Category: Uncategorized

Markets

• DJIA, S&P 500, and NASDAQ experienced their biggest monthly declines since January and was a third consecutive losing month for the DJIA which hasn’t happened since 2011.

• Global government bonds experienced their largest drop since May 2013. The 10yr U.S. Treasury bond yield shot up meaningfully, from 1.6% to 1.84%, the largest monthly increase since June 2015. The trend of higher yields can act as a ceiling for equity market multiples.

• The upcoming U.S. election is dominating headlines and materially impacting market sentiment. Risk markets have grown soft in sympathy with Clinton’s deteriorating lead due to the fact that Trump’s anti-immigration and anti-trade policies are generally not known to be market/growth friendly policies. A Clinton presidency is seen as much more predictable, while a Trump presidency seems to be anything but predictable.

• Third quarter earnings reports are well underway and have generally exceeded expectations. FactSet reports earnings growth of 2.7% with 85% of the S&P reported. A positive year over year result would break a streak of five consecutive negative quarters of earnings results.

• The dramatic move higher in 3mo LIBOR witnessed in the third quarter continued in October, finishing at its highest mark, 0.89%, since spring of 2009.

• October was the busiest M&A month in 12 years with $248.9 billion in announced deals, surpassing the July 2015 record of $240 billion.

Central Banks

• Central banks pivoting off their dovish postures have contributed to the rise in yields. Likelihood of Fed tightening in December, uncertainty over the ECB bond buying program, and hawkish tones in BOE, BOJ, and PBOC statements have market participants pressing yields higher.

• All four major central banks have indicated that they will likely ‘look through’ initial inflation indications and not act too quickly, supporting the lift in yields.

• A December hike is looking likely at this point with futures markets pricing in a 76% likelihood, the highest level since November 2015, just prior to the December 2015 hike.

Economics

• 3Q GDP grew at 2.9%, beating expectations and posting the highest growth since Q3 2014. • October generated 161,000 jobs (vs 175,000 expected) and prior months were revised upward, leaving unemployment at 4.9%. Wages grew at a 2.8% annual rate, the fastest clip since 2009.

• PCE (Fed’s preferred inflation gauge) registered 1.7%, still below the 2% target, while CPI climbed 1.5% and core was up 2.2%. This is the highest core CPI reading since October 2014 but headline CPI is in the midst of the longest streak of less than or equal to 1.5% in 53 years (1963).

Politics

• Betting market odds for a Clinton presidency have fallen from 82% to 70% while Trump has risen from 19% to 34% over the past two weeks.

• The Clinton advantage in the Real Clear Politics Average polling data has fallen from 7.1% on 10/19 to only a 1.7% edge on Friday 11/4. This is going to be closer that most people think.

• Predicit.org has odds of a Republican Senate at 34% and a Democratic House majority at 7% coming into election week.

• Theresa May announced her intention to trigger Article 50 and move forward with a ‘hard exit’ in March 2017. The British Pound crashed in response, falling to levels not seen since 1985. The Pound has fallen over 30% versus the USD (-15% trade weighted) since the Brexit vote. To add to the uncertainty, the U.K. high court ruled that the Prime Minister must seek parliamentary approval to trigger Article 50 regardless of what she has indicated.

September closed out the third quarter on a relatively positive note with global equities posting respectable gains. Small caps continued to outperform large caps in September, maintaining the technical leadership they began to assert back in July. From a sector standpoint, technology and energy maintained the market leadership they displayed throughout the third quarter, highlighting the rotation out of first half 2016 winning sectors of utilities and telecoms into some more aggressive sectors of the market. Non-U.S. equity markets were up over 1% in September, aided by a declining dollar and a rally in commodity prices.

Bond markets weathered a mid-month climb in interest rates, but ultimately reverted back to where they started, while credit spreads compressed back toward cyclically tight levels in sympathy with a continued appetite for risk and yield. Commodity markets outperformed most other assets in September, up 3.1%, aided by a declining U.S. dollar and a robust rally in crude oil. Energy and agricultural commodities were up over 4%, industrial metals rose 5.2%, while precious metal gains were muted with gold +0.5%.

All four major global central banks held widely anticipated meetings during the month which garnered the lion’s share of market headlines. Policy announcements from the ECB (9/8), BOE (9/15), BOJ (9/21), and Fed (9/21) were met with mixed reviews. The ECB and BOE underwhelmed investors by holding steady on both interest rates and bond buying programs. Investors had hoped for more action to stimulate lackluster European growth. The Fed narrative could be best described as a ‘hawkish hold’, meaning they held steady on interest rates but signaled an increasing likelihood for a hike at their year-end meeting in December. Meanwhile, the BOJ opted to push their initiatives even deeper into unchartered waters. The BOJ is now targeting a 0% yield on the 10yr JGB, with a floor below and ceiling above, essentially managing the shape of the yield curve. They also took an unprecedented step of signaling their intent to ‘overshoot’ their inflation target of 2%, striking an even more aggressive posture. The moves in Japan didn’t seem to phase market participants as the yen strengthened in the days following the BOJ meeting and had the strongest finish of all major currencies for the month, +2.1% – much to the chagrin of the BOJ. Regarding global central bank policy, it seems that the tail is losing its ability to wag the dog.

From an economic standpoint, the September data maintained the slight negative trend that has been in place since mid-August with regard to negative surprises versus estimates. Housing remained resilient with tight supply of existing and new homes at 5mo and 3.2mo respectively, which is at or near multi decade lows. At the same time, housing demand, as measured by housing starts, is still running only 65% of long term average levels. Job numbers are being closely watched from a Fed perspective and September’s increase of 156,000 jobs was not hot enough to make a strong case for an FOMC rate hike, nor was it cool enough to take it off the table.

Global equity markets in August managed to post marginally positive returns with emerging markets (+2.5%) again outpacing developed markets (+0.3%). After a double digit loss to begin the year, emerging markets have rallied strongly, posting year to date gains of over 16% which is 7% higher than the average returns for developed markets. U.S. equity markets in August managed to hold onto small gains as the back half of the month gave back nearly all of the gains posted in the initial two weeks. Large caps (+0.14%) again lagged small caps (1.77%) as global multi-national corporations wrestled with a strong U.S. dollar which climbed 0.52% against a trade weighted basket of foreign currencies. The rotation in sector strength away from high yields and lofty valuations became more pronounced in August as yield oriented utilities (- 5.6%), telecommunications (-5.7%), and consumer staples (-0.5%) lagged the market while technology (+2.1%) and financials (+3.8%) posted robust returns. Over the past few weeks, financial stocks have broken decisively to the upside, climbing a barrage of negative storylines including negative interest rates, European NPLs, subdued capital market activity, regulation, flattening yield curves, and concerns over thin balance sheet capitalization.

Fed narrative throughout the month was seemingly intended to guide markets toward higher expectations of a rate hike in 2016. Regardless, fed funds futures continued to price in a low likelihood of September hikes (21%) and a coin toss in December (51%). Anecdotally, within 10 days of every Fed announcement dating back to 2006, futures markets have correctly predicted the outcome, going 86 for 86, by pricing a minimum of 60% or greater likelihood on each occasion. The August jobs report of 151,000 came in well under June and July levels and missed expectations for 180,000. Most market participants read this result as one that will keep the Fed on hold at least until the December meeting as it did not support the hawkish view of an overheating economy. Also of interest in the report was wage growth of 2.4% year over year. Every month so far in 2016 has posted wage growth of equal to or greater than 2015’s average level of 2.3%. For the month of August, the yield curve flattened further and rates rose slightly as the 2yr rose 13bps, from 0.67% to 0.80%, while the 10yr moved only 0.07% higher, from 1.51% to 1.58%.

Other notables in August included a significant change in U.S. equity sector classifications, which carved REITs out of financials, creating their own sector classification. Dilma Rousseff was officially impeached in Brazil, which has posted the strongest returns globally so far this year (+62%). Interestingly, Brazil’s stock market is trading at a 162x price to earnings multiple but less than 10x price to trailing sales. The Bank of England took the widely expected step of cutting interest rates in response to Brexit but also levied an unfavorable comment on the central bank trend of negative interest rates.

July was a boon for market bulls, a very solid month for equities across both developed and emerging markets. Interestingly, there were no significant central bank accommodations announced during the month to drive market rallies, but expectations and indications of policy support in England and Europe certainly provided market participants a push of confidence. The ECB, BoJ, BoE, and Federal Reserve all held steady on rates in July. Active QE programs in Japan and Europe continued to pressure yields and drive capital across borders seeking encouraging fundamentals and higher yields. Case in point, Swiss government bond yields are now negative across the full maturity spectrum with 50 year bonds yielding -0.04% at month end.

The broad U.S. equity market posted a gain of 3.7%, including several new record high closes during the month, while the rest of the world climbed 4.8% on average. A slightly weakening U.S. dollar (-0.64%) contributed to the performance differential but the market bounce in the first two weeks of the month was more pronounced in the non-U.S. markets where volatility at the end of June (Brexit) was more severe. U.S. stocks notched their sixth consecutive month of gains while Europe (+4.8%), Japan (+6.5%), and emerging markets (5.0%) all rallied sharply. Of note was that the Nasdaq 100 hit a new record high for the first time since the tech bubble of ‘99/’00 toward month end. There was also a notable rotation within the U.S. equity market in terms of sector leadership as consumer staples, telecommunications, and utilities which have driven markets during the past year gave way to technology, healthcare, financials, and materials. Additionally, small caps have outperformed large caps in two of the past three months, posting a robust 6% return during the month of July.

A sluggish U.S. economy and lackluster earnings provided a lovely wall of uncertainty for the market to climb in July. Second quarter GDP growth came in at an underwhelming 1.2% rate, significantly under consensus forecast of 2.5%. The 1% growth achieved during the first half of the year is the weakest result since 2011. Details within the GDP report paint a somewhat less concerning picture of a relatively strong consumer and a larger than forecast drawdown of inventory which will likely show up as a positive build in the Q3 report. Per Thomson Reuters, second quarter earnings are shaping up for a fourth consecutive negative quarter (-2.6%) and revenues a sixth consecutive negative quarter (-0.4%). The earnings drag from energy companies (-87%) is pronounced but earnings ex-energy are still uninspiring at +1.8% annual growth rate.

Bond yields in the U.S. fell for a second consecutive month as the 10yr U.S. Treasury fell from 1.49% to 1.46%. Ten year and thirty year U.S. government bonds both hit record lows on July 1st of this month. Commodity markets were battered in July as the energy and grains complexes fell sharply. Oil officially entered a new bear market at month end which is defined as a 20%+ decline from a bull market high.

June was anything but sleepy. Last month may well be the month that will stand out, looking back 10 years from now, as the beginning of the new or the end of the old European Union. It was also a notable month from the perspective of the Fed. Overall, it was a market that was very favorable for fixed income and mixed for equities, depending on currency and geographic region.

The June 23rd British referendum delivered a shock to the global markets that neither equity nor fixed income markets properly anticipated. As the dust settled in the last week of June and first week of July, markets recovered and cooler heads prevailed. Financial markets seemed to acknowledge that there will be much time, negotiating, and uncertainty across both economic and political realms that will need to settle before one can properly discount the catalyst. That said, and as stated in our flash memorandum, it is potential for destabilization of the EU that has our attention. It has been a long standing stabilizing force in the Western world. The ‘If them, why not us’ scenario, where other member nations follow suit would fall in the all bets are off category pretty quickly. Additionally, one must be cognizant of the potentially significant fiscal policy implications resulting from the resounding working class populist voice expressed in a major world economy like the UK. Similar tones currently in the U.S. and long standing momentum in Latin America are notable. Not surprisingly, European (ex-UK) equity markets fell -4.8% in June while the UK fell -3.6%. UK returns were far worse after accounting for the precipitous fall in the Sterling, which instantly fell to 30yr lows on the news of the referendum vote.

The June FOMC meeting was notable in that it marked a capitulation of sorts by the Fed to conform to market expectations of continued accommodative monetary policy. As expected, the Fed kept interest rates steady, noting softening labor market indicators (May payroll increase of only 11,000) and weak business investment. Meanwhile, the Fed’s preferred inflation gauge is rising at a 1.7% annual rate (2% target) and household spending has remained relatively supportive. Perhaps more significant was a notable reduction in future rate hike expectations to become more in line with market forecasts. For the first time since publishing forward rate forecasts, a voting FOMC member, withheld his long-term forecast, in somewhat of a symbolic gesture, citing the difficulty of accurately forecasting rates beyond two years. Fed policy implications on the global bond market is significant in that it remains the only major central bank likely to maintain or even hike interest rates for the foreseeable future. Given that nearly $13trillion of global sovereign bonds and over $250b of global corporate bonds are yielding less than 0%, it makes capital inflows to U.S. bonds, and the resulting suppression of yields, a very real outcome for the foreseeable future. Negative bond yields qualify for the ‘bubble’ label by any measure. Large or surprise fiscal packages in Europe or Japan could certainly mark an inflection point in yields, something we are intently monitoring.

Despite the global turbulence, emerging market equities rallied in June, increasing their lead on developed markets. Brazil alone climbed 19% on hopes that the darkest days are behind them. Brazil stands up 46% on the year after falling 41% in 2015. Potential Chinese stimulus and strong commodity markets (+4%) certainly benefited Latin America (+11.4%) as well as emerging Asia (+2.8%). Lastly, everyone’s favorite pet rock, gold, jumped nearly 9% for the month on its preferred backdrop of geopolitical uncertainty.

May continued the trend of the past couple of months, posting positive results in general. The U.S. led the way in the global equity markets while global interest rates continued their decent toward all-time record low yields. International equity markets meaningfully lagged the U.S. as various external forces again made U.S. capital markets more attractive on a relative basis. As the month drew to a close, much of the market narrative began to focus on the June 14-15 FOMC meeting and the June 23rd British referendum vote. Japan meanwhile looks likely to delay next spring’s scheduled 2% increase in the consumption tax in a bid to stimulate their lackluster economic growth. Globally, notable events during the month included a challenging emerging market equity environment, conclusion of Q1 U.S. earnings season, and an ongoing conversation among global policy makers regarding how to stimulate growth and inflation.

Emerging market equities fell sharply (-3.7%) with the exception of India (+1.9%) and Greece (+11.4%). Greece averted a near term default as European authorities adopted the IMF’s “plan” to again kick the problem down the road. India’s reform minded government continued to attract capital investment as more infrastructure improvements were slated to improve one of the world’s largest populous. First quarter earnings season concluded in May, posting an unsettling fourth consecutive quarterly decline. Poor quarterly earnings and some hawkish rhetoric found in the April FOMC meeting minutes drove the S&P 500 down to 2040 in mid-May, testing some key technical support levels. By late May, futures markets were pricing in as high as a 32% likelihood of June rate hikes. Those levels quickly dissipated in the first few days of June after a dismal jobs report on June 3rd indicated many challenges remain to inflation and growth looking forward. U.S. GDP forecasts for the second quarter have been revised upwards in general, with the Atlanta Fed forecasting a slightly more robust 2.8%, up from less than 2% at the end of April.

With April in the rearview mirror, 2016 is officially one-third completed, and what a four months it has been. Volatility in January and February was followed by a recovery in March and continued recovery in April. April kicked off the second quarter with relatively encouraging returns across global equities, high yield debt, and commodities despite an uptick in volatility during the last week of the month.

The month was not friendly to NASDAQ stocks and Japanese equities. Technology companies such as Apple, Alphabet, and Microsoft were punished for disappointing investors on their 1Q earnings announcements. Overall, first quarter earnings look fairly certain to register a fourth consecutive negative year over year decline. Most analysts predict more robust year over year comps in the back half of 2016, with several looking for double digit growth in the fourth quarter of 2016. Japanese markets sold off 6.5% in the last week of the month alone due to, in a highly anticipated announcement, the Bank of Japan failing to provide investors with the accommodative monetary policy they craved.

More pronounced positive moves occurred in commodities and commodity oriented non-U.S. markets. In spite of failed talks among OPEC nations to curtail production, oil prices rose nearly 25% for the month, providing a tailwind for commodity exporters and real pressure on the U.S. dollar. The USD lost ground versus most major currencies including the Yen (5%), Canadian Dollar (3.3%), and the Euro (0.5%). The weakening U.S. dollar and stronger energy/commodity prices greatly benefited several non-U.S. equity markets including Japan (+4.65%), Russia (+7.8%), Brazil (+10.4%), and Canada (+6.7%).

U.S. equity markets were positive overall and also bucked a couple of trends that have been in place for some time – value stocks outperformed growth stocks and smaller/mid-sized companies outperformed their larger cap peers. The rally and strong relative performance of small cap stocks has been particularly interesting and enough to push the Russell 2,000 into a new bull market (a 20%+ rally that was preceded by a 20%+ decline). While the S&P 500 never moved into bear market territory, the Russell 2,000 did, falling 26.4% from its high on 6/23/15 to a low on 2/11/16.

Overall economic tone globally remained relatively sluggish. U.S. GDP for the first quarter registered 0.5% growth while inflation indicators remained largely at bay. Sentiment indicators are encouraging as well, from a contrarian perspective. AAII (American Association of Individual Investors) surveys put bullish sentiment near the lows of February 2016, while neutral sentiments are relatively high. Short interest in the market has been falling precipitously as hedge fund investors seem to have rushed to cover their shorts in the recovery rally of March and April.

Gold, long duration U.S. Treasuries and the U.S. dollar were all strong performers in a month where a continued oil price collapse and concerns surrounding slowing Chinese growth weighed on market psychology. Were it not for a furious rally in the final week of January, the already ‘red’ numbers engulfing risk assets would have been all the more uninspiring. Market drivers on the month were essentially a higher pitched version of the same narrative that closed out the year – the uncertain trajectory of the Chinese economy and a nasty oil bear market. The net effect drove U.S. Treasury yields down sharply despite significant selling by the Chinese central bank in an attempt to minimize the Yuan’s fall. Global equity markets fell over 6% on the month with the more volatile emerging markets (-6.5%) and U.S. small caps (-8.79%) bearing the brunt of the selling. Odds of a recession in the U.S. crept to the 20%-25% range over the course of the month as U.S. manufacturing contracted at its fasted pace in six years and investors began to fear ripple effects (defaults, layoffs, reduced capital expenditures) of the oil industry crisis throughout the U.S. economy.

Markets continued to focus on central bank activity with the narrative out of Europe being a likely increase in accommodative measures while Japan joined the ranks of negative interest rate markets in an attempt to aid their weakening economy. The Fed came into the new year well-documented, projecting four rate hikes in 2016. As financial market volatility grew and global economic activity waned, the Fed hike narrative softened as the month wore on. Despite the troubling fact that the correlation of equities with central bank purchases is 3x the correlation of equities with earnings growth, the highly anticipated earnings season began in earnest in January with fourth quarter results and 2016 forward guidance. Results thus far have been mixed with S&P 500 revenue -4.6% and earnings -6.3% and notable negative guidance for 2016. Meanwhile, 2015 full year earnings ex-energy are projected to have grown 5% y/y. Bond markets were anxious in January as well with spreads in energy (1445), industrials (972), and materials (911) all very elevated while spreads in the broad high yield market now sit over 800 above comparable U.S. Treasuries.

Accommodative central banks, reasonable equity market valuations, U.S. housing market strength, and the longest ever job creation streak in American history offer the bulk of the constructive view of the markets. Developed market economies of U.S., Japan, and Europe look like slow growth for certain but recession currently seems far from certain.

December saw markets limp to the finish line to close out a relatively challenging year for investors as concerns surrounding monetary policy, Chinese fundamentals, and commodity/currency volatility dominated the conversation. As has been the case for several years, central bank policy maneuvers grabbed headlines and drove markets.

Overall, U.S. equities fell 1.5%-5.05% with smaller stocks underperforming larger blue chip cap names. Non-U.S. markets fell in a similar fashion but were penalized more for currency depreciation than equity market moves. Bond yields increased with the mid-month Fed rate hike acting as the primary catalyst while spread widening contributed to further losses across corporate investment grade and high yield credits. The commodity complex continued its descent with crude oil plummeting 16% while grains fell 2.6%. The dollar stabilized somewhat in December as did industrial metals such as copper, aluminum, and zinc.

Mario Draghi underwhelmed markets after weeks of rhetoric by opting not to increase the amount of QE but rather extending the duration (through 3/2017) of the program and initiating additional rate cuts. The Fed embarked on its first rate hike campaign since 2006, ending seven years of ZIRP (Zero Interest Rate Policy), by guiding the Fed Funds rate higher by 0.25%. The U.S. Congress passed a growth friendly spending bill which opted to end the ban on oil exports, provided tax cuts estimated at $50b, and authorized a substantial fiscal spend on infrastructure related initiatives.

The inter-relationship of deteriorating Chinese fundamentals and currency market volatility seems now to have moved to the front seat of market dialogs as China’s policy makers struggle to manage capital flight, estimated over $900b between Q214 and Q315, and yuan volatility. China has been forced to intervene in FX markets to defend (support) the yuan’s valuation as evidenced by a record foreign exchange reserves December drawdown of over $100b. Also prevalent in December’s backdrop were the benefits (cost savings) and consequences (industry stress) of the oil price decline and the ensuing impact on market psyche. While a substantial uptick in oil industry defaults seems inevitable, the precise spillover effects will most certainly be rather difficult to forecast.

Global markets limped into September with the swift August correction still freshly in the rearview mirror. The first half of the month saw a short lived relief rally give way to worries over global trade, resulting in a weak finish to wrap up the worst quarter for U.S. equities in the past four years.

The primary focus of the month was the lead-up to and digest of the September 17th FOMC announcement in which the Fed opted to maintain Zero Interest Rate Policy, noting concerns over global growth and lackluster inflation conditions. Subsequent to the FOMC announcement, Fed Governors quickly rushed to the microphones in an attempt to downplay the market’s negative growth perceptions by signaling their expectation to still hike rates in 2015. A survey of economists seems to take the Fed at its word, signaling a 64% likelihood of an initial hike in December. Meanwhile, futures markets, at 36% likelihood, remain less convinced.

China has played largely into market psychology recently and throughout September. Bespoke notes that, for 2015, on days in which the Chinese markets are closed, U.S. markets are positive a whopping 63% of the time for an average gain of 0.33% whereas, for the year, negative days outnumber positives and the average move in the market has been down, not up. Despite equity market price action and an abysmal September jobs report, consumer confidence actually strengthened in September to the second highest reading since the recession, due to positive overall perceptions of the job market.