December 2019 - Positive Momentum Continues; Best YTD since 2013
Risk assets continued their upward trend in November, driven by constructive headlines on trade and Brexit and stronger economic data. The MSCI All-Country World Index returned 2.3% on the month in $US terms, bringing YTD gains to 23% (including dividends). Government bond yields rose slightly on the month, gold prices declined and credit products had positive excess returns. The U.S. and China appear likely to sign a phase 1 trade deal, though a few obstacles and tensions remain among both sides. We remain cautiously optimistic on the backdrop for risk assets going into next year but see scope for higher volatility in the next coming weeks.
The S&P 500 index delivered total returns of 3.6% in November, bringing year-to-date gains to 27.6% (the strongest since 2013). Small caps continued to outperform large caps for the 3rd straight month, with the Russell 2000 rising 4.1% (20.5% YTD). On a sector basis, Technology, Healthcare and Financials outperformed (5.2%/4.8%/4.8%) while bond-proxy sectors such as Utilities (-2.3%) and Real Estate (-2%) lagged. Information Technology remains the top performing sector YTD (42%) while Energy is the laggard (1.7%). We remain overweight U.S. equities vs. other regions given stronger growth dynamics and maintain a preference for domestic sectors that benefit from the resilient consumer such as Consumer Discretionary and Financials. We also like small caps given the resilient economy and the potential for tactical shifts by investors.
In Europe, the Euro Stoxx 50 index returned 2.8% on the month in EUR terms, leaving YTD total returns at an impressive 27.8%. The region’s manufacturing index rose slightly in November but remains at contractionary levels. The British Pound continued to appreciate vs. the USD amid the expectation that the Conservative part will win the upcoming elections. This led to an underperformance of large cap UK equities (up 1.4% on the month) while UK mid-caps returned 4%. The ECB left its deposit rate unchanged but has started purchasing corporate bonds as part of its quantitative easing. We maintain our marketweight stance on European stocks given weak growth prospects offset by the ECB’s QE. In Israel, the Tel-Aviv 125 index returned 3% and is up 22.8% in local terms and 33.5% in USD terms. Elsewhere, Japanese stocks as measured by the Nikkei 225 underperformed by returning 1.6% on the month in JPY terms.
Emerging Market equities were particularly weak and returned only 0.6% on the month in local terms and -0.1% in USD terms. By region, Latin America lost -4.3% in $US terms, EM Asia returned 0.5% and EMEA -0.2%. Signs of a stabilizing manufacturing backdrop for the global economy and particularly China should provide support for EM equities going forward, and valuations are attractive with the MSCI EM index trading at a forward P/E of 12.2x, compared to 16.3x for MSCI World. We continue to prefer equity markets in China and Brazil.
In credit markets, US investment grade corporate spreads tightened 6 bps in November to 111 bps and total returns were 0.2%. Supply volumes accelerated to $103 bn in November from $85 bn in the prior month, driven by one large M&A-related supply of $30 bn (Abbvie). On the demand side, IG mutual funds received inflows of another 1% of AUM. Following the strong rally in spreads (they are at their YTD tights), we reduce out overweight view to marketweight. We continue to prefer BBB credits whose management is committed to maintaining an investment grade rating and enacting creditor-friendly policies.
US HY credit returned 0.3% as the coupon income of 0.5% was able to offset a decline in prices driven by the move in U.S. treasuries. Credit spreads tightened by 13 bps to 402 bps (yield of 5.8%). BBs and Bs returned 0.6% while CCCs lost -1%. Aerospace outperformed (2.2%) while energy lagged (-0.4%). European HY outperformed US HY by delivering total returns of 0.9% (10.1% YTD) as spreads tightened 24 bps to 348 bps (Yield of 2.9%). On the demand side, US HY funds saw modest outflows of $250 mn, bringing YTD inflows to $16.2 bn. In the primary market, corporations raised $30 bn in USD-denominated bonds, the busiest November in 6 years. We maintain our marketweight view on US HY given tight spreads but see more value in Bs over BBs: Bs are yielding 1.8% more than BBs vs. a 10-year average of 1.6%. We also see room for outperformance of the leveraged loan market given attractive relative valuations (average yield of 6.5%).
Emerging Market debt had a mixed performance with a large divergence across the asset classes, driven by idiosyncratic country events. EM hard currency returned -0.5%, while EM corporates returned 0.4%. EM local currency sovereigns returned -1.8% in $US terms, driven by a 1.6% depreciation in local currencies vs. the USD. Much of the difference in performance across the EM asset classes can be attributed to idiosyncratic country events which have different weightings in various indices. For example, EM sovereigns suffered from large negative returns for Lebanon (-19%), Ecuador (-14%), countries that don’t have any significant corporate issuers. EM local currency suffered from large negative moves in Chile (-8%) and Brazil (-6%). We maintain a positive view on EM debt with a preference towards external corporates and local currency sovereigns.
Overall, the deceleration in global growth is showing signs of stability but it is too early to call for a major turnaround. Risks of a recession in the next 12-months have receded, leaving the Fed on the side lines for now. Financial markets have cheered these moves, sending equity prices to new all-time highs and credit spreads to tight levels. We are cautiously optimistic on risky assets across our portfolios but are not ready to be in full risk-on mode given rich valuations. As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance. As usual, don’t hesitate to contact us to discuss our investment views or financial markets more generally.