After reviewing the 2018 performance of the Maltese equity market over the past two weeks and highlighting the main developments across various companies, it is also important to assess the performance of the Malta Government Stock market.
Following the three per cent decline in the RF MGS Index in 2017 (representing the first annual decline since 2011), it is immediately worth highlighting that Malta Government Stock prices suffered their second consecutive annual decline as the RF MGS Index shed a further 1.7 per cent in 2018. Moreover, the prices of the large majority of MGSs ended the year lower with the exception of the longest dated securities, namely those maturing between 2035 and 2041.
When looking back at the overall trend of the RF MGS Index in the past 12 months, the intense volatility from one period to the next is immediately evident. Few investors may appreciate the volatility in MGS prices from one week or one month to another. However, in recent years, sovereign bond prices have indeed experienced wide bouts of volatility and 2018 was no different.
In fact, the 2018 performance of the RF MGS Index can be analysed in four different parts. In the year’s first five months, prices initially declined (yields rose) but then recovered quickly. Meanwhile, between early May and the third week of November, the decline in prices was almost uninterrupted with the RF MGS Index shedding 3.3 per cent to its lowest level since September 2014. However, the RF MGS Index partially recovered in the last six weeks of the year as MGS prices rebounded strongly, helping the RF MGS Index to climb by 1.5 per cent and trim the 2018 overall loss to ‘just’ 1.7 per cent. It is worth highlighting that the four-year low in November 2018 of 1,077.817 points represents a decline of an extraordinary 8.8 per cent since the peak in the RF MGS Index in October 2016, just before the US Presidential elections.
Once again, movements in MGS prices were influenced by the regular publication of economic data and credit rating assessments, statements by key officials of the major central banks across the world as well as global political developments. I will now endeavour to highlight the main developments that led to the wide periods of volatility in Malta Government Stock prices over the past 12 months.
At the start of 2018, the RF MGS Index maintained the same trend as in the final part of 2017 with MGS prices mainly declining as yields moved higher as a result of the evidence of stronger economic growth across most parts of the world. In the eurozone, business and consumer confidence rose to the highest level since late 2000 and the unemployment rate fell to a fresh nine-year low of 8.7 per cent. The European Central Bank claimed an “increasingly self-sustaining economic expansion” which led many analysts to expect that the central bank would start a process of monetary policy normalisation by ending the quantitative easing programme and start focusing on very gradual increases in interest rates. The Bank of England had also signalled at the time that “monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent” than previously anticipated amid inflation overshooting.
The future direction of MGS prices is much more uncertain today
Despite a change at the head of the Federal Reserve, there was evident indication of more aggressive interest rate hikes than previously estimated amid upbeat inflationary indications which led many renowned bond investors to declare that bonds are about to enter a new era after an end to the 30-year bull market in US bonds. Since MGS prices reflect developments in the eurozone with a specific inclination to developments in some peripheral nations such as Italy and Spain, the upgrade to the Spanish credit rating by Fitch Ratings to A- from BBB+ was an important event at the start of the year. The same international rating agency also confirmed Malta’s A+ rating by making reference to Malta’s “robust economic growth” and very tight labour market conditions.
Shortly afterwards, another rating agency (S&P) also upgraded Spain to A- (the most positive assessment since 2012) which led to lower yields and a recovery in prices.
The strengthening of the euro in the first half of 2018 was of concern to economists due to the negative implications on inflation and exports while economic data in the euro area started to disappoint, leading to a number of ECB rate setters to send out conflicting signals about future monetary policy. The ECB highlighted that “monetary policy will remain patient, persistent and prudent” and that interest rates are expected to remain at current levels for well past the end of the current asset purchase programme. The heightened political uncertainties in Italy and Spain in the first half of the year also impinged on the movements of euro sovereign bond prices, including Malta’s.
Comments by the ECB largely shaped the rally in yields and the decline in prices in the second half of 2018. On June 14, the ECB announced the end of its €2.4 trillion bond-buying programme and revealed it will be reducing its monthly assets purchases to €15 billion a month (from €30bn) between October and December and subsequently terminate the programme at the end of the year. The ECB added that it was convinced that the economic slowdown in the euro area was only temporary and that growth remained “solid and broad-based”. Moreover, after a period of political turbulence, Italy formed a new government (a coalition of the 5-Star Movement and the Northern League) and though concerns remained on the country’s fiscal stability and economic outlook and its membership of the euro area, yields in Italy began to slowly ease.
The more remarkable movement in MGS prices took place in the last six weeks of the year when yields plummeted in response to higher perceived risks in global equity markets due to the US and China disputes related to trade, concerns over the prospects of the world’s largest technology companies, volatility in oil markets, questions about Italy’s debt levels and uncertainties related to Brexit. As equity markets tumbled in the last weeks of the year (December was the worst month for global equities since 2008), there was a broad ‘flight to safety’ and sovereign bond yields declined rapidly. The Fed chairman remarked that the pace of interest rate hikes may slow in the months ahead.
Apart from the movement in MGS prices it is also worth commenting on the trading activity in the MGS market. The volumes of MGS deals on the secondary market fell for the fourth successive year. In 2018, just under €215 million worth of MGS traded on the secondary market, a yearly drop of almost 47 per cent. Trading activity in MGS had peaked at €836 million in 2014.
The decline must also be seen in the context of the start of the ECB’s quantitative easing programme in early 2015. Purchases of MGS under the QE programme take place as ‘off-market’ deals and so are not included in this data. In fact, given that the ECB publishes bond repurchases across each of the eurozone nations, it is important to highlight that the Central Bank of Malta repurchased a total of €127 million worth of MGS in 2018 compared to €220m in 2017. Since the start of the QE programme, a total of €1.15 billion were repurchased, so this must be taken into account too when comparing the activity prior to 2015.
Given the most recent developments it is very difficult to judge whether MGS prices will face another negative performance in 2019 or whether they will recover some of the losses experienced in the past two years. The multitude of factors, including political developments (such as a potential accord between the US and China over trade) will largely impact the performance of MGS prices, especially those with longest periods to maturity. Investors who regularly track the performance of their portfolios and continue to hold an overweight exposure to long-dated MGS mainly for capital gains purposes should have realised that the future direction of prices is much more uncertain today and sizeable declines can indeed take place in a relatively short period of time, as was seen over the past two years.
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