GLOBAL EQUITIES 

TRADE AND CENTRAL BANKS REMAIN IN FOCUS

The S&P 500 Index slipped 1.8% during August, or 1.6% including dividends, as escalating trade tensions and concerns that the Fed may not cut rates enough led to a 4.8% pullback within the first three trading sessions of the month. The index fell more than 6% below its record high set July 26 before stocks pared losses at the end of the month. The Nasdaq fell 2.5%, while the Dow Jones Industrials held up better with a 1.3% loss. Year to
date, the Nasdaq leads the major averages with a
21% gain, ahead of the S&P 500 (18.3%) and Dow Industrials (15.1%).

The calendar had barely turned to August before trade swung stocks around. On August 1, President Trump tweeted that he would impose a 10% tariff on approximately $300 billion of Chinese imports, to be effective September 1. China then responded by pulling prior commitments for agricultural purchases and weakening its currency. The United States labeled China a currency manipulator and restricted U.S. companies’ ability to conduct business with China’s telecom giant Huawei. The United States announced mid-month that it would delay some of the tariffs until December, while President Trump struck a more conciliatory tone at the G7 summit in Japan, which helped diffuse tensions in late August, even though China retaliated with its own tariffs.

The bond market continued to send a cautionary signal to the stock market about the potential for a recession as a closely watched part of the yield curve inverted. Specifically, the 10-year Treasury yield dipped below the 2-year Treasury yield, an event that historically has preceded a recession. Based on the resilience of the equity market, we‘re not convinced this modest inversion is a near-term recession signal, but it could be evidence that Fed policy is too restrictive given trade uncertainty and that yield-starved international bond investors are buying U.S. Treasuries in full force.

Large cap stocks held up better than their small cap counterparts during August, as the small cap Russell 2000 Index fell more than the larger cap Russell 1000. The fact that small cap stocks lagged large caps within all 11 S&P equity sectors suggested a clear preference for higher quality, generally more defensive larger cap companies. Mid caps have led year to date with a 19.6% return, ahead of the 18.5% and 11.8% advances for large caps and small caps, respectively, based on the Russell indexes.

International

The U.S.-China trade conflict, a strong U.S. dollar, and geopolitical uncertainty got the best of the international equity markets during August as both the MSCI EAFE Index (developed international) and the MSCI Emerging Markets Index underperformed during the month.

The MSCI EAFE Index lost 2.6% for the month, bringing its year-to-date return to 10.1%. In August, developed international equities were hurt by slowing global growth, partly related to the trade conflict, a stronger U.S. dollar, and that market’s value orientation. At the country level, losses in the United Kingdom, Hong Kong, Australia, and Germany contributed most to index losses. Brexit uncertainty weighed on the U.K. market, Germany has been hurt by manufacturing weakness, and protests negatively impacted investor sentiment in Hong Kong. Underperformance was concentrated in the financials, materials, and technology sectors.

Emerging markets lost 4.8% for the month but held onto a 4.2% year-to-date return. Underperformance was driven primarily by losses in Brazil, China, South Africa, and South Korea, all directly or indirectly related to the U.S.-China trade conflict. Weakness was concentrated in the financials and natural resource sectors.

FIXED INCOME

10-YEAR YIELD DROPS IN AUGUST

The bottom fell out of U.S. Treasury yields in August as a combination of global economic uncertainty and stock market volatility pushed investors into U.S. debt.

The 10-year Treasury yield fell 52 basis points (0.52%) in August, its biggest monthly slide since January 2015, to close at 1.5%. The 10-year yield’s highest monthly close was 1.89% on August 1, a day after the Fed announced its first interest rate cut of the cycle.

The yield curve continued to flatten in August, and another closely watched part of the curve inverted (long-term yields falling below short-term yields). The spread between the 2-year and 10-year yields closed negative on August 27 for the first time in this economic cycle, after falling negative intraday during a few trading sessions during the month. The spread between the 3-month and 10-year yields closed at -49 basis points (-0.49%) and has stayed inverted since the end of May.

Eight of 11 fixed income asset classes we track rose in August, as shown in the Fixed Income Performance Table. Safe-haven debt outperformed, as Treasuries led all classes with a 3.4% gain. The Bloomberg Barclays U.S. Aggregate Index rose for a sixth straight month, its longest monthly winning streak since July 2016.

ALTERNATIVE INVESTMENTS

GAINS IN MANAGED FUTURES CONTINUE

Trend-following strategies continued to perform well, as the HFRX: Systematic Diversified Index gained 2.8% during August, bringing year-to-date gains to 10.7%. Long fixed income positioning once again provided the majority of positive returns, as bonds across the globe and maturity levels moved higher. Currency positioning also was beneficial in providing attractive returns and an additional source of diversification, as long positions in the U.S. dollar against the euro, pound, and peso were profitable.

Volatility within equity markets has led to lower levels of equity positioning, with shorter-term strategies actually moving net short many equity indexes. Discretionary macro strategies also performed well, with the HFRX Macro/CTA Index returning 1.7% during the month and 6.2% on the year. Ongoing trade negotiations between the United States and China, as well as several adjustments by central banks around the world have led to an increasingly attractive opportunity set and additional relative value opportunities within currency and rate trading.

The HFRX Equity Hedge Index declined 0.2%, which was in line with the risk-adjusted performance of the S&P 500’s 0.7% monthly loss. Short holdings supported the industry’s downside protection, as underweight and commonly shorted sectors such as energy and financials were down 8.1% and 4.8%, respectively. Stock selection on the long side of portfolios was difficult, as only defensively oriented sectors increased in value, an area of the market in which long/short managers have limited long exposure.

The HFRX Merger Arbitrage Index gained 0.5%, as low rates, management confidence, and significant private equity capital available for deployment support the mergers and acquisitions landscape. The strategy continues to provide attractive diversification benefits and drawdown protection, while the average deal spread is roughly 6%; in line with the long-term average. 

REAL ASSETS 

STRONG REAL ESTATE PERFORMANCE

Real estate and infrastructure displayed their defensive characteristics within the liquid real assets category last month by delivering August gains despite global stock market weakness.

Master Limited Partnerships (MLP)

The Alerian MLP Index lost 5.5% in August, lagging behind the broad equities indexes despite lower interest rates. Losses in crude oil and the energy sector overwhelmed the attractive yields and sent the group lower. Partnership-specific challenges also played a role. MLPs have still produced a respectable 10.3% year-to-date return, but the group has trailed the S&P 500 by 8 percentage points so far in 2019.

REITs and Global Infrastructure

The MSCI U.S. REIT index outperformed the S&P 500 in August with its 3.4% return, pushing the domestic real estate investment trust (REIT) index’s year-to-date return to a very strong 23.3%.