U.S. Equity Investment Environment
Mounting fears of inflation, an ongoing Congressional budget impasse and anticipation of a reduction in the Fed liquidity provision all weighed on the stock market. Despite opening September with its 54th closing high of the year, the S&P 500 finished September down 4.7% but eked out a 0.6% gain for the third quarter to finish the nine months up 15.9%. Small and mid-cap stocks fared better in September’s decline but lagged for the quarter with the S&P MidCap off 1.8% and the
Russell 2000 down 4.4%, versus the S&P SmallCap 600’s -2.8%. The S&P SmallCap was helped by names that benefited from the transitionary period as the economy reopened. The energy sector made a dramatic turnaround in September, up 9.4%, substantially diminishing its quarterly loss to end at -1.7% to finish the nine months as the year’s best performing sector, up 43.2%. Financials, the third quarter’s best performing sector, up 2.7%, benefited from higher interest rates and turned in the second best nine-month return at 29.1%. Information technology, the S&P 500’s largest sector at 24.2%, rose 1.4% in the quarter and contributed 0.4% to the period’s return, fully offset by a loss of 4.2% from industrials that accounted for only 8.9% of the index.
International Equity Environment
International stocks were weak in the quarter as U.S. Dollar strength proved a headwind as both developed and emerging markets outperformed the U.S. in local currency terms. In dollar terms, the MSCI All Country World ex-USA index was off 8.2% in September, and -3.0% for the quarter. The EAFE index of developed markets and the MSCI Emerging Market index were down 0.4% and -8.3%, respectively, in the quarter. For the three months, Austria, up 10.4%, was Europe’s best performing market, the result of improvements at Erste and Raiffeisen banks and the OMV energy group, which make up more than 40 per cent of its index. Japan, often a winner in risk-off environments, was up 4.6% in the quarter along with energy exporters that bucked the trend. Saudi Arabia rose 8.2% and Russia gained 9.5%. Chinese stocks were hit hard in the quarter, -18.2%, in reaction to government-imposed restrictions on a number of technology companies and the near bankruptcy of China Evergrande Group, a massive real estate conglomerate. Brazil, a country expected to perform well in booming commodity markets, fizzled -20.2% amid political tensions and the central bank’s aggressive rate hike actions.
Fixed Income Environment
In late September the Federal Reserve signaled it would possibly begin to raise interest rates next year and scale back its bond buying program in November. Combined with higher inflation reflected in oil and commodities prices, investors began selling government bonds, causing prices to fall. As yields rise when bond prices decline, the 10-year Treasury yield closed the quarter at 1.52%, up from 1.30% the prior month-end, a relatively large move over a short period. The 30-year Treasury yield broke out of a small trading range and topped 2% for the first time since mid-July. Despite September’s interest rate volatility, the Bloomberg Barclays U.S. Aggregate index finished the quarter essentially flat at 0.1% but was off 1.6% over the nine-months. Corporate high yield bonds have fared the best as investors’ continued search for yield drove prices higher to finish the quarter up 0.9%, and the nine-months up 4.5%.
Supply disruptions persisted with semiconductors a focal point, but oil and natural gas continued to notch multi-year highs as commodities posted gains driven by the recovery in energy. The S&P GSCI index rose 4.6% in the quarter and 37.5% over the nine-months.