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Commentaries

PMC Weekly Review - September 9, 2019

A Macro View—August Monthly Recap

The domestic equity markets were roiled in August by the trade war between the US and China. The announcement of another round of higher tariffs on Chinese goods at the beginning of the month was quickly followed by an increase in the tariffs on US goods entering China. The Trump Administration responded with even higher tariffs on virtually all Chinese goods. Sprinkled throughout the month were several conciliatory statements, mostly by the US, on progress being made toward a broad trade deal that would eliminate the tariff increases scheduled to take effect on September 1. This push-and-pull on market sentiment created a great deal of uncertainty, which in return resulted in increased volatility in the equity markets. Complicating matters, August’s economic data showed growth slowing in most of the world as tariffs enacted earlier in the year began to affect the global economy.

The major domestic indices all showed losses for August, but large cap securities outperformed mid- and small cap securities in a flight to quality. The Russell 1000 Index was down 1.83%, while the Midcap Index was down 2.85% and the 2000 Index declined by 4.94%. Despite the general flight to quality in the market, the growth indices beat their value counterparts across the market-cap spectrum. This was driven by the collapse in the Energy sector, which has a significantly higher weighting in the value indices. In the large cap space, the Energy sector declined more than 5%, but makes up less than 1% of the growth index. In small caps, the sector was down nearly 16%, where it accounts for less than 2% of the growth index, but more than 4% of the value index. Modestly positive returns in the defensive sectors like Staples, Utilities, and Real Estate could not counter the steep losses.

International equity markets declined around the globe in August as weakening economic data and continued trade fears took their toll. Developed markets, as measured by the MSCI EAFE Index, declined 2.59%, slightly underperforming the US markets. Growth outperformed value in developed markets by nearly 3%      (-1.21% versus -4.11%, respectively). Europe was negatively affected by continued uncertainty surrounding Brexit negotiations that appeared to sour. Boris Johnson was elected Prime Minister of the UK on the promise of exiting the European Union at the end of October, regardless of whether an agreed-upon deal is reached, raising the specter of a “No-Deal Brexit.” Amid the confusion, UK markets declined 4.68%, which was greater than the broader European market decline of 2.52%. Japanese equities, having thus far avoided being directly caught in trade tensions, outperformed on a relative basis, fell by only 1.01%. The US dollar was relatively stable versus developed markets currencies and had little effect on returns during the month.

Emerging markets had a more difficult time escaping escalating trade tensions, declining 4.88% in August. Currencies played a pronounced role, as returns measured in local currencies were down only 2.53%, highlighting the US dollar’s strength during the month. Trade wars took center stage, as both the US and China announced escalating tariffs that took effect on September 1. The trade war is beginning to show its effects in the global economic data as business confidence wanes and uncertainty rises. Stock markets in China slid 4.19%, while Korea (a major supplier to China), dropped 5.03%. Sentiment continues to be uncertain, as a resolution to the trade conflict appears illusive. Markets in Latin America declined by 8.13%, led by Argentina, which plummeted more than 50% as investors questioned capital controls put into place to protect the rout of the Argentine peso.

The domestic fixed income markets1 feasted on the uncertainty in the global equity markets, as the flight to quality drove 10-Year Treasury rates to levels not seen since early 2016, and the yield on 30-year Treasurys fell below 2% for the first time since records began in the 1970s. The result was the strongest monthly return for the long end of the Treasury market in more than eight years. The 20+ Year Treasury Index rose 10.82% and is now up 23.93% for the year. This in turn contributed to the yield curve inverting (where short term rates are higher than longer-term rates) for the first time since 2007. The broader Aggregate Index advanced 2.59% in August, as both Treasurys and corporates rose more than 3%, but the MBS index was up just 89 basis points, weighed down by the prospect of increasing prepayments in a lower-rate environment. The month’s sharp advances did not extend to the noninvestment grade market, as credit spreads widened significantly. The High Yield Index was up just 40 basis points, where the Energy sector was a particular drag. The S&P LSTA Performing Loan Index was down 33 basis points, as falling rates and credit concerns sharply reduced demand.

In August, municipal bonds posted another strong return, with the Bloomberg Barclays Municipal Bond Index gaining 1.58%. Interest rates continued to decline in August, and the municipal curve flattened in tandem with the Treasury curve, which ultimately led to longer-dated bonds driving the majority of performance. Shorter-dated municipal issuance still posted a positive return, but could not keep up with the long end’s robust performance. The municipal/Treasury ratio continued to offer better relative value for municipal bonds at the intermediate and long end. However, ratios fell below 65% for municipals with maturities two years and under, meaning that Treasurys with similar maturities offered better relative value (assuming a 35% tax rate). Investors have not let up on their demand for municipal bonds, as fund flows totaled $63 billion year to date and have now notched 34 consecutive weeks of positive flows. New issuance in August was slightly more than $40 billion, a 30% increase over July, and led to year-to-date 2019 issuance surpassing 2018’s by roughly 3%.

Developed markets sovereign credits rose 2.24% in dollar terms in August, as global yields fell in conjunction with US yields. More than $14 trillion in sovereign debt (roughly a third of the global debt market) now trades with a negative yield. The entire German yield curve is negative, as are maturities out to 15 years in Japan and out to ten years in France. Emerging markets bonds were laggards for the quarter, particularly the local currency issues. The hard currency index was up just 75 basis points, while the local currency index was down 2.64%. Latin America was the biggest regional laggard, led lower by Argentina. Asian bond markets also were soft on the slowdown in growth and devaluation of the Chinese yuan relative to the dollar.

1Unless otherwise noted, returns are for the appropriate Bloomberg Barclays Indices

Nathan Behan

SVP Investment Research

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