Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist
After several months of modest gains shadowed by questions over potential central bank tightening, investors interpreted US Fed Chair Yellen’s July testimony to Congress as somewhat more “dovish” on the outlook for inflation and the pace of further monetary policy action. The European Central Bank was more reticent, but EU officials tried to calm concerns regarding potential reduction in accommodation. On the corporate front, earnings growth continued to impress and mergers and acquisition activity remained robust. On the geopolitical scene, US politics continued to be roiled with each new revelation while tensions over North Korea increased with bombast coming from both sides. Given all of the macro and political drama of the last several months, the month of August was relatively quiet as volatility remained low and US 10 year yields declined, reflecting a sanguine if not jaded view of things. While consumer spending and factory activity showed some softening, corporate results continued to be strong and broader macroeconomic growth was steady if unspectacular. Low inflation readings clouded the outlook for further US Fed action, but the consensus view was still one of balance sheet reduction and an additional rate hike before year end (although there appeared to be more dissention than normal on this point). September saw the return of the bulls as a mostly benign macro environment gave optimists reasons to believe the market rally still had legs. A debt-limit deal in the US produced a brief moment of bipartisan action, but those feelings would prove to be short-lived. At the US Fed meeting, the group expressed enough confidence in the strength of the US economy to start reducing its $4.5 trillion balance sheet in October. Outside of markets, the hacks on consumer credit reporting firm Equifax and the US SEC highlighted the growing potential risk of lax cybersecurity throughout the business community.
For the quarter, the US broad market Russell 3000 Index finished at +4.6% extending year-to-date returns to nearly +14%. Returns in US small cap stocks finally outpaced their large cap counterparts as the Russell 2000 Index returned +5.7%. Outside of the US, performance in developed markets continued to outpace the US with the MSCI World ex USA Index returning +5.6%. Performance in developing markets was even stronger with the MSCI Emerging Markets Index returning +7.9%, increasing its advantage over developed markets to over 8% on a year-to-date basis.
Market volatility remained quite low with the VIX hitting its lowest level in decades. Despite the strength of market performance, trade volumes were well below long-term historical averages. At the factor level, Value, Stability, and Low Volatility were fairly negative. Momentum, Quality, and Smaller Size were positive factors. Equal-weighted portfolios underperformed market-cap weighted portfolios, highlighting the outsized contribution a few larger cap Technology names continue to have on index performance for the year. At the sector level, Technology and Energy led while Consumer Staples was the only negative performer for the period.
