The MSCI EAFE index remained flat in August while the MSCI EM index gained 2.3% on the month. With the US Dollar having fallen nearly -10% year to date versus a basket of international currencies, exposures to foreign markets have been amply rewarded. Whereas London’s FTSE 100 is down -3.0% YTD for a Eurobased investor, it has returned 9.3% to a US Dollar based holder. Likewise, whereas an investor in continental Europe has seen a 4.8% return thus far in 2017 on the Euro Stoxx 50 Index, a US Dollar based investor has gained over 18.0%!
Japan’s Nikkei 225 Index remains relatively cheap versus it’s 10-year average on a Price-to-earnings ratio basis. So far in 2017, it has returned just 3.0% in local currency terms; however for a US Dollar-based investor, the Nikkei has gained 9.2%. A continued commitment to the principles of Abenomics, including robust quantitative easing, should provide a long lasting tailwind to the Japanese economy. Recent inflation reports in Japan showed consumer prices rising 0.4% YoY in July, a seemingly underwhelming number but after years of battling deflation, this 4th consecutive reading of rising prices is promising.
Emerging markets continue to win back investors after years of lagging developed markets. The MSCI EM Index has gained 28.5% thru 8/31, as continued low interest rates in the US along with a weakening US Dollar have improved the outlook for many EM economies. China, as usual, remains the key to the region; however, YTD the Shanghai Composite is up 10.4% and fears over bad debts and a housing bubble have yet proven unfounded.
Fixed Income Investing Update
Bond investors were better buyers in August as softening US economic data, an increasingly benign Fed, and little to no consumer price inflation combined to spur the latest chase for yield. The broad ML US Treasury/Agency Master Index gained 1.11% in August as the yield on the 10-year US Treasury fell from 2.25% to 2.12%. Fears over the potential for a hawkish speech by Janet Yellen at the annual August Jackson Hole Symposium went unrealized as she spent most of her prepared remarks defending the work of the Federal Reserve and policymakers following the collapse of the credit bubble.
Risk-on in debt markets took divergent paths in August with bond investors actively seeking returns in the EM space while at the same time cooling on US high yield. The ML USD Emerging Market Sovereign & Credit Index surged 1.7% on the month, and is now up 8.9% YTD. The ML US High Yield Master II Index fell -0.03%, yet remains up a solid 6.09% for the year. US high yield spreads over Treasuries did widen out almost 25 bps in August after touching a 3-year low of +368 in late July. Along with tighter spreads, we have seen the continued deterioration in investor protections with the vast majority of high yield debt now being issued along cov-lite lines. As taxable high-yield investors have pulled back, we’ve seen increased interest in tax-exempt high-yield, with the ML Municipal High Yield Index rising 1.4% in August, for a 5.31% YTD gain.
Despite a 13 bps pullback in the spread over Treasuries on investment-grade debt, the ML US Corporate Master Index gained 0.85% on the month and is up over 5.5% YTD. Demand for investment-grade bonds remains robust across the board and despite the continuation of heavy issuance (Amazon floated $16 billion in August to help fund the Whole Foods acquisition and the deal was met with $47 billion in investor interest), the relative attractiveness of US yields versus those available in the eurozone and Japan has spurred investor demand.
The odds for a December rate hike currently stand at 34% according to the futures market. Todays somewhat underwhelming employment report for August, along with meager inflation data, has reduced the likelihood that the Fed will feel any sense of urgency around the timing of its next rate hike.
Alternative Investments Update
Trepidation around the devastating impact Hurricane Harvey is having on the Texas Gulf Coast has roiled energy markets and injected a fair amount of uncertainty into the forward curve. The immediate impact of Harvey, beyond the human toll, has been a drop in oil prices as crude stockpiles increase, unable to find their way to the massive refineries currently closed by the storm. At the same time, gasoline prices are surging as shortfalls are anticipated until production can come back online.
At the end of the day, however, prices will adjust sooner rather than later while the unfortunate human impact of Harvey will likely linger for some time.
Oil prices fell nearly -9% in August with much of that decline coming pre-hurricane. The US continues to be buffeted (blessed?) with an abundance of oil and gas, and the net impact of increased exports is only starting to be felt. Brent crude declined only -3.7% on the month as global demand for petroleum products remains robust.
NYMEX Gasoline prices surged nearly 14% in August, mostly on the heels of Hurricane Harvey. At the distribution level, MLP’s suffered broad declines with MLPA, the Global X MLP ETF falling -7.2% in August.
The price of gold rose 4.3% in August, as interest rates declined and geopolitical risk heightened. North Korea’s provocative missile launches have global investors seeking some sort of hedge against a scaling up of tensions on the Korean peninsula. Metals in general rose in August as solid demand around the globe has driven prices of everything including copper (+6.5% in Aug), aluminum (+10.3%), palladium (+8.9%) and platinum (+7.05%) higher.
Hedge funds stabilized a bit in August despite mixed results. Year to date, Event-driven and Convertible Arbitrage have “outperformed”, returning 5.4% and 5.1% respectively, versus the 11.9% return for the S&P 500. Most of the other hedge fund strategies have realized returns more consistent with the fixed income markets, perhaps offering investors risk diversification away from traditional long equity portfolios. A glance at the 5-yr number column, however, should cause most rational investors to scratch their heads and at least contemplate whether there’s a cheaper way to earn returns in the low single digits.