August 2019 Monthly Market Review
August ushered in a shift in investor sentiment that put downward pressure on risk assets and sparked a flight to safety, which manifested in both the interest rate and currency markets. U.S. equities fell 2% but outpaced the local returns of both international (–2.4%) and emerging markets (EM) equities (–2.5%). Global trade tensions and negative implications for growth continued to weigh on equities. Markets also continued to grapple with ongoing geopolitical uncertainty caused by Brexit, rising tensions between China and Hong Kong, and growth of populism. Latin American equities sold off sharply amidst country-specific headwinds and contributed to the decline in emerging markets. This included primary election results in Argentina and a shift in sentiment in Brazil which was further fueled by tension regarding wildfires in the Amazon rainforest.
Global bond yields fell during the month. By month-end, negative yielding debt globally was more than $17 trillion, according to Bloomberg. Despite declining U.S. Treasury yields, domestic debt traded at a premium to the debt available in other nations. The interest differential between U.S. and other countries’ debt has led to demand for longer-dated U.S. Treasuries from foreign buyers. Combined with hedging activity of pension plans, holders of mortgage-backed securities, and other investors with long-term liabilities, this has contributed to falling yields at the long-end of the U.S. yield curve.
Demand at the long-end of the U.S. yield curve caused the spread between the two-year Treasury and the 10-year Treasury (also known as the “2s10s inversion” or “2s10s”) to invert several times during August. At first, the inversions occurred on an intra-day basis but reverted back to a positive spread before the day’s close. However, during the third week of August, the 2s10s spread was negative at the close. Historically, an inverted yield curve has been a fairly good predictor of a U.S. recession in the future, with a lag of 12–18 months between inversions and the onset of the recession.
The positive interest rate differential between the U.S. and other nations has also contributed to a strong U.S. dollar. Aside from the positive interest differential, there is evidence that investors sought safety in August. Both the Japanese yen (+2.3%) and the Swiss franc (+0.1%) appreciated against the USD as investors sought a safe store of value.
The sentiment shift that caused the decline in risk assets also caused inflation expectations to drop. Breakeven inflation expectations show markets expect inflation to be 1.4% for the next five years— a 20 bps decline since the end of July. Expectations for the next 10 years also moderated about 20 bps, falling from 1.8% to 1.6%. Within the inflation-hedging allocation of a typical portfolio, the only two categories to deliver positive returns were TIPS (+2.4%) and real estate (+2.0%), both of which benefited from falling yields. Other areas of real assets declined, including natural resource equities (−5.1%) and commodities (−2.3%). Commodities were dragged lower by weakness in oil prices and falling agriculture prices amid the ongoing trade war.