Markets maintain positive movement, with a side of volatility

by: , Chief Investment Officer and Managing Director | IndexIQ

This month’s macroeconomic themes focused around tariffs, labor, and the Fed’s stance on rates. Yet, despite the implications of each, the markets maintained their positive movement, but with a fair bit of volatility in response to these exogenous themes.

With the Administration’s intent to impose tariffs on Canadian lumber and steel, Mexican steel, European steel and aluminum, and imported goods from China, these counter parties have similarly responded in-kind by imposing tariffs on American exports, primarily targeting agricultural commodities. While it remains to be seen if the Trump Administration will be able to secure any victories in the tariff dispute, the inflationary impacts on businesses and consumers is the primary worry.

With the threat of escalating trade barriers, the U.S. markets outperformed both international developed and emerging markets in June, with U.S. small caps outperforming U.S large caps. This is, in part, due to the lesser impact of global trade on small-cap companies.

What may pose a threat to small caps, however, is the further tightening of the labor market. With unemployment rates near record lows and labor force participation holding steady, companies are finding a shortage of skilled labor to fill open positions, possibly leading to rising wages and labor costs.

With the backdrop of trade and labor, the Fed raised rates for the second time this year (bringing the count to seven since liftoff in 2015). While a third rate increase is almost a given at this point, the Fed is maintaining its stance of gradual hikes, as it continues to monitor economic data. In order to make informed policy decisions, the Fed is looking for signs that the target inflation rate of 2% can/will remain at a sustained level in order to inform their policy decisions.1

With short-term rates moving upward, the yield curve has continued to flatten, with the 2/10 spread further compressing another 10bps and the 2/10/30 yield curve butterfly compressing another 6bps. High yield spreads (versus the 10-year Treasury) have widened slightly, in part due to the 9bps decrease in 10-year Treasury yields, contributing to the widening. This contributed to high-yield bonds outperforming investment-grade credit during the month.1

The dollar rallied in June, outperforming both developed and emerging market currencies. The Q1 gross domestic product (GDP) figure was revised slightly downward from 2.2% to 2.0%, due to softer consumer spending. Headline Consumer Price Index (CPI) was up 2.8% (YoY). Mergers and acquisitions (M&A) flows are up through the first half of 2018, compared to the same period from this time last year and from 2015, indicating robustness in the M&A market year-to-date.1

Broad hedge fund returns were down in June, with three of the eight hedge fund strategies providing positive returns. Merger arbitrage was up .63%, followed by relative value at .39%, and global macro at .12%. Distressed strategies was the laggard, at -1.73%.2

Key Economic Data2

  • The U.S. Bureau of Economic Analysis (BEA) revised first quarter 2018 GDP to 2.0% from 2.2%. Real GDP grew by 2.9% in the fourth quarter of 2017, 3.2% in the third quarter, and 3.1% in the second quarter of 2018.
  • Headline inflation (U.S. Consumer Price Index for All Urban Consumers seasonally adjusted (CPI-U SA)) was at 0.2%. Core inflation (CPI-Ex Food and Energy) also came in at 0.2%. For the last 12 months, the CPI-U NSA was 2.8% and the CPI-Ex Food and Energy was 2.2%.
  • The U.S. Bureau of Labor Statistics (U.S. BLS) announced that non-farm payrolls increased by 223,000 compared to the prior level of 164,000. Private sector payroll employment gained 218,000 compared to 168,000 from the prior level. The unemployment rate fell -0.1% to 3.8%. The underemployment rate also fell by -0.2% to 7.6%. The labor force participation rate remained at 63%.
  • 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 up 4.1% to 689,000. Housing starts were also up to 1,350k from 1,287K, a change of +4.9%. Building permits were down -3.77% to 1,301k. Existing home sales were 5.43 million units, a change of -.55%.
  • The Conference Board Consumer Confidence Index® was 126.4.

1. Bloomberg, as of 6/30/18.

2. IndexIQ, FactSet, as of 6/30/18.

The information and opinions contained herein are for general information use only. New York Life Investments does not guarantee their accuracy or completeness, nor does New York Life Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results. It is not possible to invest directly in an index.

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.

Treasury Securities are backed by the full faith and credit of the United States government as to payment of principal and interest if held to maturity.

The 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate once every six months, and pays the face value to the holder at maturity.

2/10 spread – The 10-year/2-year U.S. Treasury spread has a general tendency to signal the market’s expectation of an upcoming recession or general downturn in growth.

A credit spread is the difference in yield between two bonds of similar maturity, but different credit quality.

The Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the U.S. economy that consumers are expressing through their activities of savings and spending.

The Consumer Confidence Survey® reflects prevailing business conditions and likely developments for the months ahead. This monthly report details consumer attitudes and buying intentions, with data available by age, income, and region.

Consumer Price Index for All Urban Consumers (CPI-U) – A measure that examines the changes in the price of a basket of goods and services purchased by urban consumers.

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.

Distressed/Restructuring strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings.

Distressed securities are securities over companies or government entities that are experiencing financial or operational distress, default, or are under bankruptcy.

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.

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.

Relative-value arbitrage is an investment strategy that seeks to take advantage of price differentials between related financial instruments, such as stocks and bonds, by simultaneously buying and selling the different securities—thereby allowing investors to potentially profit from the “relative value” of the two securities.

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.

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 S&P 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The U.S. Consumer Price Index (CPI) is a set of consumer price indices calculated by the U.S. Bureau of Labor Statistics (BLS). To be precise, the BLS routinely computes many different CPIs that are used for different purposes. Each is a time series measure of the price of consumer goods and services.

The U.S. Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the economy that consumers are expressing through their activities of savings and spending.

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.

Yield curve butterfly – A positive butterfly is a non-parallel yield curve shift in which short- and long-term rates shift upward by a greater magnitude than medium term rates. This yield curve shift effectively decreases the curvature of the curve.

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Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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