Market balance: Currency contagion, trade rhetoric, and rate hikes
The U.S. equity markets posted positive returns during a period where, on balance, the scales could have tipped in either direction. Apple and Amazon both reached the trillion-dollar market cap milestone, Turkey’s Lira crisis touched off worries of an emerging market (EM) contagion, rhetoric regarding trade and tariffs took a more aggressive tone, the Jackson Hole Fed symposium confirmed the Feds gradual rate hike stance, but cautioned over the weak wage inflation hovering over the tight labor market, and Elon Musk caused a stir with his tweet about taking Tesla private.
The U.S. large cap and small cap equity markets continued their YTD upward climb by posting convincing positive returns, while both international developed and emerging markets continued their YTD slide, driven by weakness in Europe, Turkey, and China. Apple became the first public company to reach the $1T market capitalization summit, followed later in the month by Amazon.com. The FAANGs aside, U.S. small caps continue to outperform large caps in 2018 by benefiting from both tax-reform and the evolving trade policies.
In the debt markets, all major fixed-income sectors were also positive in August, with the medium and long end of the treasury curve outperforming the near-term tenor and high yield credit continuing to outperform investment grade, as it has done throughout the year. The yield curve has continued to flatten in August, with short-term rates rising, while points beyond the two-year key rate have fallen. The positive carry offered by long-term treasuries and the positive price movement from the drop in long-term rates provided a boost to performance.
U.S. capital markets have been resilient despite some of the rising tariff tensions involving China, as well as other trading partners. The President announced plans to increase the initial steel and aluminum tariffs on Turkey, which resulted in an in-kind response by Turkey to tax additional U.S. exports of autos, alcohol, and tobacco.
The labor market continues to remain tight with unemployment below 4.0% and jobless claims trending downward and job openings continuing to rise. Despite the lack of any slack in the labor market, wage pressure has remained muted. With second quarter gross domestic product (GDP) revised up 0.1% to 4.2%, personal consumption expenditures (PCE) trending upward to 2.0%, and CPI up 2.9% YoY, the Jackson Hole symposium did queue up the possibility of a rate increase at the next meeting, but signaled that the risk of the economy overheating would be less likely if wage growth remained subdued.
Aggregate Hedge Fund returns in August were positive in August, with five of the eight hedge fund strategies posting positive returns. Equity Hedge, Merger Arbitrage, and Event Driven strategies posted negative returns in the month.1
Key Economic Data2
- The U.S. Bureau of Economic Analysis (BEA) second quarter 2018 GDP was revised 0.1% to 4.2%. Real GDP grew by 2.0% in the first quarter of 2018, 2.9% in the fourth quarter of 2017, and 3.2% in the third quarter of 2017.
- 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) came in at 0.2%. For the last 12 months, the CPI-U NSA was 2.9% and the CPI-Ex Food and Energy was 2.4%.
- The U.S. Bureau of Labor Statistics (U.S. BLS) announced that non-farm payrolls changed by 157,000, compared to the prior change of 213,000. Private sector payroll employment gained 170,000, compared to 202,000 from the prior period. The unemployment declined .1% to 3.9%. The underemployment rate also declined by 0.3% to 7.5%. 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 down 1.7% to 627,000. Housing starts were up by 0.9% to 1,168K from 1,173K. Building permits were up 1.5% to 1,311K. Existing home sales were 5.34 million units, a change of -0.70%.
- The Conference Board Consumer Confidence IndexTM was 133.4.
1. Bloomberg, as of 8/31/18.
2. IndexIQ, FactSet, as of 8/31/18.
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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.
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.
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.
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.
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.
FAANG is an acronym for the market’s five most popular and best-performing tech stocks, namely Facebook, Apple, Amazon, Netflix and Alphabet’s Google.
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.
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.
Large cap (sometimes “big cap”) refers to a company with a market capitalization value of more than $5 billion. Large cap is a shortened version of the term “large market capitalization.” Market capitalization is calculated by multiplying the number of a company’s shares outstanding by its stock price per share. The dollar amounts used for the classifications “large cap,” mid cap” or “small cap” are only approximations that change over time.
Personal consumption expenditures (PCE), or thePCE Index, measures price changes in consumer goods and services.
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.
Small cap is a term used to classify companies with a relatively small market capitalization. A company’s market capitalization is the market value of its outstanding shares.
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.
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