertainty in markets have led to almost indiscriminate selling across UK markets as some investors have grown fearful. Prices have fallen and although earnings have also been affected, their declines are far less relative to falls in share prices. Some valuations across the market still remain elevated, but the median CAPE ratio for this particular universe of stocks has now fallen to levels that historically have provided excellent opportunities to investors that know where to find value. Despite the economic turmoil and uncertainty facing markets, there remains reason to be positive for those willing to take a longer-term approach to investing.  

Additional Note: A data error resulted in the publishing of an inaccurate chart for the 06/10/2022 Chart of the Week Podcast. The error has since been amended and the updated chart can be found here. We apologise for any inconvenience caused.

What does the chart show? 

This chart shows the relative performance of a variety of major asset classes from the end of June to the end of September. Global equities, as captured by the MSCI World Index, started the quarter in the midst of a rally, but the gains were erased later in the quarter with equities returning -7.1% in USD terms. Global Bonds also rallied early in the quarter but also saw their gains subside. High yield credit and US Treasuries were the two strongest performers with returns of -2.7% and -5% respectively. Commodities continued to decline from their earlier peaks. Oil fell to just over $85 per barrel at the end of September, a decline of -25% from its early June highs with a -16.7% decline throughout the quarter. Gold also declined throughout the quarter with a return of -8.4%. 

Why is this important? 

Despite having rallied until the first half of August, major asset classes suffered throughout the third quarter. The initial rally, which was driven by hopes that weakening economic data might force a pivot in strategy from the Federal Reserve and other Central Banks, saw global equities rise as much as 10%. However, persisting inflation saw increasingly hawkish moves by central banks with the Fed leading the way. This quickly put an end to hopes for a more dovish pivot in the short term. Monetary tightening combined with high levels of inflation have damaged the confidence of consumers and businesses. These headwinds have contributed further to a slowdown in economic activity and fears of a recession. This has helped push commodity prices from their peaks, although they remain high. Supply chain pressures are also showing signs of easing, raising hopes for a return to more natural price levels. Significant uncertainty surrounding the depth and duration of the now expected recession, as well as developments in the war in Ukraine, means that fear is extremely prevalent in markets. Although short-term timing risks remain, the substantial corrections in markets mean that longer-term opportunities are now beginning to emerge.

What does the chart show? 

This chart shows the relationship between changes in the US M2 money supply and the monthly returns of the US stock market since 2000. The M2 money supply is a measure of the levels of cash in an economy held outside of the private banking sector, which is largely made up of deposits in current accounts. Other highly liquid assets are also included in the measure. Control of the money supply is one of the key tools used by the US Federal Reserve (Fed) to either control inflation or stimulate an economy. Increasing the money supply through quantitative easing or by lowering interest rates to encourage borrowing helps to stimulate an economy. A reduction in the money supply, through quantitative tightening or interest rate hikes, helps reduce inflation by lowering overall economic activity. As can be seen on the chart, there are large increases in the money supply during recessionary periods, as the Fed seeks to stimulate a stagnating economy. We can also see that performance in the stock market is closely linked to growth in the money supply. Monetary stimulus is a key driver of growth and so when the money supply grows, investors increase their expectations for the growth of companies, which drives growth in the stock market. 

Why is this important? 

The US stock market has had a disappointing year so far with the S&P 500 index down 22% YTD. This has largely been driven by a significant pivot to a strategy of monetary tightening by the Fed to tackle the rampant inflation in the US following a long period of loose monetary policy during the Covid-19 pandemic. In 2022 alone, the Fed base rate has risen from 0.25% to 3.25% and the Fed has begun a policy of quantitative tightening through the offloading of assets on its balance sheet. This has increased expectations for a recession, as higher borrowing costs cool economic activity and limit growth. An inverted yield curve and falling levels of confidence among manufacturers and consumers are all indicators of an impending recession. For investors this presents a difficult dilemma. Cooling economic activity and reduced growth will damage the balance sheets of many companies. However, for some there is an element of moral hazard. As we have seen, recessions have led to the need of monetary stimulus in the past and with it, sharp reversals in the future growth expectations for companies. Historically, some of the strongest periods of stock market growth have come during recessions following announcements of monetary stimulus. Close attention is paid to any comment or news from the Fed, as investors hope to ‘catch the bottom’ of the stock market by looking for any signs of a pivot in strategy. With some indicators suggesting that a recession is imminent, there are those who expect the reversal in the Fed’s strategy soon. However, inflation remains persistently above desired levels and other indicators, such as the labour market and companies’ balance sheets, remain healthy. The market’s base rate expectations have changed significantly throughout the year and with Fed Chairman Jerome Powell stating that decisions will be taken on a case-by-case basis, it is possible that not even he knows what the Fed’s position will be in a year’s time.