Following October’s broad-based decline across nearly every area of the global investable universe, investors were presented with some relief in November, with most asset categories posting positive returns. A potential thematic shift rounded out the month, as Fed Chairman Jerome Powell’s remarks on interest rates during a speech to The Economic Club of New York represented a “dovish” reversal from previous hawkish sentiment in early-October. In the global equity markets, emerging market equity logged a solid monthly gain, outpacing domestic and international developed counterparts, while in fixed income, positive momentum across high yield sectors encountered headwinds. Real assets performance was mixed, with strong returns across real estate-related sectors, essentially flat performance in energy infrastructure, and outsized losses experienced in commodities.
Federal Reserve Softens Rate-Hike Stance
On Wednesday, November 28, Federal Reserve (Fed) Chairman Jerome Powell’s remarks during a speech at The Economic Club of New York helped spark a sharp yet short-lived rally among most risky asset sectors. Powell’s seemingly dovish reversal on the Fed’s expectation for the near-term path of interest rates was interpreted by market participants as a “risk-on” development.
Specifically, Powell noted, “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy…” This sentiment contrasts meaningfully from his comments in early-October when Powell explained that the Federal Open Market Committee “…may go past neutral. But, we’re a long way from neutral at this point, probably.” As of the Fed’s last update to their dot plot, this theoretical “neutral” level on the federal funds rate (FFR) sits just 75 bps above the current upper bound on the FFR.
There are many possible reasons for this unexpected dovish reversal. For example, October’s sharp market-wide downside volatility may have influenced the Fed despite being outside the purview of the Fed’s mandate of promoting price stability and maximum employment. Another possible influence might have been President Trump’s harsh criticisms of the Fed’s plan for ongoing rate hikes. Regardless of the circumstances that led to this position adjustment, however, market-implied measures appear to be moving against the Fed’s dot plot projection of three interest rate hikes in 2019. Pricing on eurodollar futures points to less than one rate hike in 2019, and zero rate increases anticipated throughout 2020.
Key risks facing central monetary authorities and investors alike includes not only the mismatch between market-based estimates and official sector forecasts for near-term interest rate increases, but also a potentially truncated “runway” for additional monetary tightening, as portions of the U.S. Treasury yield curve have already begun to invert—a trend that would presumably be exacerbated by additional Fed tightening.
To conclude, asset category performance in November was generally positive, apart from below investment grade credit and energy-related sectors. During the month, Fed Chair Jerome Powell’s dovish reversal related to the near-term path of Fed rate hikes spurred a brief risk-on rally late in the month, with dovish monetary sentiment corroborated by the fixed income market.
- Markets experienced volatility in November due largely to geopolitical events, including continued trade tensions between the U.S. and China, the U.S. midterm elections, and instability between Russia and Ukraine. These events limited the markets’ rebound after October’s decline.
- The U.S. continued to show strong economic data despite softness in the housing market, as interest rates have continued to rise and the increase in mortgage rates have weighed on buyers, in addition to the seasonal winter slowdown.
- Value stocks outperformed tech-heavy growth stocks across market capitalizations within the U.S. during November, continuing the trend of the past few months. Apple declined almost 20% amid Chinese tariff concerns while Facebook fell due in part to the ongoing scrutiny of the company’s handling of users’ data.
- Third quarter corporate earnings exhibited strong growth; however, corporations provided guidance to investors stating that future earnings could be weaker due to higher costs and increased margin pressure.
- Economic growth outside the U.S. appeared to slow, as Europe and China’s economic data pointed to subdued growth. European GDP for the third quarter was disappointing, as the growth rate remained at 1.7% year-over-year, primarily held down by Germany’s negative GDP growth. In additiion to China's announced fiscal stimulus plan to be implemented in 2019, the country is expected to provide additional monetary stimulus to help Chinese banks.
- Core fixed income markets recovered slightly in November and more substantially in early December amid the resurgence in market volatility. Higher quality securities continued to outperform their lower quality counterparts as investors sought safety resulting in compressed yields.
- As was anticipated, the Fed did not hike rates at their November 7-8 meeting; however, Fed Chair Jerome Powell’s speech on November 28 stirred markets when he suggested that the federal funds rate may be “just below” the neutral rate. Powell also acknowledged the lag between the implementation of monetary policy and its actual impact on the economy, demonstrating the Fed’s awareness of the pitfalls of hawkish monetary policy.
- In early December, the markets saw an inversion at the short end of the yield curve, with the 2s/5s spread touching negative territory. This was largely perceived as a sign that the market was pricing in an end to the Fed’s hiking cycle. Investors should note that while inversion of the 2s/10s spread has historically suggested an impending recession, inversion of the 2s/5s is largely tied to the Fed’s actions and the perceptions of those actions, and not linked to the health of the economy at large.
U.S. REITs posted a positive return of 5.1% in November after producing negative returns in September and October. The strong gains in November were due in part to a potential pause in the Fed’s interest rate tightening cycle. Previously, the sell-off in September and October was fueled largely by fear that the Fed would not slow the pace of quarterly rate hikes, creating yield competition for REITs from the fixed income markets.
Overall, fundamentals in the REIT market remain attractive, as REIT earnings remain solid and many REITs are trading at material discounts to NAV.
Crude oil (WTI) prices fell 22% in November, closing the month at under $52/barrel, down from a high of $76/barrel in early October. This represented the largest one-month decline since October of 2008.
The precipitous decline in oil prices was triggered by issues related to the sanctions against Iran, which took effect in early November. Saudi Arabia and the U.S. ramped up production in anticipation of the loss of Iranian oil once the sanctions took effect, but last-minute waivers from the Trump administration to multiple countries resulted in a less-than-expected reduction in supply.
In the near term, oil market participants are expected to focus on the results of OPEC's meeting in the first week of December where production cuts of just under two million barrels per day were announced.
Raw materials and agricultural commodities may receive a boost, if signs develop of a truce in the escalating trade war with China, which substantially impacts both agricultural products and industrial materials.
Hedge fund performance was mixed during the month. Lower U.S. interest rates and a flattening yield curve posed headwinds for discretionary macro managers positioned for tighter central bank policy. Systematic trend followers were generally down for the month as negative trends in equities and emerging market currencies reversed.
In aggregate, event-driven strategies generated losses despite positive performance from merger arbitrage managers. Event-driven losses were driven by distressed strategies, particularly those with exposure to the consumer, energy, and industrial sectors.
Relative value strategies were up slightly, with gains from multi-strategy and volatility managers offset by losses from asset-backed corporate bond strategies.
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Index performance results do not represent any managed portfolio returns. An investor cannot invest directly in a presented index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.
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All data is as of November 30, 2018 unless otherwise noted.
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