Q3 2015 Market Commentary
Market volatility returned in a profound way during the third quarter. Nearly all major equity markets entered correctional territory, falling at least 10% from a previous peak, as uncertainty surrounding the path of the global economy began to weigh on investor sentiment. The MSCI World Index dropped 8.4% in U.S. dollar terms during Q3. In late August, China surprised the markets by devaluing its currency which, paired with weak economic indicators, sparked fears that the economy was sliding into a recession. The reaction caused a global sell-off which led to the worst performing quarter for equities since 2011. The U.S. Federal Reserve kept interest rates unchanged based on disparate economic measures and short-term uncertainty generated by foreign markets. Overseas, Europe survived another Greek debt crisis and a migrant crisis. Measures of unemployment and inflation remained far below policy target levels. The European Central Bank (ECB) helped cushion the markets by indicating that it is ready to increase monetary easing measures if necessary. Emerging market countries were dragged down by a slew of negative news economic news coming from China, Brazil, and Russia, as well as commodity price and currency weakness.
U.S. stocks fell sharply during the third quarter. The S&P 500 officially entered correctional territory and finished the quarter down 6.4% with the utilities sector being the only positive performer for the quarter. The Federal Reserve Committee decided to keep policy rates unchanged moving into the fourth quarter; citing volatility overseas and its potential to cloud the economic outlook of the domestic economy as its main reason for staying put. Investors appeared to be wary of deploying capital to risk assets given the poor news emanating from China and the lack of a definitive plan from the Federal Reserve. Markets were further damaged by backlash in the healthcare market following comments by presidential hopeful Hillary Clinton regarding drug pricing procedures. Economic measures remained mixed with swings in the jobs reports, little to no inflation, and an upward revision to Q2 GDP.
Emerging market led the decline in global equities during the quarter. Emerging markets equities fell due to uncertainty surrounding the US rate hike, concerns about China’s slowing economy, political risk, commodity price weakness, and currency weakness. The MSCI EM IMI Index fell 17.7% in U.S. dollar terms over the quarter, making it the worst performing major index. China’s major stock index fell 8.49% on “Black Monday” and lost more than 25% of its value through the end of the quarter. The dramatic sell-off in China led to market declines in other emerging Asian economies and sparked an outflow of capital from global emerging markets. International developed market equities fared better than emerging markets. The MSCI EAFE index fell 10.2% for the quarter. The eurozone was pulled into negative territory as the fragile economy reacted poorly to the “Grexit” fears early in the quarter and the fall-out from China in late August. Additionally, growth there has been low due to a stagnant unemployment and inflation. Alexis Tsipras and the Syriza party won their second election this year after Tsipras resigned in a strategy to remove internal opponents from his party’s seats in parliament. The new parliament finally agreed to terms with creditors on a bailout deal which should alleviate “Grexit” concerns for some time. M&A activity continued to support stocks in the UK, but overall the FTSE 100 Index fell 6.1% during the quarter. The Bank of England backed off its initial forecast that key interest rates would rise by the end of the year. Economists are now predicting that the BOE will keep interest rates unchanged until 2016 due to a lack of consistent job growth and inflationary traction. Elsewhere, Japanese equities suffered amid weaker than expected economic data and yen inflows due to its perceived “safe haven” status. The MSCI Japan Index lost 11.8% in U.S. dollar terms during the quarter. Labor and market conditions appear to be on track, but core inflation fell for the first time in over two years, which could encourage the Bank of Japan to further ease monetary policy.
Overall, Q3 bond market activity was characterized by a large divergence in the performance of rate sensitive securities versus those that are more dependent on credit conditions and investor sentiment, such as high yield bonds. While rate sensitive issues generated mostly positive returns as investors fled risky assets in light of the global slowdown fears that hit the markets in August, high yield bonds suffered greatly. Additionally, the Fed’s decision to keep interest rates on hold put pressure on yields. U.S. 10-Year Treasuries experienced a wide trading range driven by economic weakness abroad and further uncertainty over the timing and extent of the Fed rate hikes. 10-year rates would eventually fall from 2.4% to 2.0%. The Barclays Global Aggregate Bond Index returned 0.9% for the quarter. High yield issues fell 4.9% as investors shifted to “risk-off” asset classes and the rout in oil prices continued.
Hedge funds continued to outpace major equity indexes during the third quarter. The HFRI Fund Weighted Composite Index outpaced the S&P 500 by nearly 3.5%, although still coming in negative for the quarter with returns of -2.9%. Many equity driven strategies had difficulty sustaining positive performance during the bought of volatility that began in late August. Macro driven strategies were some of the top performers during the quarter as they took advantage of long fixed income exposure and short term plays in the commodities markets. Credit driven strategies were dragged down by widening spreads in the high yield market. After showing signs of a recovery in Q2, all major commodities sectors contracted during the third quarter. The negative performance was largely driven by the negative news from China and other emerging markets as well as signs that the supply and demand dynamics in the oil industry have yet to converge, driving crude prices to new lows. The Bloomberg UBS Commodity Index fell 14.5% over the quarter. Gold returned to form as a volatility hedge during Q3. Although returns were negative, -4.83% for the quarter, gold was the strongest performing asset class during the volatility peak in August. Other precious metals were hit by a lack of demand driven by the potential for higher interest rates in the U.S. and a stronger U.S dollar relative to global currencies. Real estate, which is typically hurt by rising interest rates, benefited from the Fed delaying raising rate. Real estate was able to generate slightly positive returns for the quarter, with the FTSE NAREIT All REITs Index generating a 0.8% return.