July 2016 Monthly Market Review
July was a strong month for equity markets as investors looked past the potential negative impacts of Brexit and equity market volatility abated to more normal levels. In Japan, officials implemented further fiscal and monetary policy expansion, while it appeared the markets expect further initiatives in the United Kingdom. Emerging markets (EM) and non-U.S. developed stocks outperformed U.S. stocks, but the S&P 500 was up 3.6% and closed at record high levels seven times during the month. With currency generally serving as a tailwind, other non-U.S. assets posted gains in both U.S. dollar (USD) and local terms, including global bonds and REITs. These asset classes were also bolstered by falling sovereign bonds yields.
Most of the advance in U.S. stocks occurred during the first half of the month as investors anticipated further stimulus measures following the Brexit vote. Information technology—the strongest sector in the index for July—was boosted by a surge in quarterly profits of both Facebook and Google parent, Alphabet. Amazon and Microsoft also beat Wall Street estimates, aided by the strength of their cloud businesses. Returns in the energy sector, which is discussed in greater detail later in this piece, were at the bottom, declining almost 2% during the month.
After being among the most disappointing developed non-U.S. markets in the first half, Japanese equity markets reversed course in July with the Nikkei gaining 6.4%. Stocks benefited from investor expectations of additional fiscal stimulus and central bank easing. Late in the month, prior to the Bank of Japan (BoJ) meeting, Prime Minister Shinzo Abe announced plans for ¥28 trillion in new stimulus, including ¥13 trillion in spending measures. However, on the monetary policy side, the BoJ surprised investors at the end of the month by announcing only a modest increase in its annual purchase of exchange-traded stock funds to ¥6 trillion ($58 billion). The bank did not adjust its yearly target of buying ¥80 trillion of Japanese government bonds and declined to cut its already negative policy rate further. The yen weakened throughout the month before a late-month rally, ending July essentially flat. The yen rallied as a result of the BoJ failing to deliver strong stimulus measures.
The FTSE 100 Index gained 3.4% in July and 10.3% YTD. However, investor uncertainty regarding post-Brexit Britain caused the sterling to fall 0.7% against the dollar for the month; it remains nearly 12% lower against the USD prior to the vote. On July 13th, the Bank of England (BoE) kept policy rates steady at 0.5% and maintained the stock of purchased assets at £375 billion. The accompanying statement noted that most committee members expected additional monetary policy loosening at the August meeting once the impact of the referendum on the economy and inflation are further assessed. On August 4th, the BoE cut policy rates to a record low of 25 bps, increased its quantitative easing program by ₤70 billion, and added the purchase of corporate bonds to its program.
European bank stress test results released at the end of the month suggested that while European banks were generally healthier since the last test in fall 2014, concerns related to a handful of institutions have not been alleviated. The worst of the group was Italy-based Banca Monte dei Paschi, whose capital ratio was the only one to turn negative in the adverse scenario test. The bank presented a plan to raise additional capital and move €9.2 billion of non-performing loans off its balance sheet into a special purpose vehicle in anticipation of poor results. While no other bank had worse results, several performed poorly, including Allied Irish Bank, Raiffeisen Bank of Austria, and Royal Bank of Scotland. These results are unlikely to result in actions like those taken by Monte dei Paschi, but also do not provide much relief to investors.
Stress in Italy and other southern European countries have garnered the attention of credit-oriented hedge funds. Many of these managers have produced strong returns in recent years through the purchases of non-performing loans in markets such as the U.K. and Germany. Banks in countries such as Italy have been slower to dispose of troubled assets; however, the recent stress test results may accelerate asset sales. Liquidity for these portfolios can be limited, so it is important to utilize managers with longer duration capital and fund structures in order to take advantage of this emerging opportunity.
Overall, global equities markets closed July higher as the MSCI All-Country World Index (ACWI) gained 4.3% and the MSCI ACWI ex-U.S. was up 4.9%. For the year-to-date (YTD) period, the two benchmarks were up 5.6% and 3.9%, respectively. In July, New Zealand (+10.5%) and Australia (+8.2%) topped developed non-U.S. markets. Larger euro area countries such as Germany (+7.4%), Spain (+6.4%), and France (+5.6%) ended the month strong as well. Emerging markets fared well, with the MSCI EM Index gaining 5.0% for the month and 11.8% YTD. Results in EM equities were more divergent than their developed markets counterparts. Egypt (+20.1%), Brazil (+9.8%), and South Africa (+8.8%) all posted robust gains, while Turkey (−5.8%), Colombia (−6.0%) and Malaysia (−1.0%) posted weaker results. Turkey (−5.8%) was among the weaker performing countries following a failed military coup attempt mid-month. Frontier markets held up, returning 1.2% during the month.
Falling interest rates and expectations that central banks would continue with stimulative monetary policies had a positive impact on global REIT returns (+5.1%). The attractive relative yields provided by real estate compared to sovereign fixed income assets provided a tailwind to the sector across regions. The perceived safety of core real estate combined with generally strong market fundamentals supported higher returns, particularly in North America (+4.6%) and parts of Asia (+5.6). The European region (+6.8%) led the advance—a strong reversal from June, when property stocks in that region declined 6.2% on concerns that the U.K.’s exit from the European Union would hamper economic growth and property market fundamentals. In July, developed Europe ex-U.K. moved 7.9% higher while UK property stocks also advanced 4.9%, recovering some of their losses from the prior month. The combination of lower share prices, weaker sterling, and falling U.K sovereign yields appeared to attract investors seeking a discounted entry point.
Elsewhere within marketable real assets, crude oil prices retreated 13.9% with WTI settling at $41.6 dollars per barrel to end the month. While global demand continued to increase—aided by a seasonal boost from the summer driving season in the U.S.—a supply glut pushed prices lower. Supply increases were driven by higher reported production from OPEC and by the resolution of multiple temporary production outages—including wildfires in Canada, militant attacks in Nigeria, and a strike at oil facilities in Kuwait. The recent recovery in prices to the $45-$50 per barrel range also induced some lower cost U.S. producers to increase rig counts during the month (+44 according to Baker Hughes). Also impacting prices were higher than expected gasoline inventories. Refiners are going into maintenance periods and higher inventories are raising concerns about crude demand over the next couple of months.
Despite falling oil prices, natural resource equities—as measured by the energy dominated S&P North American Natural Resources Index (80% energy) were flat for the month, gaining +0.2%. Energy equities appeared to benefit from market sentiment that oil markets will come into balance later this year—despite short term volatility. In addition, many energy companies have material exposure to natural gas (look through exposure to the index is approximately 20%)—which has increased 28.9% year to date. The high yield bond market also shrugged off the decline in oil prices returning 2.7% and marking a reversal of a relationship observed in previous periods. On the month, high yield spreads tightened by more than 50 basis points and are close to their long term average level after sharply rising in late 2015/early 2016. Elsewhere within the marketable real assets segment, metals and mining equities climbed 10.6% during the month as precious metal prices (+4.3%) and industrial metals (+3.2%) continued to rally. The mining and metals sector also appeared to benefit as mining companies have demonstrated an ability to restructure their balance sheets, rationalize assets, and weather an extended period of low prices. Precious metal prices continued to benefit from investors seeking a safe haven amidst concerns around global growth, volatility in the currency markets and even lower interest rates which reduce the opportunity cost of holding these assets. Meanwhile, industrial metals moved higher as central banks around the world continued with aggressive monetary stimulus and as Chinese and global demand for certain metals continued to rise.