U.S. Economy: Data Cornucopia Mixed
Unemployment remains at a still low 3.7% amid 10.7 million job openings, while retail sales and consumer confidence surpassed expectations. But residential real estate, a major engine of economic growth, has stalled. In November, the S&P/CoreLogic Case-Shiller Home Price Index fell 1.2%, its largest monthly drop in a decade.
U.S. Stocks: November to Remember
U.S. equities gained for the second straight month. Investors saw potential for the Fed to slow interest rate hikes due to inflation moderating recently to 7.7% annualized and subdued economic data. However, the possibility of further supply chain disruption over COVID-19 lockdowns in China dampened enthusiasm going into December.
Foreign Stocks: Weaker Dollar a Plus
A sharp drop in the U.S. dollar, down 4.8%, aided most developed market equities, including in the Eurozone and Japan, up 13.5% and 9.7% respectively. Emerging markets soared, led by China, up 29.7%, and Hong Kong, up 24.5%, due to broader efforts to stabilize the struggling domestic real estate market and anticipated loosening of COVID-19 restrictions.
Fixed Income: Inflation Relief
The news that U.S. inflation was lower than expected in November drove the yield on 10-year Treasury bonds down 30 basis points, one of the larger single-day moves in recent history. Both U.S. taxable and tax-exempt core fixed income rose, up 3.7% and 2.9% respectively, while local currency emerging markets debt, up 9.1%, was the star, given the weaker dollar.
Real Assets: Nice Rebound
While real assets didn’t fly as high as non-U.S. equities, they were among the better performers in November. Commodities priced in dollars benefited from a weaker greenback, although oil was down 7.2% during the month, and the prospect of lower interest rates made the dividends from REITs and infrastructure equities, at 6.4% and 8.1% respectively, more attractive.
Alternatives: Mixed Results
Hedge funds were relative underperformers in November, although generally accretive to client portfolios year-to-date. Relative value strategies, up 1.6%, were a bright spot, benefiting from the shift in interest rate and bond trends on inflation good news, while managed futures strategies, down 4.8%, were caught wrongfooted by these same shifts.
Source of data: Bloomberg
Equities Total Returns
Fixed Income Total Returns
There is a phrase in sports that “you’re never as good as your best day, and you’re never as bad as your worst day.” The lesson: success is best achieved by maintaining an even keel. A recurring takeaway in this space in 2022 has been “staying the course” in managing our portfolios, which are built to withstand short-term volatility in the pursuit of longer-term client objectives.
The markets keep providing us with excellent examples of why this sort of patience is warranted. As just one example, international equities, which have faced unique headwinds in both Asia and Europe, and been portfolio underperformers this year as a result, performed very well in November, with the weakening U.S. dollar accounting for most of the excess return relative to U.S. stocks. Last month, we pointed out that the U.S. dollar was at a lofty level and that some measure of a pullback wouldn’t be a surprise. This month, we continue to see the dollar as more than likely supporting, or at least not impeding, international investments versus the distinct headwind it had been for most of the last decade.
Toward the end of November, investors cheered an inflation print for seemingly little reason: Year-over-year consumer inflation (CPI), which is a lagging indicator, came in at 7.7%, reasonably good relative to economist expectations of 7.9% and October’s 8.2%. However, upon closer look, there was good reason for the cheering: Over the past four months (August through October) the pace of consumer price inflation has actually eased to +2.8% annualized from +12.2% over the prior four-month period. Looking even further into headline numbers cited by the Fed, core inflation over the past two months has actually been negative if one replaces the lagging CPI shelter component with the more current Case-Shiller Home Price Index.
While there are indications that inflation may be headed lower, albeit slowly, the economic landscape continues to offer conflicting signals. Despite the Fed’s dramatic monetary tightening thus far, U.S. unemployment remains historically low, fueling wage increases recently running at 5.1% annualized. Workers are still being squeezed, however, given that inflation has been running higher than wage increases, yet consumer spending has been seemingly resilient. For example, both Black Friday and Cyber Monday retail sales appear to be 6%-8% above 2021 in nominal terms although they are down when adjusted for inflation.
What does this mean? The Fed is almost certainly going to continue to raise interest rates in the months ahead, but the pace is potentially a bit slower, perhaps lowering the risk of severe economic pain. That said, we will not know the impact of the rate increases so far for quite some time, let alone the effects of future rate increases.
Eyes on the Prize
Strong and broad financial market results these last few months have been built around optimism that the Fed may be able to pull off a soft landing. With some signs that the economy is holding up alright, and after a couple of months of strong equity performance, it may feel to some like a market recovery is under way and there is no looking back.
However, such sentiment can and often does change quickly, with multiple instances of Fed policy expectation swings this year whipsawing investors. We are maintaining an even keel as 2022 comes to a close but are excited about the opportunities this year’s dislocation in financial markets may present as we enter 2023. In general, with valuations and yields at more attractive levels, our longer-term return expectations for both stocks and bonds are back to levels we haven’t seen since early in the recovery from the Global Financial Crisis. Also, the dislocation in the capital markets this year, and potential dislocation to come in areas such as real estate, have created compelling opportunities to invest in a wide array of higher-yielding corporate credit and the reinvigoration of the U.S. supply chain.
Glossary of Indices
U.S. Large Capitalization = S&P 500 Index
Tracks the performance of a representative sample of 500 leading companies in the major industries of the U.S. economy.
U.S. Small Capitalization = Russell 2000 Index
Tracks performance of the 2,000 smallest companies in the Russell 3000 Index, representative of the U.S. small capitalization equity market.
U.S. Growth Equities = Russell 3000 Growth Index
Tracks the performance of those Russell 3000 companies that have higher price-to-book ratios and higher forecasted growth values.
U.S. Value Equities = Russell 3000 Value Index
Tracks performance of those Russell 3000 companies that have lower price-to-book ratios and lower forecasted growth values.
International Equities (Developed Countries) = MSCI EAFE Index
A float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. Consists of the stock market indices of these 20 developed countries: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
Emerging Market Equities = MSCI Emerging Markets Index
A float-adjusted market capitalization index designed to measure equity performance in the major emerging markets. Consists of the following 25 emerging-market -country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
U.S. FIXED INCOME, TAXABLE
U.S. Aggregate Bond = Barclays Capital U.S. Aggregate Bond Index
Covers U.S. dollar-denominated, investment-grade, fixed-rate, taxable bond market consisting of SEC-registered securities. Includes U.S. Treasuries, U.S. agency bonds, U.S. corporates, mortgage-based securities (MBS, CMBS) and asset-backed securities (ABS).
TIPS (Treasury Inflation-Protected Securities) = Barclays U.S. Treasury Tips Index
Measures the performance of TIPS of various maturities issued by U.S. Treasury.
INTERNATIONAL FIXED INCOME
International Developed Bonds = BofA Merrill Lynch Global Government Bond II ex U.S.
Measures the performance of non-U.S. developed-market government bonds on an unhedged currency basis.
Emerging Market Bonds = BofA Merrill Lynch Emerging Markets Sovereign
Bond Index Measures the performance of emerging markets government bonds on an unhedged currency basis.
U.S. FIXED INCOME, TAX-EXEMPT
Intermediate Municipal Bonds = Merrill Lynch Municipals, 3-7 Yrs Index
A subset of The Merrill Lynch U.S. Municipal Securities Index, including all securities with a remaining term to final maturity of between 3 and 7 years.
Municipals, Broad Market = Merrill Lynch Municipal Master Index
Tracks the performance of U.S. dollar denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions.
Absolute Return Funds = HFRX Absolute Return Index
Tracks the performance of hedge funds aiming to provide stable performance regardless of market conditions. Such funds tend to be less volatile and less correlated to market benchmarks. Data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month and is subject to revision.
Market Directional Funds = HFRX Market Directional Index
Tracks the performance of hedge funds that add value by participating in the direction of various financial markets. Such funds characteristically have higher expected volatility than Absolute Return strategies (see above). Performance data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month, and is subject to revision.
Equity Volatility = CBOE VIX Index
Aims to measure investor expectations for near-term stock-market volatility as conveyed by the pricing of stock options on the S&P 500 index that mature within 30 days.
Implied Inflation = 10-Yr TIPS Implied Inflation
Gauges investor expectations for future U.S. inflation based on the difference between the yield on a 10-year TIPS (Treasury Inflation Protected Security) and the yield on a nominal 10-year Treasury.
Gold Spot $/oz.
An index intended to measure the current price of gold, based on futures contracts deliverable in the following month priced in U.S. dollars per Troy ounce.
Oil = Brent Crude Oil Spot Price $/bbl
Brent Crude Oil refers to a particular grade of crude oil often quoted in financial reports as the global benchmark for the price of oil. It typically trades at a premium to the West Texas Intermediate price.
U.S. Dollar = Trade-Weighted U.S. Dollar Index
Value of the U.S. dollar relative to a composite of 26 currencies of major U.S. trade partners, weighted based on trade data.