Q3 Quarterly Review: Central Banks Remain in Focus
The influence of central banks and questions about future policy dominated the headlines during Q3. The US Federal Reserve, the Bank of England, and the European Central Bank all held rates steady. The Fed continued to hint at a rate hike this year, while the BOE and the ECB indicated that further easing measures should not be ruled out. The Bank of Japan was the most active monetary policy player. BOJ officials revamped their policy targets and the actions used to affect interest rates. Global economic growth persevered through the Brexit fallout, political battles, currency fluctuations, and a fairly hands-off approach from central banks. Markets rebounded early in the quarter but moved mostly sideways during the later months during a lull in volatility. The MSCI All-Country World Index returned 4.79%.
U.S. stocks followed the global markets sharply upward as investors realized that fallout from the Brexit vote will likely be a slow drip rather than an economic collapse. After moving higher through June, the major indices were relatively flat through the end of the quarter. Economic data showed improvement during the quarter. The labor market continued to tighten, wage growth gained momentum, real estate values improved, and consumer spending trends remained strong. Concerns remain over a lack of business spending and stagnant manufacturing. A lack of action by the ECB and hawkish comments by US Fed committee members in early September took a toll on stocks, but the markets recovered following the Fed’s announcement that it would not raise rates until a later date. The S&P 500 returned 3.31%, the DJIA returned 2.11%, and the NASDAQ led the way with a 9.69% return. Telecom was the top performing sector with a 12.81% return. Technology and financials also performed well, posting returns of 10.60% and 9.96% respectively.
Overseas, the falling price of the pound Sterling fueled a strong showing in the UK markets. After a short period of unrest, it was clear that over the short term the Brexit is not likely to have a major impact on the economy and the decline in the pound sterling led to an increase in exports and a short-term boost in demand for local goods and real estate. New British Prime Minister Teressa May helped stabilize the political and economic situation and has garnered support from both domestic and foreign leaders. The FTSE 100 index returned 3.06% in USD terms. Stubbornly low growth and inflation in the eurozone suggest that the recovery is still fragile. European markets were relatively stable late in the quarter but were adversely affected by the ECB’s decision to keep its monetary policy steady as well as renewed fears about the health of the banking sector. The MSCI EMU Index returned 7.84%. In Japan, Prime Minister Shinzo Abe and the Liberal Democratic party gained undisputed control of Japan’s upper house and announced a massive government spending stimulus package. Japanese equities performed well with the MSCI Japan Index returning 8.76% bolstered by weaker Yen and growing corporate profits. The BOJ kept interest rates unchanged but announce an overhaul of its approach to monetary policy. The BOJ abandoned its money printing targets in favor of a new focus on controlling the yield curve. The central bank will now purchase 10-year government bonds with the goal of keeping the 10-year rate near zero percent, allowing longer-dated rates to rise while hypothetically capping short-term borrowing costs. Emerging markets outperformed developed markets due to developed market central bank inactions, an increase in demand from investors searching for higher-yielding assets, and signs of economic stabilization in China. The MSCI EM index returned 9.15%.
The bond markets lagged equities during Q3 due in part to low levels of volatility and rising expectations of a US rate hike before the end of the year. Rates on longer-dated issues rose while short-term rates fell slightly. The Barclays US AGG Bond Index returned 0.46%. High yield bonds continued to perform well as economic data remained stable and interest rate spreads narrowed. The BofAML US High Yield 100 Index returned 3.48%. Overseas, the demand for fixed-income assets remained strong despite rates hovering near historically low levels. Developed market fixed income performed relatively better with returns of 1.03% in USD terms. Weakening currencies in the US, UK, and Eurozone and a renewed demand for higher yields helped boost emerging market bond performance. The asset class was the strongest performer during the quarter returning 3.13% in US dollar terms and 4.96% in local currency terms.
Commodities retreated during the quarter with agriculture posting the weakest results. Returns were depressed by massive supply growth in many flagship crops. Oil prices were highly volatile but recovered early losses to end the quarter relatively flat following the anticipation of OPEC’s deal to cap production. The WTI oil price declined 1.53%. Gold prices remained elevated but showed a slight downward trend heading into the end of September. The spot gold price declined -0.77% in during Q3. The move lower was influenced by currency trends including a weakening euro and pound sterling along with a rising US dollar. Despite positive supply and demand dynamics, domestic real estate failed to keep pace with equities as interest rate sensitive sectors fell in anticipation of Fed action. The Dow Jones US Real Estate index fell -1.15% in Q3. Global real estate fared somewhat better as borrowing rates remained low and demand remained elevated despite fears of a Brexit fallout in the sector. The Dow Jones Global Ex US REIT index returned 2.17%. Hedge funds performed well during the quarter with the top strategies outperforming both the S&P 500 and the DJIA. Overall, the HFRI Fund Weighted Composite Index returned 2.78%. The top strategies over Q3 were equity hedged strategies and event-driven strategies which returned 4.74% and 4.58% respectively. Macro strategies posted the worst performance of the quarter with returns of -1.06%. Private equity performed well during Q3 but initial data shows that both traditional private equity and venture capital saw a decline in fundraising. One likely explanation for the decline in fundraising activity is the record amount of dry powder currently held by private equity funds. Additionally, private equity and venture deals and financing activities have experienced a reversion to the mean following strong deal activity in recent years. Buyout and secondary transactions were the most active areas of the private markets.