Riskier assets, the ones investors shun in times of uncertainty, did well. In the jargon, markets were in risk-on mode, in search of higher yielding assets.
Thus equities easily outperformed the classic ‘safe havens’ of government bonds and gold. US equities, for instance, returned 22% compared to 14% for gold and just 3% for US government bonds.
The pattern of riskier assets doing well repeated elsewhere. Emerging market equities outperformed those in developed world. Shares in smaller companies did better than those in larger companies. The return on Greek equities was more than twice that on German equities.
The performance of individual countries, sectors and companies tells its own story about the shape of the recovery.
A marked reduction in fears about growth in Japan and China pushed equities sharply higher in these two economies. In India, the world’s fastest growing major economy, equities returned 32%.
Investors’ enthusiasm for technology stocks showed no signs of abating. The so-called FAANGs soared last year. Facebook, Apple, Amazon and Netflix returned over 50% and Google delivered 33%. The Chinese tech giants, Alibaba and Tencent, doubled in value in 2017.
Shares in Caterpillar, the world’s largest construction equipment business, yielded 76%, testifying to a global recovery in the construction sector.
In the UK mining stocks returned 30% helped by higher commodity prices. UK-listed Glencore yielded 43%, benefiting from steeply rising prices of cobalt, of which it is a leading producer. Cobalt is the base material for lithium-ion batteries used in electric cars and smartphones.
Oil prices rebounded in the second half of last year reflecting stronger global demand and production cuts by OPEC and Russia. In recent days oil hit $70 a barrel, a three-year high. Shares in the major oil companies have headed up in the wake of rising oil prices.
House prices rose in most countries last year, but at far slower rates than most national equity markets. In China and the US house prices rose by around 5%. The UK’s Halifax house price index registered a gain of just 1.0% last year.
The bull market in equities has been driven by a convincing global recovery, growing levels of optimism and still low interest rates.
Supply and demand dynamics have also helped. On the supply side levels of equity issuance through initial public offerings and secondary issuance have been running at relatively low levels. Meanwhile mergers and acquisitions, share buybacks and companies going private have shrunk the existing pool of equity. This process, so-called de-equitisation, has left a growing stock of risk-hungry capital chasing a shrinking volume of assets.
Investors generally think that the equity party has further to run. The mood is, with some exceptions, pretty euphoric. In the US equity analysts are more bullish on equities than at any time in almost 40 years.
The American Association of Individual Investors reports that private investors in the US have increased their holdings of equities from 66% to 72% of their assets in the last year, the highest level since the dotcom boom in 2000.
A Bank of America Merrill Lynch’s survey shows that most institutional investors do not expect equity markets to peak until 2019 or later. In a classic sign of optimism investors are buying into technology and industrial stocks and selling defensive, or lower risk sectors, such as utilities or telecoms. Equities in emerging markets, euro area and Japan are in favour. UK equities are more unpopular with institutional fund managers than at any time since 2001. (A notable exception to this bearishness on the UK is the prominent UK fund manager, Neil Woodford, who believes that Brexit-related risks to UK stocks have been overdone).
High levels of investor optimism could be a harbinger of further gains in equities and other risk assets - though history shows it could equally be a harbinger of a sell-off. Bulls emphasise the momentum of the global recovery, still low interest rates and the difficulty of finding better value, income-generating alternatives to equities.
Bears worry that the forces behind the bull market may be weakening. Central banks are starting to tighten monetary policy, taking back the cheap money that has powered assets higher. Equities no longer look terribly cheap, and nor do many other risk assets. The vertiginous ascent of Bitcoin, whose price rose fifteen fold last year, has provoked comparisons with famous asset bubbles through history. (Bitcoin peaked at just over $19,434 at the end of last year but last Wednesday briefly dropped below $9,500). The fact that lower grade corporate debt in the euro area yields just 2.5%, less than the 2.6% return on an ultra-safe US government bond, is indicative of how the search for risky assets has affected asset prices. Still, this could run for much longer and a lot of investors expect just that. The challenge for central banks will be to tighten policy without hitting assets markets and the growth which cheap money was designed to boost.
PS: Last week the UK’s Office of National Statistics said that a failure to measure falling prices in telecoms had caused a significant underestimation of productivity gains and output growth in the sector. Revisions to the statistics will transform telecoms, which accounts for 2% of UK GDP, from a productivity laggard to a leader. The episode illustrates the difficulty statisticians face in capturing price and quality changes, often brought about my technological advances. Productivity growth in Western economies may well have been understated as a result of such measurement errors.
PPS: Last May we wrote about research by two US-based economists, Angus Deaton and Anne Case, which charted a shocking decline in life expectancy among less educated, white Americans. At that time I wrote that this was a US phenomenon and that European mortality rates were continuing to decline. This was premature. The latest UK data show that life expectancy in some parts of the UK has fallen by more than a year since 2011. People living in post-industrial and rural areas are dying younger whilst life expectancy is rising in London and parts of the south-east. Possible culprits include rising obesity, smoking and drinking and cuts to social care services. The geographical spread and possible causes are similar to those seen in the US.