Risk assets experienced a generally volatile first quarter, with mixed results experienced across a range of markets.
After a troubled start to the year, markets regained some ground throughout the rest of the three-month period. The US Federal Reserve adopted a dovish tone at its March meeting, which suggested that US rates would not rise at the same pace that was initially expected at the end of last year.
While Europe had to contend with the additional headwind of a possible exit of the United Kingdom from the European Union, the unprecedented stimulus package initiated by the European Central Bank in March provided some support towards the end of the month.
Many of the underlying causes of the declines in equities – concerns about growth in China, economic strength and the negative rate environment in Europe and Japan – persisted throughout the quarter and led to varied returns.
Fixed income markets’ performances were particularly noteworthy, with a nearly 50-basis-point decline in yields in the United States and Europe, which, along with a contraction of spreads, led to strong returns for government and corporate bonds.
Equity markets were not as strong, however. While some market indexes such as Brazil’s Bovespa performed well, overall returns were generally weak, with the S&P 500 Index, for instance, only managing to return to positive territory after a large gain in March.
Oil prices began the year by declining temporarily to 2008-09 financial crisis levels, but soon began a recovery that lasted throughout the first quarter, as supply-and-demand dynamics shifted somewhat to more favourable conditions for producers – and overall sentiment improved as a result of the tentative beginnings of cooperation between Russia and Saudi Arabia on managing production levels.
Emerging market bonds generated solid returns, helped by a positive fixed income environment and strengthening currencies, as the US dollar declined more than 4 per cent; the JP Morgan Emerging Market Bond Index Global-Diversified returned 5.04 per cent for the quarter.
Spreads for emerging-market bonds over US Treasuries, as measured by the CDX Emerging Markets Index, contracted over the three-month period as well.
Regional fixed income indexes also performed well, with the Citi Mena Broad Bond Index up 1.97 per cent and the Dow Jones Sukuk Index up 2.4 per cent. While these are strong quarterly returns for these generally lower-beta (and high-credit-quality) indexes, the difference in returns compared with emerging market bonds is also partly due to spreads actually widening over the quarter.
For the GCC region, economies continue to be affected by developments in energy markets, but the first quarter of this year also provided reasons for some optimism.
An array of economic reforms across the GCC, meant to improve public finances and economic performance, continued to be enacted over the past three months.
Current and proposed reforms in GCC economies are important for efforts to achieve greater fiscal discipline, growth and economic diversification over the medium and long term, despite the potential impact on short-term growth.
We are seeing some of that slowdown now, but at the same time are pleased to see that concerns voiced over Saudi Arabia’s currency peg and liquidity levels in the region’s banks are fading to some degree.
Other data, such as those from the February report from the Saudi Arabian Monetary Authority, indicated year-on-year declines in cash withdrawals from ATMs and in point-of-sale transactions.
Naturally, some of this weakness on the consumption side reflects continuing changes in the economy and is compounded by a rise in energy prices in December. This decline, however, needs to be viewed in the context of the high-base effect from the same period of the previous year, because of the one-off bonuses granted by King Salman.
We believe second-quarter data will provide a clearer picture of year-on-year economic trends.
As investors, we are selective in our exposure to risk in the GCC region and our outlook, which is perhaps more positive than that of the broader market, comes from rigorous analysis.
The performance of GCC fixed-income markets in the first quarter was respectable but with spreads ending the quarter wider than at the start of the year, we believe the region’s credit markets continue to offer significant value.
Mohieddine Kronfol is the chief investment officer for fixed income and global sukuk at Franklin Templeton Investments (ME)
