Q3 2017 Quarterly Review: Onward and Upward
The global economy continued to expand throughout Q3. The Organization for Economic Co-Operation and Development (OECD) projected that all 45 countries that it tracks will expand in 2017. Through Q3 the MSCI All Country World Index posted positive returns for 11-straight months. The backdrop of stable macroeconomic data and limited volatility supported growth in equity markets. Foreign equities continued to outperform domestic equities. The Euro-area posted the highest returns, followed by emerging markets. Central banks’ focus on tightening or reducing monetary policy accommodations led to higher interest rates and underperformance for fixed income assets. Despite the run-up in equities, geopolitical tensions fueled demand for safe-haven assets which generated positive returns for fixed income. Overall, the lack of surprises during the quarter resulted in greater investor confidence and a continuation of the current bull-market.
U.S. stocks powered through two major hurricanes and geopolitical concerns regarding North Korea and President Trump. Equities were supported by steady economic data, a weaker U.S. dollar, and healthy growth in corporate earnings. The Federal Reserve announced plans to decrease its balance sheet holdings and many Fed Governors publicly expressed support for raising rates again this year. The Fed’s outlook indicated that the economy is heading in a positive direction. Investor and business sentiment both remained elevated during the quarter. The S&P 500 and the DJIA returned 4.0% while hitting record highs. The tech-heavy NASDAQ index set the pace with a 5.8% return. Tech was the top performing sector, posting an 8.4% return. Energy, materials, financials, and industrials rounded out the top five sectors, respectively. Consumer staples was the worst performing sector with a -1.14% return.
Foreign equities outperformed their U.S. counterparts on a USD basis. Brexit fears were put on the backburner as Theresa May’s camp and the EU failed to develop constructive discussions on the UK’s exit from the European Union. The MSCI EMU Index returned 7.9%. Returns were driven by stronger economic data. GDP growth came in higher than expected and the unemployment rate remained at its lowest level since 2009. Investors focused on the European Central Bank (ECB) for much of the quarter. Comments from the governing council indicated that ending the current quantitative easing program and raising interest rates were discussed. The initial report rattled the markets and sent the euro higher, but after investors digested the potential time frame for any monetary policy changes the markets resumed their climb higher. As with the U.S., cyclical sectors were the top performers while defensive sectors lagged. U.K. equities underperformed the rest of Europe. Sterling strengthened against the dollar, and the Bank of England (BOE) indicated that it is considering raising rates which created headwinds for equities. The FTSE 100 rose 4.1% for the quarter. Japanese markets gained on the back of improving economic data. The MSCI Japan Index returned 4.1% for the quarter. The effects of Abenomics appeared to be working their way through the economy. Industrial production and inflation improved which helped to boost business conditions and sentiment. Emerging markets (EM) maintained their spot as the top performing equity region. The MSCI EM Index returned 7.0%, bolstered by strong returns in China, Brazil, and Russia. EM countries were also supported by growing confidence in the strength of the global economy, U.S. dollar weakness, and rising commodity prices. Brazil was the top performing index, rebounding from lows hit following the announcement of additional government scandals. The MSCI Brazil Index returned 22.4% for the quarter. China and Russia both rose 14.8%. Chinese returned were driven by reduced fears of capital outflows due to a stronger yuan and better than expected GDP growth. Russia was supported by the rebound in oil prices.
The economic backdrop remained relatively similar from Q2 to Q3 leading to less demand for fixed income assets. Moderate economic expansion paired with moderate inflation continued to be the main theme for many regions. Additionally, central bank activity was minimal which removed a major tailwind for fixed income markets. Domestically, the Barclays US Agg Bond Index rose 0.9%. Corporate bonds performed slightly better as spreads tightened and positive profit estimates renewed confidence in corporate borrowers. The Barclays US Int Term Corporate Index returned 1.5% and the Barclays US High Yield Corporate Index returned 2.0%. Global bonds outperformed U.S. bonds in USD terms. North Korean tensions generated demand for safe-haven assets in regions closer to potential conflict. The Barclays Global Agg Ex US Index returned 2.5%. Emerging market bonds performed similarly well. EM issues were supported by a weaker U.S. dollar and a lack of developed market central bank activity. The Barclays EM Agg USD Index returned 2.3% and the Barclays EM Agg Local Issue Index returned 2.5%.
Industrial commodities rebounded strongly during the quarter, supported by strengthening Chinese growth and global production outlooks. The S&P GSCI Index returned 7.2% during the quarter. Fears of a significant break in the supply chain for U.S. crude oil due to hurricane damage led to an increase in crude oil prices. WTI Crude Oil spot prices increased 11.2% and remained relatively stable through the end of the quarter. Agriculture was the worst performing commodity subset. Prices fell on better than expected harvests. The S&P GSCI Agriculture Index declined -7.2%. Gold prices continued to rise but lost some momentum after North Korean actions proved to be little more than headline provoking. The gold spot price rose 3.3%. Real estate underperformed during the quarter. Interest rate sensitive sectors were subject to selling pressures as the prospects for future interest rate hikes strengthened. The DJ US Real Estate Index rose 1.1% and the DJ Global Ex US RE Index rose 2.0%. Hedge funds continued to perform well. Many strategies have been able to capitalize on weaker equity correlations and the divergence of global monetary policies. Equity hedged strategies were the top performing subset with returns of 3.52%. Equity market neutral and event-driven strategies also performed well with returns of 2.0% and 1.8% respectively.