3Q2019 Market Commentary: Embrace the Mid-Cycle and Don’t Fear the Repo

Data Source: Bloomberg

September 2019 Highlights:

  • Global stocks posted positive returns (MSCI All-Country World Index or ACWI up 2.1%) for the month.  Japan and Europe led major regions (MSCI Japan and Europe up 4.0% and 2.7%, respectively) while Emerging Markets, Pan-Asia, and the U.S. lagged (up 1.8-1.9%).
  • This month saw a reversal of fortune as what didn’t work in July/August outperformed in September and vice versa. However, a good chunk of this reversal ‘reversed’ itself during the second half of the month, likely due to concerns over the state of the repo market, lack of trade talk progress, and Japan following through on an increase to its consumption tax. 
  • Throughout the quarter, broader Asia continues to bear the brunt of a breakdown in global trade as well as rising escalations between the Chinese government/Hong Kong Governing Authority and pro-democracy protesters.
  • September also witnessed a significant reversal with U.S. small caps outperforming large and value outperforming growth.  S&P Small Cap returned 3.0% vs. 1.9% for the S&P 500 while S&P Pure Value returned 6.0% vs. 0.3% for Pure Growth. 
  • There was some reversal effect observed in relative sector performance with cyclical sectors and utilities outperforming growth and other defensive sectors
  • High Dividend and Value factors participated in the September reversal with Momentum lagging.
  • Fixed income experienced a modest loss in September as the 10-Year Treasury Yield shot up to 1.9% from 1.50% at the beginning of September before settling at 1.67% at the end of the month.  The U.S. Bloomberg/Barclays Aggregate Index returned -0.5% in September although it was down as much as 2% earlier in the month. 
  • High yield posted a positive month as corporate credit spreads rallied from the sell-off in August, although the continued sell-off in high yield energy is somewhat concerning.
  • Precious metals gave back their July/August gains losing 3.9% while commodities initially spiked over the drone attack on a major Saudi Arabian oil installation, but then gave back those gains as the worst fears over oil supply disruption did not materialize.
  • Consensus analyst estimates are expecting a recovery in S&P company earnings in CY2020, forecasting 10.5% earnings growth on top of 5.7% revenue growth.  Economists may be expecting a recession soon, but not Wall Street.

3rd Quarter 2019 Highlights:

  • The 3rd quarter saw U.S. stocks and bonds (once again) outperform the rest of the world as investors fled to the high ground of U.S. safe-haven assets amidst a backdrop of global economic uncertainty.  
  • During the quarter, investors grew increasingly anxious over a lack of progress in U.S./China trade negotiations and the imposition/threat of additional tariffs (not to mention the escalating protests in Hong Kong) as well as the drawn-out Brexit drama that is now in its fourth year since British voters passed a referendum to exit the European Union.
  • Global markets recovered in September from the August swoon characterized by the strong outperformance of ‘low volatility’ interest-sensitive equities, such as utilities, real estate, and consumer staples. 
  • The MSCI All-Country World Index (ACWI) returned -0.03% for the quarter.  Japan and the U.S. generated positive 3rd quarter returns while Europe and Emerging Markets posted negative returns.  Much of the world is feeling the effects from the U.S. China trade-war as well as lower import demand from China, a strong signal that the Chinese economy is experiencing a slowdown. 
  • For the quarter, U.S. large caps outperformed small caps while value marginally outperformed growth.  
  • Sectors that benefited from lower interest rates such as utilities, real estate, and consumer staples outperformed growth and cyclical sectors (health care and energy sectors were down for the quarter).
  • Precious metals benefited from the flight-to-quality while commodities were hurt over concerns of slowing global economic activity.  Over the past year, oil prices have dropped from $73/barrel to $54/barrel at the end of the quarter.
  • Despite the risk-on behavior in global equities, fixed income also performed well, largely in response to more dovish policy stances taken by the ECB and the Fed following their respective June meetings.  Foreign currency bonds also benefited from a weaker U.S. dollar while High Yield benefited from spread tightening. 
  • U.S. Treasury Yields dropped to 1.62% at quarter-end, down from a year-to-date high of 2.78%.  This drop has contributed to a strong quarter for the Bloomberg Barclays U.S. Aggregate Bond Index which returned 2.3% and is up 8.5% for the year. 
  • Corporate credit posted a positive return for the quarter although it could not keep up with the rally in U.S. Treasuries.  U.S. High Yield returned 1.3% for the quarter and is up 11.4% for the year.
  • As the third quarter came to a close, many macroeconomic issues remained unresolved with an impending U.S. House of Representatives impeachment initiative looming on the horizon.  As global government bond yields drop in the face of slowing manufacturing activity, investors are climbing a wall of worry that continues to push U.S. markets higher but driven by safe-haven, defensive sectors.

To view the full commentary including 3Q2019 market exhibits, click here.

By: Benjamin Lavine