Q4: More of the Same?
Photo courtesy of Ms Eleanor W., Perth, W.A..
Three quarters into the year, let’s take stock of where we are in terms of performance across the different equity and credit asset classes and regions:
The clear outperformer has been Emerging Market equities as problems in the developed markets, from the European system to Brexit and the perceived inability of the ECB and BOJ to successfully reflate their economies drove funds flows into the emerging markets which were bizarrely viewed by some as safe havens. The rebound in crude prices also bolstered sentiment towards the commodity-dependent markets.
Credit investors would have done well too as persistently low yields pushed money into the higher yielding credits. US and Asian credits have posted impressive returns of 8-9% while the 5+% return on Euro credits is not something to be sniffed at too given that large swathes of the European bond markets have been trading at negative yields for a large part of the year.
The biggest divergence in performance has come in the developed equity markets. After a horrendous start to the year, few people would have expected the S&P to be up 6% at this time. The European and Japanese markets are still languishing, driven in no small part by their domestic problems. Having said that, if we take into account the massive appreciation of the yen versus the US dollar (16%), the Nikkei 225 would actually be up almost 6% YTD in USD terms, almost on par with the S&P500!
Given this huge divergence in performance across asset classes and geographies, this would have been a year where asset allocation decisions would have made the big difference between meeting/exceeding the benchmark handsomely or having to write countless emails to management, explaining the underperformance.
This has also been a year where the dangers of over-leveraging have been brought to the fore. At the depths of the traumatic sell off in January/February, how many positions were forced to be cut as the pain from the mark-to-market became unbearable and margin calls were a daily affair? The recovery from the lows then to current levels for some names has been nothing short of astonishing. Take for example, the Banco Do Brasil 9% Coco which had the distinction of being the world’s worst performing COCO in February:
Fast forward to the present, and the same bond has turned into one of the top performing COCOs this year after an almost 40 point turnaround! And this is a bond we are talking about.
What’s in store for the fourth quarter? If the first 2 weeks of October are anything to go by, VOLATILITY is the only thing we can say with near certainty. After all, there are so many high-risk events on the card. US Presidential Elections, Fed raising rates, uncertainties surrounding Brexit, Deutsche Bank. You name it.
Wait a minute, we ARE in October, aren’t we! This by definition has to be a volatile period. While what happened 29 years ago may not have any personal significance for many in the market (unless you are of a certain vintage), events in more recent years will certainly give reason for caution. It does feel like we will chop about quite a bit, whether in credit or equities, but will probably end the year close to where we are now. (Highly regarded) market participants may say P/E multiples in the US are elevated, or that the US Treasury market is a bubble waiting to burst, but it seems clearer to me than before that we are dealing with a market-dependent Fed, not data-dependent. We had the Bernanke put. Now it’s the Yellen put, and hey let’s not forget Kuroda while we are at it. It’s not often that someone sells (more like gives) you a 0% strike put on a bond for free. Betting against central banks has been a losing proposition for the last 8 years. Will Fed & Co finally not be able to keep the party going? Possibly sometime down the road. In the meantime, enjoy it while it lasts.