Research & Insights

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

At the start of the quarter, although there were few meaningfully positive developments in the markets, the lack of “bad” news was enough to give buyers confidence that the recent sharp declines in the market were overdone. Economic data was mixed, and most growth forecast revisions continued to be down with the IMF lowering its forecast for global growth from 3.3% to 3.1% on weakness in emerging markets. At the corporate level, M&A activity remained robust with 2015 on track for a record. By the time the calendar rolled into November, the momentum from the market rally of the prior month was already tapering off. Fed comments pointed strongly towards a mid-December increase in interest rates which served to further dampen risk appetites. A terrorist attack in Paris mid-month shook the geopolitical status quo, but it was unclear what, if any, significant changes in approach that would drive. Volatility continued into December with the Fed’s somewhat controversial decision to raise rates ending an unprecedented period of monetary stimulus. Weak data and financial market volatility in China remained on investors’ minds as events highlighted the limits of the Chinese government’s control of the equity markets. On the commodity-side, oil prices resumed their descent from an intermediate plateau of $45/barrel towards the mid-$30s/barrel, making the Energy sector the worst performing segment of the market (by far) for the second year in a row. Turmoil in the high-yield bond market, driven by a liquidity crisis at a mutual fund, added to investor disquiet.

For the quarter, the US broad market Russell 3000 Index finished at +6.3% with essentially all of the positive return coming in October. US small cap stocks continued their underperformance for the year as the Russell 2000 Index returned +3.6%. Outside of the US, developed markets were only modestly ahead with the MSCI World ex USA Index returning +3.9%. The +0.7% return for the MSCI EM Index was a welcome respite from an otherwise dismal year in emerging market stocks.

From a technical perspective, daily price volatility was fairly muted in October and November before jumping up in December. Implied volatility as measured by the VIX Index moved sporadically upwards but still finished the year below its long-term average. Average volumes traded remained below average, and short-interest declined modestly. At the factor level, Stability and Low Volatility were once again outperformers while smaller Size and Value were distinctly negative. Momentum and Low Beta were neutral. At the Sector level, Health Care and Technology led while Energy and Utilities lagged.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

By the time the calendar rolled into November, the momentum from the market rally of the prior month was already tapering off. Economic data from China continued to be mixed, and the arrest or disappearance of several finance executives and an intensifying crackdown on financial firms there added to investor anxiety. US Federal Reserve Chair Yellen’s comments pointed strongly towards a mid-December increase in interest rates, and strong US job growth figures bolstered the position. This all served to further dampen risk appetites. At the same time, low inflation and a mediocre growth outlook in Europe meant that the ECB was likely to remain more accommodative in both magnitude and duration. A terrorist attack in Paris mid-month shook the geopolitical status quo, but it was unclear what, if any, significant changes in approach – to either Syria, ISIS, or the refugee crisis in Europe – that would drive. Non-US markets initially fell in reaction, but the US markets were surprisingly nonplussed. As consensus firmed around the Fed’s likely action in December, investors appeared more willing to engage. Q3 US GDP was also revised up from 1.5% to 2.1% annualized. On the commodity-side, oil prices resumed their descent from an intermediate plateau of $45/barrel towards the mid-$30s/barrel, presaging a challenging period to come for the Energy sector.

Following the strong rebound seen in October, market performance in November was more muted with the Russell 3000 Index finishing the month up +0.6%. However, that result masked meaningful intra-month volatility where the index fell 2.5% in the first two weeks and rebounded 3.1% in the last two weeks. Financial Services was the top sector for the month as defensives areas such as Utilities and Consumer Staples lagged. US small cap stocks outperformed large cap stocks for the month as relative leadership shifted temporarily, and the Russell 2000 Index returned +3.3% Outside of the US, performance was more challenging as dollar strength and global growth concerns weighed. The developed market MSCI World ex USA Index returned -1.6% while the developing market MSCI Emerging Markets Index returned -3.9%.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

Although there were few meaningfully positive developments in the markets, the lack of “bad” news was enough to give buyers confidence that the recent sharp declines in the market were overdone. The completion of negotiations on the 12 nation Trans-Pacific Partnership was a positive while mixed US jobs data and a muted inflation picture gave investors the sense that the Fed may remain on the sidelines for a bit longer. Despite ongoing volatility in the Chinese market, the World Bank expressed confidence in China’s policy buffers and did not believe that there was a risk of a hard landing. However, most growth forecast revisions continued to be down with the IMF lowering its forecast for global growth from 3.3% to 3.1% on weakness in emerging markets. At the corporate level, M&A activity remained robust with Anheuser-Busch InBev’s $104 billion bid for SABMiller (rejected), Dell’s $67 billion takeover of EMC, Aetna’s $37 billion acquisition of Humana, and Pfizer’s potential $150 billion acquisition of Allergan making the headlines. At month end, Q3 US GDP was reported at 1.5%, but underlying strength in consumer spending was seen as positive for economic momentum.

Rebounding strongly from the declines of the prior few months, the Russell 3000 Index finished the month up +7.9%. Energy and Industrials were the leading sectors in the rally. The strong performance of the markets brought many broad US equity markets into the positive for the year with mega cap growth companies faring particularly well. Indicative of the liquidity-driven nature of the rally, US small cap stocks were up, but less so, with the Russell 2000 Index returning +5.6%. Outside of the US, the developed markets were essentially in-line with the US as the MSCI World ex USA Index returned +7.5%. Developing markets continued their relative underperformance and trailed slightly with the MSCI Emerging Markets Index returning +7.1%.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

The main event for the month was the surprise devaluation of the Chinese Yuan which catalyzed a dramatic decline in global equity markets. While the magnitude of the devaluation itself was modest (~5%), the impacts were substantial as demonstrated by the greater than 10% decline in equity markets in the six trading days from the 18th to the 25th. The devaluation served to highlight economic weakness in China and contributed to market fears regarding the sustainability of a market rally in its seventh year. All of this volatility further complicated the picture surrounding the timing of the Fed’s lift-off in interest rates, making the outcome from September’s meeting particularly hard to call. While Fed officials appear to want to begin moving away from the zero-bound, many outside groups (notably the IMF and the World Bank) have come out strongly against action at this time. Once the predominant macro story, the Greek debt crisis moved to the background as the Greek government and its lenders reached an agreement in principle for a third bailout. US GDP for the second quarter was also revised up to 3.7% from the previous estimate of 2.3% growth.

Market declines during the month were broad-based and fairly severe as volatility surged and correlations increased. The broad market Russell 3000 Index finished the month at -6.0%, a data point in the bottom decile of monthly returns for the last 25 years. US small cap stocks were similarly down as the Russell 2000 Index returned -6.3%. Performance was even worse in most non-US markets with the developed market MSCI World ex USA returning -7.3% and the developing market MSCI Emerging Markets Index returning -9.0%.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

The main event for the month was the surprise devaluation of the Chinese Yuan which catalyzed a dramatic decline in global equity markets. While the magnitude of the devaluation itself was modest (~5%), the impacts were substantial as demonstrated by the greater than 10% decline in equity markets in the six trading days from the 18th to the 25th. The devaluation served to highlight economic weakness in China and contributed to market fears regarding the sustainability of a market rally in its seventh year. All of this volatility further complicated the picture surrounding the timing of the Fed’s lift-off in interest rates, making the outcome from September’s meeting particularly hard to call. While Fed officials appear to want to begin moving away from the zero-bound, many outside groups (notably the IMF and the World Bank) have come out strongly against action at this time. Once the predominant macro story, the Greek debt crisis moved to the background as the Greek government and its lenders reached an agreement in principle for a third bailout. US GDP for the second quarter was also revised up to 3.7% from the previous estimate of 2.3% growth.

Market declines during the month were broad-based and fairly severe as volatility surged and correlations increased. The broad market Russell 3000 Index finished the month at -6.0%, a data point in the bottom decile of monthly returns for the last 25 years. US small cap stocks were similarly down as the Russell 2000 Index returned -6.3%. Performance was even worse in most non-US markets with the developed market MSCI World ex USA returning -7.3% and the developing market MSCI Emerging Markets Index returning -9.0%.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

The month started inauspiciously enough with news of Greece’s default on a payment due to the IMF and the subsequent rejection of bailout terms by Greek voters in a snap referendum. While somewhat expected, the actual events still had the effect of unnerving investors in a period when good macro news was hard to come by. An improving US job market (although not on the wages front) and some M&A activity (particularly in Health Care) offered some comfort, but markets remained mostly range-bound. Chinese equity markets continued to fluctuate despite further efforts by the Chinese government to support prices. Towards the end of the month, an abrupt about-face by the Greek prime minister on rescue terms brought that debt crisis to a temporary pause. A historical agreement on Iran’s nuclear program was a geopolitical bright spot, but the actual implementation and impacts were still to be determined. And in a further example of the mixed nature of recent macro news, the Q2 US GDP estimate came in at 2.3% with a upgrade of Q1 US GDP to 0.6% (from a 0.2% drop initially), but historical revisions showed that GDP growth for the last three years was weaker than originally projected (2.1% annualized versus 2.4% annualized).

In an oddly exact reversal from June’s 1.7% decline, the broad market Russell 3000 Index finished the month at +1.7%. US small cap stocks reversed their recent gains with the Russell 2000 Index returning -1.2%. Outside of the US, the developed markets were essentially in-line with the US as the MSCI World ex USA Index returned +1.6%. However, developing markets continued their dramatic absolute and relative collapse with the MSCI Emerging Markets Index returning -6.9%.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

Early in the quarter, the absence of any significant macro news saw the performance of markets appear to reflect relative assessments over absolute fundamentals. Of note was the continuation of the recovery in the price of oil from its March lows to an intermediate plateau of $60/barrel. Economic news was somewhat mixed (capped by a negative reading for Q1 US GDP), but a standoff between Greece and its international creditors – marked by oddly different assessments from the negotiators of where the negotiations stood – re-emerged as a source of global macro uncertainty. The major policy discussion was still the timing of Fed “lift-off” as a strengthening US labor market came against the backdrop of muted inflation data and lower growth expectations. Interestingly, external parties such as the IMF and World Bank have been quite vocal in their calls for a delay. Volatility returned towards the end of the quarter as a dramatic collapse in the Chinese equity market was met with heavy (and somewhat ineffective) government interventions and default, bank closures, and the announcement of an economic referendum threw the Greek debt crisis into uncharted territory. With valuations for many asset classes at fair or full levels and the end of central bank accommodation becoming incrementally more real than academic, it feels that we are in a period of unstable equilibrium which is resulting in increased market volatility. Despite the S&P 500 Index reaching a record high in mid-May, the markets were mostly somewhat range-bound as most periods of rally or decline were met with quick reversals. The US broad market Russell 3000 Index finished the quarter up a modest +0.1% as gains in April and May were largely offset by June’s declines. US small cap stocks were marginally better as the Russell 2000 Index returned +0.4%. Outside of the US, developed markets were generally in line with the MSCI World ex USA Index returning +0.5% while emerging market stocks as represented by the MSCI EM Index were slightly stronger at +0.7%. Performance for active managers was mixed during the quarter with those in large cap faring better than their peers in the small cap. A fair amount of the discrepancy could be attributed to the significant contribution of Health Care to index performance and the general lack of exposure to small cap biotechs among small cap managers. While cross-sectional volatility remained meaningfully below historical averages, price volatility increased in June on both a realized and implied (VIX) basis. At the factor level, Stability and Low Volatility were both underperformers as was Momentum. Smaller size was incrementally positive while Value was incrementally negative. This interplay may be somewhat indicative of a narrow market with one dominant sector (Health Care) bucking the trend.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

Despite the S&P 500 Index reaching a record high mid-month, the markets were otherwise somewhat range-bound in May as most periods of rally or decline were met with quick reversals. With valuations for many asset classes at fair or full levels and the end of central bank accommodation becoming incrementally more real than academic, it feels that we are in a period of unstable equilibrium which is resulting in increasing market volatility (particularly in bonds). Economic news was somewhat mixed (capped by a negative reading for Q1 US GDP), but a standoff between Greece and its international creditors – marked by oddly different assessments from the negotiators of where the negotiations stood – re-emerged as a source of global macro uncertainty.

US equity markets were able to recover from last month’s declines as the broad market Russell 3000 Index finished the month at +1.4%. US small cap stocks did even better with the Russell 2000 Index returning +2.3%. Outside of the US, the month a reversal in recent strength with the developed markets MSCI World ex USA Index returning -0.9% and the developing markets MSCI Emerging Markets Index returning -4.0%.

Active manager performance was again mixed with individual portfolio positioning and security selection mattering more than style orientation among large cap managers. The story was different among small cap managers as relative performance was uniformly negative, and Health Care (biotech) continued to be the dominant sector performance-wise. Volatility and market volume remained low. On a factor basis, larger size and momentum were positive with stability and quality negative. Other factors were largely neutral.

Kai W. Hong, CFA
Managing Director & Chief Investment Strategist

In the absence of any significant macro news, the performance of markets appeared to reflect relative assessments over absolute fundamentals.  While March had seen more sustained shifts in market direction, most of the moves in April were confined to a range of -1% to +1%.  Of note was the continuation of the recovery in the price of oil from its March lows to an intermediate plateau of $60/barrel.  The major policy discussion was still the timing of Fed “lift-off” as a strengthening US labor market came against the backdrop of muted inflation data and lower growth expectations.

The US broad market Russell 3000 Index finished the month at +0.5%.  US small cap stocks reversed their recent leadership with the Russell 2000 Index returning -2.6%.  Outside of the US, returns continued to be robust with the developed markets MSCI World ex USA Index returning +4.3% and the developing markets MSCI Emerging Markets Index returning +7.7%.

Overall, active manager performance was mixed with Value and Core managers performing best on a relative basis.  At the sector level, the big story for the month was the strong rebound in Energy.  This benefitted those managers that had the stomach to either maintain or increase positions during the drawdown of the last several months.  Volatility and market volume remained low so allocation decisions were likely to be more impactful than security selection.  On a factor basis, a value orientation was helpful while smaller size, quality, low volatility, and momentum were all generally negative.