What'd You Miss in Markets Over the Holidays?

No shortage of political intrigue and noteworthy market moves.

Markets Winners and Losers: A Look Back at 2016

If the last thing you remember in markets is the Federal Reserve's rate hike, it's time to get back up to speed.

The end of the year provided no shortage of noteworthy headlines with the potential to shape markets in 2017, as well as the retracement of nascent trends that have captured investors' imagination since the U.S. election. Here's a roundup of what you may have missed.

Bond bears hibernate

The defining story of 2016 may turn out to have been the end of the bond bull market, as hopes of fiscal expansion and rising inflation spurred a severe selloff in government debt.

But in the final weeks of the year investors appeared to dispense with some of that caution, helping developed-market government debt to pare a chunk of its post-election losses.

The 10-year U.S. Treasury yield peaked in the session after the Fed's interest-rate increase, and proceeded to fall by 20 basis points by year-end.

Market-based measures of inflation expectations were largely steady over this stretch, with real yields leading the way lower.

Real Rally for USTs
Source: Bloomberg

The steepening of the yield curve, a key driver of the success of financials since the Nov. 8 election, also came off a bit in the final days of 2016.

The rally in gilts was even fiercer than for Treasuries — but both are so far having a very poor start to 2017.

A lot going on beneath the S&P 500's steady surface

The S&P 500 Index ended the year at 2,238.83, marking a 9.5 percent advance for 2016. While the benchmark index spent 12 of its last 15 sessions in a holding pattern before giving back 1.3 percent in the final three trading days, sector leadership has shifted.

Defensive stocks lived up to their name, with rate-sensitive sectors like utilities outperforming at the same time that industrials, a cyclical sector, notably lagged.

SPX Defense
Source: Bloomberg

That's in stark contrast to the "reflation trade" type of advances that had fueled the S&P 500's gains since Nov. 8, with banks and other segments of the market most sensitive to economic growth leading the way higher.

Strong finish for gold and oil

The decline in real Treasury yields typically comes as welcome news for shiny metals.

But given how poorly gold has performed since the U.S. election, its year-end comeback barely registers on a chart that tracks its performance since Nov. 8.

Gold Bounce
Source: Bloomberg

Nonetheless, the bounce-back for bullion was enough to make the S&P 500 Gold Index the best-performing group since Dec. 19, gaining 7.6 percent over this span.

Meanwhile, oil took a one-way ticket higher in the aftermath of the Fed's hike, with West Texas Intermediate rattling off an eight-session winning streak through Dec. 28. The front-month West Texas Intermediate contract has rung in the New Year by breaching the $55 per barrel mark for the first time since July 2015.

Oil55
Source: Bloomberg

While OPEC so far appears to be living up to its promise to curb output, providing support for crude prices, this also opened up opportunities for U.S. shale drillers, with rig counts and output rising.

The term structure for crude oil continues to prove challenging to interpret, currently lying in a state of contwardation, so to speak.

When politics and markets collide

The massive moves across asset classes since Nov. 8 underscore the impact that potential policy changes can have on financial markets, and the appointments and announcements made over the holidays look likely to shape the investing backdrop in the months to come. 

On Dec. 21, President-elect Donald Trump announced the formation of a trade council to be led by University of California Professor Peter Navarro, a fierce critic of China's trade practices.

Just before the (non-Chinese) New Year, Beijing shifted the weights of the currencies within the basket it uses to gauge the value of the yuan in a move that watered down the importance of the U.S. dollar, and greatly increased that of the South Korean won — a new addition. Given the outsized amount of foreign-exchange trading in which the U.S. dollar serves as one half of the pair, however, the move may be more symbolic in nature.

More recently, Chinese authorities took further measures to curb capital flight in the face of accelerating outflows, taking particular aim at money moved abroad to purchase property.

USDCNY Curncy (USD-CNY X-RATE) L 2017-01-03 07-40-22
Source: Bloomberg

Despite this heavy newsflow, the U.S. dollar has been virtually flat versus the yuan since Dec. 16., while measures of implied volatility over one and six month horizons have come in sharply to start 2017.

In one sign this year may not necessarily be a repeat of 2016, where fears of a hard landing in China hit markets hard early on, the Caixin Manufacturing PMI ended the year at 51.9, far better than its level of 48.2 in Dec. 2015. A sub-50 reading points to contraction in the sector.

To Russia, With Sanctions

Entering his final days in office, President Barack Obama sought to strike back at Russia over alleged interference in the 2016 election via cyber-attacks. Obama kicked nearly three dozen Russian diplomats out of the U.S. and issued a round of sanctions on some of the nation's officials and agencies.  

Short interest in the VanEck Vectors Russia ETF, the largest of its kind by assets, more than doubled in the 30 days ending Dec. 15, with the product receiving large inflows in the last month of 2016. Amid firming crude prices, the ruble strengthened relative to the U.S. dollar in December.

In Istanbul, a deadly attack at a water-front night club just hours into the start of 2017 suggested that the terror that has plagued the emerging market isn't necessarily going to turn out to have been a relic of the year that's just ended. The shooting by a lone gunman, which was claimed by Islamic State, helped the lira fall to a new record of 3.6042 to the dollar today. 

On Jan. 13, ratings agency DBRS will make a decision on whether to downgrade Italian sovereign debt, a move which could affect the collateral quality of these bonds in the eyes of the ECB, and in turn raise funding costs for the nation's banks. Speaking of which, the Italian cabinet led by Prime Minister Paolo Gentiloni agreed last week to plow as much as 20 billion euros ($20.8 billion) into Monte Paschi and other banks after the world’s oldest lender was unable to find a new core investor.

Nevertheless, Italian debt joined in the year-end bond rally.

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