Longboard’s portfolio managers are long-term trend followers, so we make decisions solely based on a disciplined, rules-based process. Though it’s not part of our decision-making process, we naturally analyze how market developments potentially relate to certain long-term trends.
Powerful trends surfaced in 2016, yet many of these market movements ultimately lost momentum and reversed direction. Here’s a recap of 2016’s notable market trends and potential fundamental drivers.
Longboard – Unpredictable equities
The global equities market oscillated between record setting declines and new record highs in 2016. U.S. stocks incurred the worst start to the year on record, before rebounding in mid-February to stage their largest quarterly recovery since 1933. When the Brexit panic shook global markets, European markets went down by double-digits in a single trading session. European central banks came to the rescue with supersized liquidity injections, providing a jumpstart to global risk assets. After a 5% plunge in overnight trading, U.S. equities rebounded towards new record highs just weeks later.
The early year volatility turned into calm by late summer, with U.S. equities seeing a record 17 straight trading days of less than 0.75% movement. The calm didn’t last long. Volatility came back to life in the lead-up to the U.S. presidential elections, as traders appeared determined to avoid a repeat of the Brexit surprise.
When Donald Trump’s win became clear, global risk assets tanked. But, in a now familiar pattern, they quickly rebounded. The reversal occurred even faster this time: the Dow Jones Index traded down more than 800 points on election night, yet made new all-time highs just 36 hours later.
In hindsight, the only theme for equities in 2016 was one of uncertainty and unpredictability. Each time equities appeared steady at new highs, powerful bouts of volatility provided shocks to the downside. What’s more, guarding against downside proved increasingly difficult, with volatility shocks disappearing even quicker than they appeared.
This type of unpredictable, back and forth market movement often sets the stage for paradigm shifts in financial markets. Going into 2017, we remain optimistic about the potential for long lasting trends to ultimately return to the equities asset class.
Fixed income reverses
Government bonds were the clear winner among global asset classes in the first half of the year. Accommodative monetary policy and demand for safe havens amid deflation and volatility created tailwinds for fixed income markets around the globe. At one point, over $13 trillion in sovereign bonds carried negative yields. Emerging market bonds received record inflows as investors reached for yield in riskier assets.
Alas, fixed income also fell prey to the year of the reversal. Tailwinds turned into headwinds as inflation crept higher in the United States and Europe. Foreign central banks ran up against practical constraints for their bond purchase programs. Plus, economic pressures caused these banks to dump their bond holdings at a rapid rate. Donald Trump’s electoral victory accelerated these trends, causing traders to dramatically reprice their expectations for larger deficits, higher inflation and potentially faster economic growth going forward. The U.S. 10-year interest rate nearly doubled from 1.35% to 2.35%.
Emerging market bonds were hit even harder, suffering double-digit losses following record inflows just months earlier (measured via the performance of the EMB ETF).
For years, investors and pundits have predicted an imminent reversal in the 35-year bull market in government bonds. Perhaps 2016’s exuberance, with record inflows and trillions in negative yields, will mark a key inflection point. Further, the potential for changes in fiscal, monetary and trade policies with a new Trump administration and Republican-led Congress provides a potential fundamental catalyst for such a sea change.
Commodities also rode the financial rollercoaster of 2016. Crude oil stole the show early on with its historic price decline below $30 per barrel—down from over $100 per barrel in mid-2014. Energy markets followed a similar path as equities in the first half of the year, bottoming in February and staging a powerful rally into the summer. This price rebound reflected a broader shift from deflation to inflation across the commodities complex through the year, including notable gains in soft commodities and industrial metals.
At the same time, there was notable bifurcation among other commodities, driven by supply and demand forces that overwhelmed the broader inflationary/deflationary backdrop.
The El Niño weather pattern disrupted crops in Brazil and Asia, driving up prices for coffee, orange juice and cotton.
On the other hand, cattle markets faced a historic glut and record price declines. These price movements marked a complete reversal from the record high prices of just two years ago. In fact, today’s oversupply traces directly back to 2014’s uptrend in prices that encouraged excess production.
This lag between prices and production is a familiar cycle in commodities markets. It highlights two important factors in commodities prices:
- Prices are rarely stable for long periods of time, due to the reflexive nature of high prices encouraging high production, and vice versa.
- Commodity prices are ultimately driven by unique fundamental considerations, which enables the asset class to generate uncorrelated price trends over time.
In 2017, we feel commodities will offer continued opportunities to capture uncorrelated price trends driven by unique fundamental drivers.
Currencies stun under pressure
The U.S. dollar was under pressure at the start of 2016, as the U.S. Federal Reserve (the Fed) walked back its previous guidance for multiple rate hikes through the year. Expectations for two or three rate hikes in 2016 gave way to just one rate hike as the year progressed and volatility persisted. The U.S. dollar’s trajectory mirrored the path of long-term U.S. interest rates—falling in the first half of the year then reversing sharply higher towards the back half.
The dollar gained across the board, rallying more than 10% against the Japanese yen and approaching parity with the euro following the U.S. presidential election. The moves in emerging market currencies were even more stunning. Notably, the Mexican peso lost nearly 50% of its value within 18 months.
Of course, the other major trend was the decline in the British pound related to Brexit concerns throughout the year. Steady declines through 2016 brought the pound to levels last seen in the 1990s against the U.S. dollar. The actual Brexit vote accelerated the slide, but the currency had faced pressure since early 2015, when traders and hedgers began anticipating the vote.
This currency move highlights how the collective wisdom of the market often provides advanced signals on major economic developments, in the form of persistent long-term price trends. When commercial hedgers and speculators combine to transfer risk and generate market trends, this creates the ultimate source of the trend following risk premium—and this has been consistent throughout time.
2017: A year of change?
Powerful trends surfaced in 2016, yet many of these market movements ultimately lost steam and reversed direction. While this proved challenging for trend following strategies that rely on sustained price movements to generate returns, these churning market conditions have historically provided fertile ground for future long-term trends.
So, going into 2017, we believe the market is ripe for a changing market paradigm that could present attractive opportunities for sustained trends going forward.
Volatility information was sourced from both CNN