Following the Federal Reserve’s (Fed’s) third consecutive interest-rate cut in late October and combined with bright spots among certain U.S. economic data, market performance across most traditional asset classes and categories, particularly in domestic markets, was positive in November. However, the strengthening U.S. dollar and fundamental concerns—including persistent trade uncertainty between the U.S. and China—served as headwinds to relative performance for international equities.
In the bond market, strong risk-on forces pressured credit risk premiums lower, supporting performance across high yield and bank loans. Performance across real assets was overwhelmingly negative in November, as strong recent REIT returns took a breather in response to an increase in interest rates and a material weakening of energy infrastructure sub-asset categories on seasonal concerns and fundamental pressures.
Solid U.S. Labor Market Strengthens Further in November
Beating sell-side expectations by a wide margin was November’s 266,000 monthly nonfarm payrolls print, which helped allay fears of a near-term business cycle inflection—from expansion to contraction—and helped send the headline unemployment rate to 3.5%, matching September’s reading as the lowest level in 50 years. The strong monthly jobs number reported by the Bureau of Labor Statistics on Friday, December 6 helped counterbalance November’s weak ADP jobs print, an alternative monthly jobs reading typically released ahead of the BLS report.
The ADP reported that U.S. employers added just 66,900 jobs during the month, the second-weakest monthly jobs reading in the post-Global Financial Crisis era, with the weakest reading occurring earlier this year in May (45,700 jobs). The news from the more-widely followed BLS Employment Situation was more optimistic, highlighting a historically strong U.S. labor market through the month, which should provide the Fed with confidence that its three rate cuts since July and resumption of balance sheet expansion have helped support business conditions. This report should also reassure President Trump that the ongoing trade battle with China has failed to materially impact the broad U.S. labor market.
However, while favorable labor market dynamics in November provide a glimpse of the current state of the economy, they cannot necessarily be relied upon as a leading indicator for future conditions. After all, nonfarm payrolls comprise more than 50% of The Conference Board’s Coincident Economic Index, a composite business cycle gauge comprised of factors that, as the name suggests, coincide with the economic cycle. Among the more useful gauges of where the economy may be going versus its current state is the Department of Labor’s weekly initial jobless claims data, more commonly known as first-time filings for unemployment insurance.
Similar to the headline unemployment rate, the cyclical evolution of jobless claims most often exhibits a sine wave pattern. That is, during economic expansions, jobless claims and unemployment witness seemingly uninterrupted multi-year periods of improvement in tandem, which then tends to reverse course during economic contractions.
Recent claims data suggests that the rate of improvement appears to be at risk of completely stalling out, with little-to-no improvement witnessed year-over-year, while hovering near 50-year lows.
A number of factors on the near-term horizon have the potential to keep the current expansion on track, including the significant room for improvement in U.S.-China trade relations, the potential for fresh fiscal stimulus in 2020, the prospect for a return of synchronized global central bank balance sheet accommodation (QE), among other latent cycle-extending tailwinds.
To conclude, market performance in November across most major asset classes and categories was strong, supported by favorable economic-related data in the U.S. and positive sentiment for an eventual Phase 1 trade deal between the U.S. and China. Strong labor market fundamentals during the month helped calm investors’ fears of a near-term recession; however, forward-based labor market measures continue to point to a moderating growth bias in the coming quarters.
As the markets often do, equity markets ignored the politics of the U.S. impeachment process and the never-ending Brexit saga, and instead focused on improved economic data and what appeared to be calm in the trade war between the U.S. and China. Market speculation suggested the absence of further escalation in tariffs.
Sentiment appeared to be improving on the back of stronger economic data such as the U.S. Purchasing Managers’ Index (PMI) and third quarter U.S. GDP. This is a reversal in investor sentiment from earlier in 2019 when investors expected a potential recession, primarily due to a yield curve inversion.
Corporate America’s earnings season, represented by the S&P 500 Index, ended with most companies reporting relatively flat earnings contrasted to the third quarter 2018. Approximately 80% of companies beat their earnings estimates, which can be partially attributed to downward revisions earlier in the year.
Growth continued to outperform value and large capitalization stocks continued to outperform small capitalization stocks during November—eliminating value’s gains from the short but severe reversal in relative performance that occurred in September.
European markets strengthened relative to previous months as Germany narrowly escaped a technical recession.
Emerging markets faced downward pressure during the month of November, underperforming developed market indices. Weakness within emerging markets was primarily due to weakness in China, which has been rife with controversy from the Chinese-U.S. trade war, the protests in Hong Kong, and increasingly concerning economic data, all of which carry potentially long-term ramifications.
The minutes released from the Federal Reserve’s (Fed) October meeting showed that most members of the Fed Open Market Committee (FOMC) believed that current policy has been supportive of the Fed’s outlook.
Long-term U.S. interest rates rose modestly more than short term U.S. interest rates, extending the re-steepening of the yield curve which began in August.
U.S. credit returns outpaced the interest rate risk as the increase in long term yields resulted in negative returns for Treasuries.
High yield bond spreads tightened by 13 basis points during the month. Although, non-investment-grade credit bifurcated with credit spreads for lower-rated issues (CCC and below) wideneding in excess of 100 basis points. The disparity has been driven by widening spreads in the energy sector, specifically.
November was only the second down month for REITs this year. REITs have enjoyed continued macroeconomic support through the year as recessionary fears ebbed and monetary policy kept rates low. In the international markets, protests in Hong Kong continued to weigh on one of Asia’s showcase property markets.
Notably in November, subsectors with overextended valuations such as infra-structure and data centers snapped back over the month, declining 2.4% and 2.5%, respectively. Additionally, retail continued to lag broader REITs, falling 1.1%. Conversely, manufactured homes, a sub-sector consisting of only three underlying securities, has become the top performing sub-sector in 2019, returning 59.4% year-to-date.
Crude prices saw a modest increase over the month, closing at almost $56 per barrel for a 1-month contract—up 3.3% from October's close. Oil prices benefitted from the Fed’s October rate cut and the reversion of the general sentiment of a broader global economic slowdown.
Despite headlines of slowing production in the Permian Basin due to higher declines than expected, the EIA revised its U.S. crude forecast upwards by 0.9% for 2020, citing higher productivity across future Permian wells.
MASTER LIMITED PARTNERSHIPS
MLPs, as measured by the Alerian MLP Total Return Index, ended November down 5.8%, reversing the gains from earlier in the year and bringing year-to-date returns to -1.8%. The Alerian Midstream Index, which includes midstream C-corps, ended the month down 1.1%, supported by stronger performance among C-corps constituents relative to their MLP peers.
The MLP index has faced technical headwinds due to significantly diminished fund flows over 2019—only $38 million at the end of the third quarter, compared to over $5 billion in inflows for midstream energy just two years ago. This has also driven a wedge between MLP and C-corp performance, as C-corps are eligible for wider inclusion in active and passive benchmarks and portfolios.
Heading into year-end, hedge funds extended their run of positive performance in November with broad-based gains across all strategies. Event-driven managers in particular enjoyed a strong month, driven by idiosyncratic positions advancing towards the eventual value-unlocking catalyst.
Trend following managers participated in strong equity markets, mainly in the U.S., as trade tensions moderated during November. Currencies were another source of profit, with short euro exposure providing the greatest gains.
The PG&E bankruptcy was widely held across credit funds and multi-strategies—both through equity and credit—and hedge fund managers with exposure to that position experienced positive momentum during the month.
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All data is as of November 30, 2019 unless otherwise noted.
The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships that provides investors with an unbiased, comprehensive benchmark for this emerging asset class.
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