Developed Market equities, as measured by the MSCI EAFE Index, also posted positive returns, up +1.53% for the period. Developed Market equities continue to benefit from strong earnings momentum in Europe and Japan. Specifically, the Eurozone, as measured by the MSCI EMU Index , returned +2.46% in EUR terms, or +1.12% for a USD based investor, as the Euro weakened against the Dollar, detracting from performance. Furthermore, the Nikkei 225 Index, a key Japanese equity benchmark, gained +8.13% in JPY terms and +7.12% in USD terms.
While the Yen’s impact on returns was only 1.01%, the Nikkei is negatively correlated to the Yen’s performance, meaning as the Yen weakens Japanese equities tend to perform strongly, emphasizing the importance of the currency component to Japanese equities. Moving forward, Japanese equities continue to be propelled by earnings growth, improving measures of
confidence, and the re-election of PM Abe, which also serves as re-affirmation of unprecedented measures of monetary stimulus from the Bank of Japan.
From a sector standpoint, it should come as no surprise that Technology was the best performing international sector during the period, much like it’s U.S. counterpart. The MSCI ACWI ex. USA
Technology sector returned +5.95% during the period, propelling the sector’s gains to +51.05% YTD.
Nearly all other sectors finished the month in positive territory, with the lone exception being Healthcare, which gave back -1.59% on the month.
Over the past month, the Treasury yield curve has continued on its bear flattener trend. Rates rose across all maturities, but the rate of increase was larger in short-term maturities. The greatest increase in yield was at the 1 year point of the curve (~13 bps), followed by the 2 year (11 bps), 3 year (10 bps), 5 year (8 bps), 10 year (4 bps), while the 30 year yield hardly moved, rising 2 basis points.
This yield curve movement, along with continued spread tightening, produced another month of outperformance for lower quality credits and longer duration holdings. Investment grade (+0.40%), high yield (+0.39%), and emerging market bonds (+0.56%), all notched strong performance in October. Credit spreads appear quite optimistic, underpricing risk, and sit at or near longer term troughs.
Corporate issuers appear to be taking advantage of the market’s demand and willingness to pay up for bond deals.
U.S. investment grade issuance has surpassed $1 trillion in 2017, and is on pace to be the 7th consecutive year of record corporate bond issuance.
High yield municipal bond performance did not follow this risk-on trend in October, and are actually trailing the YTD return of the broader municipal market (+4.64% vs. +4.83%). Investors’ recent negative experiences with lower quality municipal holdings such as Illinois and Puerto Rico are likely dampening demand for these bonds.
Market expectations for the Fed to approve a rate increase in December rose from 70% at the beginning of the month, to where they currently sit, slightly above 85%. This is the market’s way of saying it believes that the increase is a sure thing. Conviction on future rate increases is not as strong. While the Fed forecasts three additional rate increases in 2018, the market in not ready to acknowledge that possibility. This may change when the next Federal Reserve Chairman is named.
Alternative Investments were largely positive performers in October, led by sharp gains in West Texas Intermediate (WTI) crude oil, which gained +5.2% on the month to close above $54/bbl. October’s closing price represents the highest monthly close since June 2015. Crude oil’s performance has risen sharply since the end of August, rising +15.1% over the past two months helped by hurricane related production issues, a falling drilling rig count, and pledges for OPEC to continue to limit production and actually comply with it. The strength in WTI helped buoy the broad Bloomberg Commodities Index by +2.0% during the period; however, the asset class remains in negative territory for the year, down -1.5%.
Real Estate, as measured by the FTSE NAREIT All REIT Index, shed -0.3% during the period, hurt by rising interest rates and continued expectations for the Federal Reserve to hike rates again in December. REITs have had a tough go thus far in 2017, gaining a mere +3.1%, compared to a +16.91% gain for the S&P 500 and a +16.24% gain for the S&P 500 Utilities sector. The sub-par performance from REITs likely also reflects structural issues within the sector.
Additionally, the U.S. Dollar, as measured by the DXY Index, rose +1.6% on the month as speculation around the next Chair of the Federal Reserve and the outlook for interest rates caused a back up in rates. Rising interest rates took their toll on Gold, with the precious metal losing -0.7% to close at $1,271/oz. While Gold may face near term headwinds from rising interest rates, it’s safe haven properties should not be forgotten in the event of a market selloff, increase in volatility, or geopolitical crisis, meaning Gold likely still has a place in most client portfolios as a hedging instrument.
From a currency standpoint, the Euro weakened from $1.18 USD/EUR to $1.16 USD/EUR on the back of increased political risk surrounding the breakaway (remains to be seen) of the Catalonia region from Spain, plus news from the European Central Bank (ECB) that quantitative easing (QE) will begin to wind down in January 2018.
Rising interest rates in the U.S., coupled with a lack of clarity on the future path of interest rates in Europe could continue to give pause to the rise in the Euro; however, the pause is likely to be short lived. This stands in contrast with the Japanese Yen, which displays a high degree of sensitivity to a rising U.S. 10-Year Treasury, meaning if U.S. interest rates are likely moving higher, the Yen is likely to weaken further in the future.