The global risk markets have hit new all-time highs as the secular bull market continues to power higher. The buzz on the street now is of a melt-up, which is in stark contrast to the worry over geopolitical issues and the beginning of quantitative tightening that the Fed recently embarked on.
For the quarter, the gains were impressive. The S&P 500 gained 4.48%, the MSCI All Country World ex USA gained 6.16%, and the Bloomberg Barclays Corporate U.S. High Yield Index advanced 1.98%. The move higher illustrates the resiliency of this market as the summer months are often a period of weakness and volatility, both of which were notably absent this year. In fact, volatility measured by the CBOE Volatility Index (VIX) just hit its fifth lowest level on record. The lack of downside volatility is not a new development. The S&P 500 Total Return Index has risen for 11 months in a row, the most since 1959. The S&P (price only) has not seen a 5% correction since June 2016, its longest stretch in 21 years. The last 3% decline ended the week before the presidential election. If it can hold until to November 9th, it will be the longest streak on record.
Third Quarter Attribution
The Fixed Income Total Return (FITR) portfolio remained fully invested in high yield bonds during the third quarter and has now been allocated to below investment grade bonds for nineteen months. For the quarter, the Fixed Income Total Return portfolio rose 1.96% gross of fees (1.20% net), marginally trailing the Bloomberg Barclays Corporate U.S. High Yield Bond Index, which gained 1.98%, and outperformed the Bloomberg Barclays U.S. Aggregate Bond Index, which gained 0.85%. Year-to-date, the portfolio has gained 6.67% gross of fees (4.31% net) compared to 7.00% and 3.14% respectively for the Bloomberg Barclays High Yield and Aggregate Bond indices.
The Fixed Income Total Return (FITR) portfolio has owned high yield bonds since the end of February 2016, now a period of over 18 months. It has been a solid run for the asset class, as the Bloomberg Barclays High Yield U.S. Corporate Index is up 26.7% between February 29th, 2016 and September 30th, 2017. Corporate earnings and balance sheets remain in good shape, and all high yield sectors gained in the quarter. The market’s attention remained on the Fed, and for much of the quarter interest rates declined, particularly in early September, when the 10-year Treasury yield fell to 2.06% amid the North Korea showdown. However, that proved to be an intermediate-term bottom for Treasury yields, and rates rose sharply during the rest of September, ending the quarter at 2.33%, the middle of their range for much of the year.
The Federal Reserve announced that it will begin the process of normalizing its bloated $4.5 trillion balance sheet. As expected, the Fed will begin the process in October and it will cap its roll off at $10 billion ($6 billion of Treasuries and $4 billion of mortgage backed securities (MBS)) for the next three months. The announcement that balance sheet run off will start in October was not surprising. The Fed did take a bit of a hawkish tone, stating that the persistently low inflation numbers are transitory or temporary. As a result, the The Fed Funds Futures market is now pricing in a greater than 70% probability of a December rate hike.
High yield spreads (Bloomberg Barclays High Yield Index yield – 10-year Treasury yield) declined to 314 basis points at the end of September, nearing its lowest spread of the year, indicating confidence in the U.S. economy and expectations of a continued low level of volatility. An additional factor contributing to the compression of spreads has been a decline in issuance of high yield bonds. In April 2015, the BofA Merrill Lynch U.S. High Yield Index contained 2326 issues, but as of September 30th it only contained 1873 issues, a 19.5% decline. The falling supply has been a bullish factor for high yield, as the huge group of investors hungry for yield are pursuing a smaller and smaller pool of issues.
The outlook as we round third base and approach the end of the year remains favorable. The global risk on trade is intact with improving economies in the U.S. and abroad, and investor and consumer confidence remain buoyed by the lack of any meaningful volatility. Talk of tax reform in Washington has the market hopeful for some policy initiatives that may help boost the economy and drive earnings growth. Risk assets are now heading into what has historically been the strongest seasonal period of the year with positive trends intact, dormant volatility, and solid economic footing.
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The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities.
The Dow Jones Industrial Average is a stock market index that shows how 30 large publicly owned companies based in the U.S. have traded during a standard trading session in the stock market.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performers of developed markets outside the U.S. and Canada.
The MSCI Emerging Markets Index is a free float adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The Russell 3000® Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market.
The CBOE Volatility Index (VIX) is a forward looking index of market risk which shows expectation of volatility over the coming 30 days.
The volatility (beta) of a client’s portfolio may be greater or less than its respective benchmark. It is not possible to invest in these indices.
Bloomberg Barclays U.S. Government and Credit Bond Index measures the performance of U.S. dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year.
The B of A Merrill Lynch U.S. High Yield Index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
The Bloomberg Barclays 7-10 Year Treasury Index tracks the investment results of an index comprised of the U.S. Treasury bonds with remaining maturities between seven and ten years.
The Bloomberg Barclays 20+ Year Treasury Index tracks the investment results of an index comprised of the U.S. Treasury bonds with remaining maturities greater than twenty years.
The Bloomberg Barclays Long-Term Treasury Index tracks the performance of the long-term U.S. government bond market.
The Bloomberg Barclays U.S. Corporate High-Yield Index covers the U.S. dollar-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
The Bloomberg Barclays U.S. Treasury Bond Index is an issuances-weighted index measuring the performance of the U.S. Treasury bond market, one of the largest and most liquid government bond markets in the world.
MSCI All Country World Index is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley and is comprised of stocks from both developed and emerging markets.
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