Volatility Dampens Markets
Markets were off to a positive start in August as the Dow Jones crossed 22,000 for the first time, driven by positive Q2 earnings, continued low interest rates, and reports out of Washington that they would be working aggressively to complete tax reform by year end. The market’s positive performance was handed back in the middle of the month as the VIX experienced the two largest single day movements since May. The increased volatility was due to rising tensions between the U.S. and North Korea, protests in Charlottesville, and the terrorist attack in Barcelona. With no new news surfacing from the speeches on monetary policy from Fed Chair, Yellen, and ECB President, Draghi, along with lower trading volumes in August, markets didn’t see much action toward the end of the month and remained relatively unchanged with domestic markets outperforming international. Small caps have underperformed large caps, due to weaker earnings and yields decreasing. Small caps strong performance earlier in the year was driven by the thought that we would be in operating in a lower-tax and higher-yield environment, neither of which have occurred up until this point.
The yield curve dragged lower in the middle of the month, as President Trump threatened a government shutdown if he didn’t receive funding for a U.S./Mexico border wall. Long rates also came down due to:
- Concern over Trump’s ability to get tax reform done weighed on growth expectations.
- North Korea tensions generated a “flight-to-safety” trade, i.e. U.S. Treasuries.
On the economic front, the advanced estimate of real gross domestic product (GDP) was 3.0%, which came in above expectations. Headline inflation remained flat at 1.7%. Employment gains were positive and exceeded expectations. Consumer confidence continued to climb.
Hedge funds had mixed results with the broad index (HFRI Hedge Fund of Funds Index) up for the month. Five out of the eight strategies had positive returns with Equity Market Neutral and Macro leading the way. Distressed and Convertible Arb had the largest negative returns.1
Key Economic Data2
- The U.S. Bureau of Economic Analysis (BEA) released the “second” estimate of real gross domestic product (GDP) growth of 3.0% in the second quarter of 2017. Real GDP grew by 1.2% in the first quarter of 2017, 2.1% in the fourth quarter of 2016 and 3.5% in the third quarter.
- Headline inflation (U.S. Consumer Price Index for All Urban Consumers seasonally adjusted (CPI-U SA)) was up 0.1%. Core inflation (CPI-Ex Food and Energy) was 0.1%. For the last 12 months, the CPI-U NSA was 1.7% and the CPI-Ex Food and Energy was 1.7%. For the last 12 months, the CPI-U NSA was 1.7% and the CPI-Ex Food and Energy was 1.7%.
- The U.S. Bureau of Labor Statistics (U.S. BLS) announced that non-farm jobs increased by 209,000, after adding a revised 231,000 jobs in the prior month. Private sector payroll employment added 205,000 jobs, following a revised increase of 194,000 jobs in the prior month. The unemployment rate was 4.3%. The underemployment rate was 8.6%. The labor force participation rate was 62.9% last month.
- The U.S. Department of Housing and Urban Development (HUD) and the U.S. Census Bureau jointly announced that sales of new single-family houses were 571,000, a change of -9.4%. Housing starts were 1,155K, a change of -4.8%. Building permits were 1,223K units, a change of -4.1%. Existing home sales were 5.44 million units, a change of -1.3%.
- The Conference Board Consumer Confidence Index® was 122.9.
1. IndexIQ, Factset as of 08/31/17.
2. IndexIQ, Factset as of 08/31/17.
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All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market. Investors cannot invest directly in a benchmark.
Basis points (BPS) refer to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
A yield curve is a curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.
A credit spread is the difference in yield between two bonds of similar maturity, but different credit quality.
Convertible arbitrage is a market-neutral investment strategy often employed by hedge funds that involves the simultaneous purchase of convertible securities and the short sale of the same issuer’s common stock.
A Global Macro strategy is a strategy that bases its holdings, such as long and short positions in various equity, fixed-income, currency, commodities, and futures markets, primarily on the overall economic and political views of various countries, or their macroeconomic principles.
Event Driven investing is designed to capture price movement generated by a significant pending corporate event, such as a merger, corporate restructuring, liquidation, bankruptcy, or reorganization.
Equity Hedge investing buys stocks that are undervalued and short sells stocks that are overvalued. This strategy may commonly employ variable exposure as well as the use of leverage.
Distressed securities are securities over companies or government entities that are experiencing financial or operational distress, default, or are under bankruptcy.
HFRI Hedge Fund of Funds Index – Fund of Funds invest with multiple managers through funds or managed accounts. The strategy designs a diversified portfolio of managers with the objective of significantly lowering the risk (volatility) of investing with an individual manager. The Fund of Funds manager has discretion in choosing which strategies to invest in for the portfolio.
The CBOE Volatility Index (VIX Index) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.
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