Q1 was a tale of two halves. Renewed fears of a global growth slowdown sparked an early increase in market volatility during the first quarter. A lack of stability in oil prices, uncertainty surrounding the US Federal Reserve’s actions, central bank interventions in Europe and Japan, and shaky economic data all contributed to the January slide in equity prices. Central banks continued to dominate the headlines in Q1. Japan made a surprise move to negative interest rates in January, the European Central Bank instituted new monetary relief measures which included plans to purchase corporate bonds and to pay banks to lend money, and the Fed decided to hold interest rates level citing an uncertain domestic economic response to foreign developments as its main reason for staying put. Investors turned to risk-off trades through January and much of February before global markets began to recover. Income producing assets and traditional risk-off asset classes benefited the most from the decline in sentiment with bonds, REITs, and precious metals leading asset class returns.
U.S. stocks fell into correction territory to begin the year with the S&P 500 falling 10.5% through mid-February. Employment data continued its positive run, but consumer and manufacturing data struggled. Janet Yellen helped calm investors’ nerves by stressing the importance of proceeding with caution in regards to raising interest rates. The Fed’s dovish tone along with the abatement of global recession fears soothed the markets into a strong turnaround. The S&P 500 finished the quarter up 1.3% with non-cyclical sectors outperforming. The DJIA returned 1.5% for the quarter, but the NASDAQ failed to make it back into the green by the end of March, returning -2.75% through Q1. Earnings expectations dropped considerably during the quarter amid concerns about growth, dollar strength, low oil prices, and weak overseas demand. Despite the negative global mood, March economic data showed that the US economy is still grinding ahead as inflation, wage growth, consumption, and home sales all showed improvement.
Overseas, European equities trended sharply downward along with the rest of the world’s equity markets. The MSCI EMU index returned -6.6% for the quarter. Economic data was lackluster with GDP and inflation coming in lower than expected. Europe did recover slightly in March, returning 2.8% for the month following the ECB’s announcement that it was cutting the deposit rate, instituting new loans for banks, increasing its monthly asset purchases by €20 billion and adding investment grade corporate bonds to its purchase options. The new bank loans are a strong push for capital to make its way of bank’s coffers and into the economy. The Bank of Japan surprised the markets by adopting a negative interest rate policy (NIRP) in January. The results of the policy change were less than desirable. The Yen rebounded sharply against the US dollar which put pressure on the equity market. Additionally, companies have not been adopting the structural reforms proposed by Abenomics at the desired rate which has kept wage growth low and stymied corporate investment. The unexpected reaction to the BOJ’s policies and a lack of confidence in the longevity of Abenomics pushed nervous investors out of Japan with the TOPIX index generating a loss of -12.0% for the quarter. Emerging markets struggled early on as Chinese data continued to disappoint and the stock market was forced to close twice within a week due to excessive volatility. Intervention by the People’s Bank of China helped support some investor sentiment, and money began flowing back into emerging markets later in the quarter. Emerging market equities then surged ahead following the alleviation of global recession fears and the Fed’s decision to maintain its current interest rate policy. The MSCI EM Index returned 2.8% for the quarter, outpacing major developed market indexes.
Overall, interest rates fell during Q1 as investors reduced portfolio risk. Fixed income assets performed well in the face of heightened market volatility. Every major bond sector generated positive gains for the quarter with emerging market debt leading the way followed by inflation-linked bonds and global investment grade corporates which returned 5.9%, 4.7%, and 4.6% respectively. Longer-dated issues benefitted the most from the shift to risk-off assets as the yield curve continued to flatten. Inflation protected securities performed well due to easing deflationary fears and the reversal of early year commodity price declines. Spreads in corporate bonds and high yields expanded during January and February but the late quarter rebound in commodity prices compressed spreads through March to end at nearly the same levels they opened the year.
Many hedge fund strategies were able to avoid the market whiplash during Q1 and the HFRI fund Weighted Composite Index outperformed equities in both January and February, returning -1.7% and 0.5% respectively, before trailing the equity rebound in March. Overall, The HFRI Fund Weighted Composite Index returned -0.83% for the quarter. Macro and trend following CTA strategies were the top performing hedge fund strategies during Q1. Real estate was one of the top performing asset classes during the quarter. The proliferation of lower for longer rates, easy access to capital, and the search for yield helped generate returns of 5.1% for the Dow Jones US Select REIT Index and 8.5% for the S&P Global ex-US REIT Index. Commodities staged a recovery during the first quarter. Oil prices plummeted during the opening months of the year, but the announcement of production capping discussions between the world’s leading oil producing countries along with a weaker US dollar helped to elevate and stabilize prices through the end of the quarter. The WTI spot price hit new multi-year lows in February but increased nearly 50% to end the quarter at $38.34. Precious metals were the top performing assets across the board. As fears of a global slowdown took hold early in the year money flowed into precious metals which are viewed as a traditional risk off and inflation hedging investment. Gold posted returns of 16.4% during the quarter, with Zinc and Silver coming in next at 12.3% and 11.9% respectively.