The S&P 500 ended the first quarter of 2016 with a slight gain after rallying in fourth quarter 2015. While the Index’s 1.35% return may seem modest, it was an impressive result in light of the fact that the Index logged its worst start to a year, ever. The year began with negative equity performance in January that flipped to a sharp move up in equities mid-February, continuing into March. The first half of the quarter was driven by accelerated depreciation in the Chinese Yuan and concerns over softening growth forecasts for the U.S. and China. The absence of strong global growth was evident as the Bank of Japan (BOJ) joined several other central banks in further easing monetary policy by moving into negative interest rate territory in January. The rally in equities from mid-February onward was driven by Chinese officials making an effort to provide stability in the Yuan; several major oil producing countries agreeing to freeze production; and greater-than-expected monetary accommodation from the European Central Bank (ECB). As a result, commodities, such as oil, steel, copper and iron ore, rebounded from their lows while the U.S. Dollar weakened following lower expectations for future rate hikes from the Federal Reserve (Fed). In mid-March Fed Chair Yellen exerted a decidedly more dovish tone, emphasizing her concern over external threats to U.S. growth. Despite robust labor market data — unemployment fell to 4.9% in January, its lowest level since 2008 — with consistent wage growth and higher levels of consumer spending, consumer confidence fell to 91.7 in February, down from 92.0 in January, while U.S. housing showed signs of slowing, as housing starts unexpectedly declined.
After the volatile start to the year, global equity markets recovered to a neutral result for the quarter. Prevailing concerns kept investors on edge. A commitment from the ECB to provide further support with some form of easing, and BOJ’s surprise move into negative interest rates, appeared to calm markets. China remained a headline concern amid persistent weakness in economic data, along with deterioration in India’s renminbi, and significant volatility in Chinese A-share equities. The ECB’s lending survey showed that credit demand was strong in the region, with 77% of banks reporting positive credit demand from households and, notably corporates, who had previously displayed lower demand. New car registrations skyrocketed in December for the region. Unemployment continued to improve at a modest pace to 8.9% across the broader 28-country union.
2016 First Quarter and One-Year Trailing Returns Across Asset Classes
“In this extremely low-nominal-growth and earnings-challenged environment, investors are looking for something else to provide support. The only game in town is central banks, but that’s not something we can hang our hat on. We need some stability in the earnings outlook.”
– Mark R. Freeman, CFA, Chief Investment Officer, Westwood Management
Following widespread volatility early in the quarter, Emerging Markets rebounded strongly in March with a gain of 13%, the ninth best month since 1987, supported by a bounce in domestic currencies, to end the quarter on a positive note. Central bank policymakers provided a more dovish stance on monetary policy in response to sluggish economic growth as the ECB, BOJ and People’s Bank of China all eased interest rates. Latin America rebounded strongly as all markets in the region posted gains, led by Brazil with an almost 30% return, the best-performing market year-to-date. The rising possibility of a change in government from presidential impeachment, a recovery in commodities, and a reversion from an oversold position by investors fueled upside in the equity market and in the domestic currency. The Europe, Middle East and Africa (EMEA) region also saw a broad-based recovery with the exception of Egypt, which declined 7% as the central bank raised its key interest rate by 150 basis points. A recent decision to adopt a flexible exchange rate and cancel the daily cap on foreign currency deposits from exporting companies was overshadowed by uncertainty from new legislation in the financial sector that included a time limit on the tenure of CEOs at commercial lending institutions, and the injection of over US$14B into local banks over the past three months to facilitate import activities on essential goods. In Asia, China and India lagged with negative returns while the rest of the region advanced. Prospects for further policy support toward growth were diminished in China as the governor of the People’s Bank of China stated that major stimulus is not needed to support growth despite weak economic indicators. Following a record year of net investments, India saw massive selling from foreign institutional investors (FIIs) with equity outflows, as optimism regarding potential reforms may have outpaced economic reality.
Investment Grade Bond prices rallied sharply during the quarter. A combination of foreign stock market weakness, global growth concerns and increased monetary stimulus from the ECB and BOJ caused investors to bid up U.S. Treasury prices. The Barclays U.S. Aggregate Bond Index gained 3.03%. With the Fed scaling back expectations on future rate hikes, Treasury prices soared across the maturity spectrum. The High-Yield market also posted strong gains during the quarter. The Bank of America Merrill Lynch High-Yield Master II Index rose 3.25% in the first quarter not without volatility. High Yield credit spreads widened by approximately 140 basis points in February before staging a sharp rally through March. High-Yield new bond issuance was exceptionally light during the first quarter. First quarter new issuance was down by over 50% compared to the first quarters of 2014 and 2015. Turning to Investment Grade, the Barclays U.S. Government/Credit Index posted a gain of 3.47%. Investment Grade credit spreads were unchanged during the quarter causing duration matched corporate bonds to outperform Treasuries. Inflation expectations rose during the quarter causing Treasury Inflated Protected Securities to outperform nominal Treasuries. All else being equal, investors with the most duration, or interest rate exposure, outperformed during the quarter. Twenty-plus-year maturing bonds were the best performer while one- to three-year maturing bonds posted a smaller gain. For context, the 30-year Treasury returned 9% while the two-year Treasury returned 1% for the quarter. Investment Grade Corporate Bond Issuance was essentially unchanged compared to the first quarter of 2015. Municipal bonds posted a 1.5% gain for the quarter which underperformed the return of both Treasuries and corporates.
In some ways the first quarter was the opposite of the fourth for MLPs. A massive equity sell-off fueled by falling oil prices early in the quarter gave way to a similarly impressive rally in energy shares at the end of the quarter. Nonetheless, the Alerian MLP Index fell 4.2% on a total return basis. Oil prices ultimately gained 3.5%, despite dramatic double-digit swings. After a 28.2% drop in the MLP Index and a 29.2% drop in oil between Dec. 31 and Feb. 11, the MLP Index rallied from the lows to finish with a 33.4% gain. Meanwhile the Philadelphia Utilities Index gained a 16.4% total return. Natural gas dropped 16.1% and re-tested multi-decade lows. An unseasonably warm winter influenced by El Nino weather patterns reduced heating demand for natural gas. Supply also continued to grow from the Marcellus/Utica region and from associated gas production. At quarter end, natural gas storage levels remained well above the five-year average.
The FTSE NAREIT All Equity index posted strong performance for the quarter, outperforming the broader market by a wide margin. Much like the broader market, it was a tale of two markets for the quarter. The NAREIT index opened the year weak, posting poor performance for the first half of the quarter; however, strong performance in the second half of the quarter more than made up for the weak performance in the first half. The relative outperformance of REITs was mainly driven by decline in rates as the yields on the 10-Year Treasury declined from 2.3% at the end of 2015 to 1.8% at the end of the first quarter. As we move through the earnings cycle in the next several weeks, we expect to see continued volatility. At Westwood, we invest for the long term, factoring in volatility and allocating accordingly.
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The information contained herein represents the views of Westwood Holdings Group, Inc. at a specific point in time and is based on information believed to be reliable. No representation or warranty is made concerning the accuracy or completeness of any data compiled herein. Any statements non-factual in nature constitute only current opinion, which is subject to change. Any statements concerning financial market trends are based on current market conditions, which will fluctuate. Past performance is not indicative of future results. All information provided herein is for informational purposes only and is not intended to be, and should not be interpreted as, an offer, solicitation, or recommendation to buy or sell or otherwise invest in any of the securities/sectors/countries that may be mentioned.