CIO3: Markets in Perspective

August 13, 2015 Categories: Portfolio Corner
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Capital Markets Chart 2015

As of July 31, 2015. Sources: U.S. Equity: Russell 3000® Index; Non-U.S. Equity: Russell Developed ex-U.S. Large Cap Index; Emerging Markets: Russell Emerging Markets Index; U.S. Bonds: Barclays U.S. Aggregate Bond Index; Global REITs: FTSE EPRA/NAREIT Developed Real Estate Index; Commodities: Bloomberg Commodity Index Total Return; Hypothetical balanced portfolio: 30% U.S. Equity, 20% Non-U.S. Equity, 5% EM, 35% Bonds, 5% REITs, 5% Commodities. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

CIO3: Key Points on Global Market Themes

Here are the top three market themes affecting positioning and performance last month from some of our experts, including our CIOs (Chief Investment Officers) across Russell Investments. All data is as of July 31, 2015. For longer-term asset class performance please see the Asset Class Dashboard.

INVESTMENT STRATEGISTS

Erik Ristuben

1.     Greece still in . . . for now

Greece agreed to a new three year bailout agreement, which preserves its status as a member of the common currency (for now). For the region as a whole, this is good news and helps allow investors to refocus on the strong macro fundamentals in Europe. Eurozone equities rallied, up 5.1%1, in local currency terms, on this news. For Greece, the economic damage has already been severe and new elections are likely in the Fall.

2.     Bottom falls out from oil again

The proposed Iranian nuclear deal and an uptick in U.S. rig counts led to renewed concerns of excess supply in the oil market. For the month, WTI (West Texas Intermediate) crude oil prices were down 22.5%2. Unease around the Chinese equity market and economy exacerbated declines in other commodity prices.

3.     Economic growth modestly improved

After a slow 2015 start, the U.S. economy bounced back in the second quarter posting 2.3% growth in GDP. European GDP numbers were also up in July and contagion from Greece to the broader European economy has been limited. Both eurozone economic activity and business sentiment remained at positive levels in July.3

EQUITY

James Barber

1. Factor performance rewarded large cap growth

Global markets focused on earnings and revenue growth but also showed a preference for larger capitalization and defensive companies. Smaller cap, value and commodity producers were out of favor during July.4

2. Sectors with less economic sensitivity outperformed

Sectors considered to be “non-cyclical,” such as health care, consumer staples and utilities were the best performers5 as global markets grappled with mixed economic data and fears about a potential hard landing in China.

3. Emerging markets plummeted

The return gap between developed markets and emerging markets was unusually wide with developed markets outperforming substantially.6 China and Brazil led emerging markets downward with the impact evident across multiple regions. There were very few places for emerging markets equity managers to hide.

FIXED INCOME

Gerard Fitzpatrick

1. Developed market government bond yield curves flattened7

Despite bouncing back in the second quarter, U.S. economic data remained subdued in July with modest GDP and corporate earnings growth. Low U.S. jobless claims and inflation uptick in July were in-line with a neutral U.S. Federal Reserve (the Fed) statement and a continued forecasted interest rate hike date in September (as noted in the Global Market Outlook – Q3 Update). In other developed markets, longer-term yields were brought down by lower inflation expectations given weaker commodity prices and generally lukewarm global economic data.

2. Global credit spreads widened, driven by the U.S.
U.S. and global industrials sectors underperformed the broader bond market mostly due to a fall in energy prices during the month. European spreads generally tightened8 moderately following the Greek debt deal in July.

3. U.S. dollar rallied sharply

In July, there was a significant tumble in commodity prices,9 including crude oil, gold, and copper. Lower commodity prices caused commodity-sensitive currencies depreciate, which caused the U.S. dollar to appreciate.10

ALTERNATIVES

Vic Levertt

1. Commodities sell off

With global producers actually (or showing signs of) ramping up production, oil fell back into the $40s in July. This development in oil also affected the pipelines sector in listed infrastructure, which was down dramatically11 (-8.5%) as the worst performing sector in the index. Precious metals fell as the market anticipated a Fed rate hike in September. Gold was also pressured by a strong USD and lack of investor interest in the safe haven asset despite global economic uncertainty. Global macro hedge fund managers benefitted12 from short positions in oil and precious metals.

2. Continued dispersion of global returns, some reversals

Real estate investment trusts (REITs) reversed second quarter trends.13 In this types of investments, the U.S. rebounded 5% in July after being the weakest region in Q2. Meanwhile, Hong Kong went from leading the globe to being down 5% for the month. European property stocks also staged a modest recovery as macro concerns about Greece subsided. Within listed infrastructure,14 emerging markets were the worst performer, as Chinese infrastructure companies fell 9%, while continental Europe was the best performer. Also this month, equity long/short hedge funds had an improved trading environment15 with greater shorting opportunities within equity markets for investors.

3. Interest rates and high yield effects

The U.S. 10-year Treasury was almost flat during the month. This helped listed infrastructure utilities rally after the second quarter sell-off.16 Widening high yield spreads (in part due to energy declines) negatively affected hedge funds in credit event driven strategies in July.

1 Russell Europe ex-UK Index

2 Source: Thomson Reuters Datastream

3 Source: Russell analysis

4 Source: Russell analysis ex Healthcare, Consumer Staples, and Utilities sectors

5 Source: Russell Global Index

6 Source: Government bond returns, Bloomberg data

7 Source: Barclays U.S. Aggregate Bond Index, Barclays Global Aggregate Bond Index, Barclays Euro-Aggregate Bond Index

8 Source: U.S. Dollar Index (DXY), Bloomberg data

9 Source: Dow Jones-UBS Commodity Index

10 Source: Bloomberg

11 S&P Global Listed Infrastructure Index

12 As observed across third party managers by Russell Investments

13 FTSE EPRA/NAREIT Developed Real Estate Index

14 S&P Global Listed Infrastructure Index

15 As observed across third party managers by Russell Investments

16 Source: Bloomberg

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

Investing involves risk and principal loss is possible.

Bond investors should carefully consider risks such as interest rate, credit, default and duration risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield (“junk”) bonds or mortgage-backed securities, especially mortgage-backed securities with exposure to sub-prime mortgages. Generally, when interest rates rise, prices of fixed income securities fall. Interest rates in the United States are at, or near, historic lows, which may increase exposure to risks associated with rising rates. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries.

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Investments in emerging or developing markets involve exposure to economic structures that are generally less diverse and mature, and to political systems which can be expected to have less stability than those of more developed countries. Securities may be less liquid and more volatile than US and longer-established non-US markets.

Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market.

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Barclays Emerging Market Bonds Index includes fixed-and floating-rate USD-denominated debt from emerging markets in the following regions: Americas, Europe, Middle East Africa, and Asia. For the index, an emerging market is defined as any country that has a long term foreign currency debt sovereign rating of Baa1/BBB+/BBB+ or below, using the middle rating of Moody’s, S&P, and Fitch.

Barclays U.S. Aggregate Bond Index is an index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities.

Past performance does not guarantee future performance.

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