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  • Writer's pictureEran Peleg, CIO

Elementary, My Dear Watson

Eran Peleg, CIO January 16, 2019

2018 was the worst year for global financial markets since the Financial Crisis of 2008. Global equities (MSCI AC World index, in USD terms) and US equities (S&P 500 index) dropped -9.4% and -6.2%, respectively. Most other asset-classes produced negative returns as well (total returns on US dollar investment-grade bond were negative for most of the year but managed to recover back to zero at the last moment, in December. Bond price return was still negative for the year, with income filling in the gap). There was nowhere to hide.

(Bull sculpture: Pablo Picasso)

Despite much commentary and media noise about a host of different factors driving global financial markets – Trump, trade wars, Brexit, Italian budget concerns, etc. etc. – the main market driver was simply rising US interest rates. More precisely, it is growth concerns arising from the cumulative tightening of US monetary conditions.

Like the economy, financial markets move in multi-year cycles. We have been in a positive cycle, especially in the US, since 2009. It is one of the longest economic/market cycles on record. As an economic expansion strengthens and broadens, it is not unusual for central banks to start normalizing interest-rates (i.e. raise them) after they have been low during the recessionary/low-growth period. Interest rates will then typically be increased to a point where tighter monetary conditions start hurting economic activity, eventually bringing about a slowdown.

If it was not interest rates but rather another negative-risk factor driving markets, you would expect a greater divergence in the performance of financial assets – for example, risk/growth-oriented assets, such as equities, would sell-off, while safe-havens, such as highly-rated bonds and gold, would perform well. That has not happened. All financial assets were down. It is the old-fashioned economic/market cycle at play. Elementary, my dear Watson.

What we experienced in 2018 is in fact a rare occurrence: it is very rare that both bonds and equities, the two main public-market asset-classes, underperform cash. The last time it happened was in 1994, when the US Fed surprised financial markets by hiking interest rates aggressively (by the way, this further supports my argument above).

Calendar years (since 1926) in which cash outperformed both US equities and bonds:

Source: When Cash Outperforms Everything, Ben Carlson (

What does this tell us about 2019? Given the rarity of this event, it is very unlikely that we will see it happen again in 2019. 


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