March saw equity markets diverge in performance as events during the month were dominated by Russia’s takeover of the Crimea region of the Ukraine after the Ukraine ousted its pro-Russian president Viktor Yanukovych. Investor sentiment was also depressed by continued tapering of quantitative easing by the Federal Reserve, poor economic data from China and reversals in the internet and life sciences sectors after a series of poorly-received news.  This was countered by a recovery in many emerging markets after a difficult start to the year.  The MSCI World index was down -0.8% for the month, with the majority of developed markets down while major emerging markets were up except for China and Russia.

Brent oil was down -1.2% despite the crisis in the Crimea; worldwide demand has tracked lower than expected, primarily due to slowing growth in emerging markets (and China in particular).  The same held true for most other commodities (with nickel being the main exception due to Indonesia’s export ban on the metal), with demand from emerging markets falling short of expectations after significant increases in the production of many commodities in recent years.  Gold fell -3.2% in March, retracing some of its gains from the first two months of the year after falling -28.3% in 2013.  Yields on 10-year US Treasuries and German Bunds increased and decreased to 2.72% and 1.57%, respectively, from 2.65% and 1.62%, respectively, at the end of February.  Rates have declined significantly from December due to reduced fears of substantial interest rate rises in the near term.  Most major emerging market currencies gained on the month, recovering some of their prior losses, as investor sentiment turned positive towards many countries due to favourable currency exchange rates after steep devaluations over the course of last year and attractive interest yields.

As mentioned above, the predominant political event in March was the Crimea crisis. Crimea then held a referendum to join Russia, after which the country annexed the region.  Russia’s central bank had to increase interest rates from 5.5% to 7% to stem portfolio outflows from the country.  A senior minister predicted that up to $70bn could flow out of the country nonetheless, and the rouble has lost more than -10% of its value since the start of the year.  The MICEX index fell -5.2% in March and is down -8.9% YTD; it had fallen sharply immediately after the invasion but recovered towards the end of the month after it became obvious that an American and Western European response would come in the form of trivial sanctions and a $18bn bailout package for Ukraine rather than military action against Russia.  Still, there is real risk of a recession if harsher sanctions are put in place.

Further south, Nigeria is still suffering from the aftereffects of President Goodluck Jonathan sacking the widely respected governor of the country’s central bank for revealing multi billion dollars of embezzlement activity from the government’s treasury.  This led to sustained portfolio outflows so far this year.  The Nigeria All Share index was down -2.0% in March and down -6.2% YTD.

Field Marshal Abdel Fattah al-Sisi, the power behind the Egyptian army’s coup against elected President Mohamed Morsi, announced his candidacy for president in order to legitimise his existing power.  So far the public supports the stability imposed by the army.  The EGX 30 index was down -4.0% for the month but is up +15.1% YTD.

In Asia, the Chinese government allowed the first corporate default (a solar equipment manufacturer) since the country opened up its economy in the late 1970s.  This follows on a string of failures of informal loan providers and a run on a small bank in the eastern part of the country.  Write-offs for non-performing loans at China’s five largest banks increased by 127% over 2013.  At 1%, China’s bank bad debt ratio is likely to be significantly understated, but the large increase in bad debt provisioning is a healthy sign that the financial sector is coming to terms with the aftereffects of the country’s credit bubble in recent years.  These actions are part of China’s reform programme to push lenders to price credit risk appropriately and to prepare the industry for an eventual liberalisation of interest rates.  China’s central bank also widened the yuan’s trading band to allow the currency to depreciate; it has now fallen -2.7% YTD versus the US dollar.  This is designed to counteract the negative impact on growth caused by the bursting of the credit bubble and to help Chinese exporters regain competitiveness (the yuan had strengthened by +30% since 2005).  Chinese exports fell by 18% in February, the most since 2009, leading to a rare trade deficit on the month, further confirmation of the substantial slowdown in the economy.  The Shanghai Composite index was down -1.1% in March and down -3.9% YTD.  However, on a case-by-case basis we have seen individual companies in China benefit from a stronger middle class despite a slowdown of the economy.

Further south, Thailand lifted a state of emergency as street protests against the government began to wane.  The opposition party in neighbour Indonesia selected Jakarta mayor Joko Widodo, highly regarded for his administrative competence, to be its candidate for the presidential election in July.  These events contributed to a general improvement in investor sentiment towards the countries.  Thailand’s SET and Indonesia’s Jakarta Composite indices were up +3.8% and +3.2% in March, respectively, and up +6.0% and +11.6% YTD, respectively.

Turkish Prime Minister Recep Tayyip Erdogan’s AK party handily won municipal elections with a larger share of the vote than it achieved in 2009 (44% versus 39%), a reflection of the party’s strong following after more than a decade of economic growth as well as the opposition CHP party’s lack of organisation and credibility. The BIST 30 index benefited from the general improvement in sentiment towards emerging markets and from the AK Party’s victory in hopes that the political situation will stabilise.  The index was up +13.0% in March, recovering its losses from earlier in the year and is now up +3.8% YTD.

Greece’s parliament narrowly passed key structural reforms, including cutting state healthcare costs, introducing more flexible collective wage-bargaining rules, and liberalising tightly controlled markets in products and services.  This clears the way for an €8.3bn additional bailout tranche from the European Union (EU).  However, the narrowness of the vote and widespread strikes afterwards highlight the difficulty of the reform process during a deep recession and how investor complacency (yields on 10-year Greek government bonds have fallen from 12.2% to 6.7% over the past year) may somewhat be misguided.

Italy’s new Prime Minister Matteo Renzi introduced a string of reforms, including tax and spending cuts and labour reforms to allow more flexibility to use temporary workers.  The reforms met with tacit approval from German Chancellor Angela Merkel and the European Commission, with hopes that they will help jumpstart the economy.  Italy also benefited from a collapse in the yields of government bonds, with 10-year yields down to 3.29% from over 4% at the beginning of the year.  The FTSE MIB index rallied +6.1% in March and is up +14.4% YTD.

Perhaps most significantly for the Eurozone, the president of Germany’s central bank, Jens Weidmann, who was previously adamantly opposed to quantitative easing, suggested that such unconventional monetary policies are not out of the question to counteract potential deflation.  This may potentially lead to the European Central Bank (ECB) launching another programme to ease the Eurozone tight credit conditions, easing the deflationary pain that peripheral European countries have experienced since the financial crisis.

In the Americas, Standard & Poor’s downgraded Brazilian government bonds to its lowest investment grade rating, citing increasing fiscal deficits from higher social spending, a slowing economy, and poor quality lending by state-controlled banks.  President Dilma Rousseff backed away from further increases in lending by state development banks after the central bank countered the inflationary effect of this with higher interest rates.  There are hopes now that the central bank will not have to raise rates further.  The Bovespa index benefited from this news and from the general positive sentiment towards emerging markets, gaining +7.0% in March (though is still down -2.1% YTD).

In the US, the Federal Reserve adjusted its forward guidance for considering raising interest rates to 6.5% unemployment from 7.0%, though it also cut its monthly quantitative easing (QE) programme by $10bn to $55bn and warned that rate hikes may occur shortly after the end of QE.  This is part of the Fed’s effort to introduce more flexibility into monetary policy in order to adapt to changing economic circumstances, but the markets took the news relatively poorly.

King Digital, the software maker behind successful mobile game Candy Crush Saga had the worst performing large initial public offering in 20 years, following on poorly received news of Facebook making another large acquisition of a company with little revenue (this time a maker of virtual reality headsets).  These events hurt sentiment and led to a broad sell-off across the technology sector, which had been the best performing since the financial crisis.  The technology-heavy NASDAQ Composite index was down -2.5% on the month (though is up +0.5% YTD); this contrasts with the +0.7% gain for the S&P 500 in March.

In developed markets equities in many sectors, especially in speculative technology companies, have outpaced their underlying earnings growth, leading to fairly expensive valuations.  However, if the ECB introduces further QE policies in an effort to ease credit conditions and jumpstart growth in the Eurozone, that could potentially lead to another equity rally.  In addition, Japan’s government seems to have refocused again on economic reforms and has been prodding companies to raise wages as a way to share the benefits of the yen currency’s depreciation over the past year and a half, which to date has primarily bolstered corporate profits.  This could boost Japanese economic growth and thus the Nikkei index.

Sources:  RisCura, Bloomberg, US Energy Information Administration, The Economist.

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