Upcoming changes to the Global Industry Classification Standard (GICS) by S&P will go into effect later this month (more on that in next month’s Market Wrap), will increase Apple and Amazon’s respective weights in their sectors by reclassifying other companies to a new Communications sector. Those using ETFs to pick sectors or industry groups may want to check the expected impact to their holdings to minimize any potential surprises.
International Equities posted another month of losses and continue to be hurt by fears of tariffs, geopolitics, and a rising U.S. Dollar (to name a few). Developed Markets equities as measured by the MSCI EAFE Index lost -1.9% on the month, and are now down -1.9% YTD. Emerging Markets fared worse, with the benchmark MSCI Emerging Markets Index losing -2.7% on the month and -6.9% on the year.
While International returns have lagged the S&P 500 YTD we continue to see absolute and relative value outside the United States. It is important to remember the three components of international returns: 1) Price Appreciation/Depreciation; 2) Dividends; 3) Currency. The latter has been an important swing factor year to date, as the U.S. Dollar, as measured by the DXY Index, has gained +3.3%. Consider the implication in the Eurozone. The MSCI EMU Index has gained +1.0% YTD in EUR terms, while the same index measured in USD has lost -2.4%. The difference between the two returns (3.4%) closely resembles the change in EUR/USD exchange rate YTD, where the Euro has lost -3.41%. In the short-term, we believe that any resolution (or incrementally positive news) to issues plaguing countries like Turkey, NAFTA negotiations, or trade negotiations with the EU and China could ultimately start to reverse the Dollar’s gains. Dollar weakness would likely lend support to International and EM currencies, as well as investor confidence in long term investing in the space.
EM total returns have also suffered from currency movements, with the MSCI EM Currency Index down -5.0% YTD. Threats of tariffs have hurt most major EM currencies, and dragged the Shanghai Composite Index down -15.7% YTD in CNY terms and -20.0% in USD terms. Fears of a currency crisis in Turkey and a spill over into other countries such as India, South Africa, and Argentina remain front page news and have painted the rest of EM with a broad stroke. Countries with sizeable current account deficits will likely see their currencies come under pressure. Valuations in Emerging Markets remain compelling, but may get cheaper.
Those with long-term time horizons who are able to ride out the volatility will likely be rewarded for their patience.
The Federal Reserve will meet September 25th and 26th, with the second day of the meeting being followed by the Fed’s economic projections and a press conference with Chairman Jerome Powell. The market is expecting another rate increase.
The front of the yield curve flattened in August, with the 2Y10Y spread shrinking from 29 bps to 23 bps. We did see some steepening farther out, with the 10Y30Y spread growing to 15 bps, from 13 bps last month. A significant push higher in inflation due to a tight employment market, or the effects of a trade war, have not made their way into the economic numbers, nor are any concerns being reflected in the current shape of the curve, as of yet.
Investment Grade and High Yield corporate bonds had positive returns for the month. In both cases, spreads widened marginally during the month, but were more than compensated for by the coupon income.
Emerging market sovereign spreads also widened (more significantly) during the month of August, as the concerns about Turkey and Argentina continued. This has weighed on the performance of EM fixed income. Of the indexes that we track, it has turned in the worst performance of the bunch over the past month, YTD, and 1-year time frames.
While EM debt has not widened enough to approach being historically cheap on an absolute basis, it is possible to frame it as relatively inexpensive. Typically, when risk asset spreads are widening, it occurs throughout the lower quality fixed income universe. Year to date, EM spreads have experienced significant widening while U.S. High Yield has weathered a much more benign spread environment. This divergence has allowed EM to appear comparatively less expensive.
Municipal bonds have lagged a bit, and now offer slightly better yields compared to Treasuries. 2-year munis now yield 65% of Treasury yields vs. 61% last month, while 5-year munis yield 74% vs. 69%, and 10-year munis yield 86% of Treasury yields vs. 84% in July.