Q4 Quarterly Review: Election Steals the Show
The U.S. presidential election and the U.S. Federal Reserve’s decision to raise its key interest rate were the highlights of Q4. Markets maintained a narrow trading range leading up to the
election and were sent on a tumultuous path as it became clear that Donald Trump would be the next President. After selling off to levels not seen since the Brexit vote, stocks recovered and
then continued to charge ahead through the end of the year. Higher interest rates, inflation expectations, and U.S. dollar took a toll on fixed income and bond-proxy sectors. Foreign markets
held up well during the quarter mostly due to currencies declining against the U.S. dollar. OPEC and non-OPEC countries, most notably Russia, inked a historic deal to limit crude oil
production in 2017. Emerging markets (EM) struggled as a stronger dollar and higher interest rates weighed on investor sentiment towards the sector, but support from fiscal spending
rhetoric and commodity demand kept losses in check.
U.S. markets outperformed versus the rest of the world. The NASDAQ was the weakest performing index with returns of 1.3%. The S&P 500 returned 3.3%, and the DJIA soared, returning
7.9% driven by financials and the expectation that industrial companies will benefit from Trump’s policy proposals. Small cap companies outperformed, rebounding from poor relative
performance over recent quarters. The Russell 2000 returned 8.4%. Financials were by far the best performing sector, generating returns of over 21%. Tailwinds for financials included
expectations of less regulation in the industry, strong consumer demand for debt, and the swift increase in interest rates following the Fed’s key rate announcement. Real estate was the
worst performing sector. REITs sold off along with other bond-proxy sectors as higher rates and inflation expectations drove investors out of the sector.
The UK continued to cope with the impending Brexit and was supported by a weak pound sterling. The FTSE 100 index returned 1.0% for the quarter and set a new all-time closing high
during December. The FTSE is mostly comprised of multi-national companies which have benefitted from earning higher cross-border profits. The Italian referendum and the President’s
resignation came and went with little market reaction, but the government’s need to step in and save the world’s oldest bank shows that downside risks are still prominent in the eurozone.
The European Central Bank (ECB) extended their asset purchase program but decreased the asset value of bonds it will purchase each month. The ECB sees the need for further stimulus to
increase inflation and help the economy gain traction. The MSCI EMU index returned 1.2%. Japan also benefitted from a weaker currency and a rebound in export activity driven by higher
demand from China. The Nikkei 225 Average returned 16.1% on a hedged U.S. dollar basis. Emerging markets struggled as investor demand declined with U.S. rates and the dollar climbing
as well as Chinese bonds selling off. The MSCI EM index lost 4.6%.
U.S. fixed income performed poorly during the quarter. Nearly all fixed income securities sold off in the months following the election as higher inflation expectations and the Fed rate hike
raised rates across the yield curve. The 10-year Treasury rate went from 1.88% up to 2.6% in just over a month before ending the year at 2.5%. High yield corporate bonds were the only
class with positive returns with the Barclays High Yield Corporate index returning 1.8%. The Barclays U.S. Agg lost 3.0%. Foreign markets did not fare any better as U.S. rate hikes and a
selloff in Chinese bonds spooked investors. The Barclays Global Agg Ex U.S. index lost 10.3% in U.S. dollar terms. Strong commodity performance was not enough to support emerging
market debt. The Barclays EM Agg lost 2.6% during the quarter.
edge funds posted positive results during the fourth quarter on the back of gains across global equities, strong dollar and commodities appreciation, and rising credit yields. The HFRI
Composite Index was up 2.2% during the quarter, reaching record highs in December. Publicly traded real estate performed poorly during Q4. The DJ U.S. Real Estate index returned -3.1%.
Global real estate fell further with the DJ Global Ex U.S. index returning -8.1% in USD terms. Real estate holdings were sold due to investors’ fear that higher interest rates and inflation will
outpace rental income and could deter demand in the space. For gold, higher inflation expectations could not match the headwind of higher rates and the S&P GSCI Gold Spot lost 12.6%.
Gold prices tend to fall when rates and the dollar rise do to a lack of yield and higher costs dampening demand. Commodities performed well during the quarter as global demand remained
steady and fiscal spending rhetoric led to the anticipation of infrastructure spending. The S&P GSCI returned 5.8%. Oil prices fell to begin the quarter but recovered quickly on the back of a
major OPEC and non-OPEC production cut deal. Both major spot prices ended the year above $50 as WTI prices climbed 7.6% and Brent Crude prices rose nearly 10%.