July was another strong month for risk assets amid ample central bank liquidity, stable economic growth, and strong U.S. corporate earnings results. The environment not only supported global equities, but several marketable real asset categories and below-investment-grade credit as well. Domestically, equity markets continued to exhibit low volatility and the VIX hit a multi-decade low during the month. The U.S. dollar (USD) weakened once again, with July marking the fifth consecutive monthly decline. The Dollar Spot Index (DXY) ended the month down 9.1% year-to-date (YTD), retracing its recent post-election high. USD weakness has been a tailwind for non-U.S. investments. On a YTD basis, the MSCI EAFE Index (+17.1%) and MSCI Emerging Markets (EM) Equity Index (+25.5%) significantly outperformed the S&P 500 (+11.6%).
The impact of the U.S. dollar decline was broad based in July. Most major developed market currencies appreciated against the USD, including the Canadian dollar (+3.9%), euro (+3.4%), Japanese yen (+1.7%), and British pound (+1.5%). The dollar also fell against most developing market currencies in the month, with notable exceptions including the Venezuelan bolivar (–8.0%), Argentine peso (–6.1%), and Russian ruble (–1.5%). These declines were generally the result of various idiosyncratic issues. In Venezuela, political upheaval and skyrocketing inflation drove the currency sharply lower. Meanwhile, the Russian ruble dipped over concerns about stricter U.S. sanctions against Russia.
A number of factors are likely behind the shift in sentiment on the dollar in recent quarters. Global markets are beginning to acknowledge signs of central bank and economic growth convergence. European economic growth is strengthening, which has attracted investor flows to the region. This economic growth has yet to spur a policy reaction from the European Central Bank (ECB). However, it raises prospects for the ECB to consider possible changes to its quantitative easing program later this year. Within the U.S., inflation remains persistently low, spurring uncertainty about whether the Fed will hike policy rates as aggressively as initially anticipated. Beyond the global economic growth convergence, political turmoil in Washington and the lack of fiscal stimulus from the Trump administration has likely weighed on the U.S. dollar.
USD weakness has caused problems for numerous macro hedge funds in 2017, particularly systematic traders. Many discretionary macro traders repositioned their portfolios earlier in 2017 to reflect comments made by the Trump administration regarding the strength of the dollar. However, quantitative trend-followers suffered larger losses when the USD’s descent accelerated in March and April, reversing the profitable trend of 2016. While the DXY fell in six of the first seven months of the year, the path was inconsistent. The U.K. pound and Japanese yen appreciated early in the year and the euro has steadily gained. However, more commodity-sensitive currencies such as the Australian and Canadian dollars shot up in the last two months. July was a better month for systematic currency trading as the USD weakened against all major currencies. However, the choppy path has made it difficult for tradable trends to develop.
Foreign equities continued their upswing thanks in part to USD weakness, as the 0.7% local return of developed non-U.S. equities was boosted to 2.9% in USD terms. Continental Europe continued to rally, aided by the strength of the euro and positive economic data. Peripheral countries such as Italy (+7.5%), Portugal (+5.4%), and Spain (+4.7%) performed particularly well. Resource-dependent countries such as Canada (+4.0%) and Australia (+4.5%) also generated gains on the back of rising commodity prices. Japan was one of the few countries that declined in local terms as the Nikkei 225 fell 0.5%; however, the 1.7% rise of the yen helped offset this weakness for U.S. based investors. Japanese stocks dipped in part on deflationary fears, which were reignited after the Bank of Japan again pushed out its target date for achieving 2% inflation from 2018 to 2019. The country also faced ongoing political turmoil as allegations that Prime Minister Shinzo Abe granted special favors to close friends drove his approval rating to record lows.
EM equities returned 6.0% in July, again outpacing their developed counterparts. On a YTD basis, EM countries have gained 25.5%—well ahead of U.S. and developed foreign equities. Returns within the emerging space were lifted in part by the continued outperformance of the technology sector (+7.0%), where Chinese internet names Alibaba and Tencent (both large index constituents) generated double-digit gains. These gains in the tech sector, as well as the property market, are behind China’s strong performance for the month (+8.9%) and YTD (+36.0%). After lagging much of the year, Brazil rebounded in July (+11.0%) despite continued deterioration in the political situation during the month with former President Luiz Inácio Lula da Silva being indicted on corruption charges. Even as current President Michel Temer faces allegations of corruption, Brazilian equities have proven resilient. The commodities rally served as a tailwind, while annual inflation fell to a decade low of 3%, prompting Brazil’s central bank to cut policy rates for a third time in 2017.
Gains were broad across marketable real asset categories in July. Crude oil prices (WTI) advanced 9.0%, closing above $50 per barrel for the first time in two months. A growing number of oil producers are profitable in the $50–55 per barrel range and pricing gains flowed through to energy equity valuations, which moved 3.5% higher. Oil rallied on larger-than-expected declines in U.S. crude inventories, plateauing domestic rig counts, record U.S. demand for gasoline, robust crude demand from China, and a weaker dollar. Other drivers included Saudi Arabia’s announcement that it would seek to cut its oil exports during August by approximately 1 million barrels per day (versus August 2016 levels), and concern that Venezuelan production may decline at a higher rate. Despite the sharp monthly gain, oil prices were still down 6.6% YTD on ongoing concern that a potential rebalancing of the global crude market may be delayed further due to the ramp up in U.S. shale production and rising output by Organization of the Petroleum Exporting Countries nations, which are exempt from production cuts.
Metals and mining stocks rallied 12.0% on strong quarterly earnings and higher industrial (+4.1%) and precious (+1.8%) metal prices. Many mining companies, which were nearing distressed levels 12-plus months ago, have demonstrated an ability to reduce debt loads, improve liquidity profiles, and return to profitability. Through July, mining stocks had advanced 17.8% YTD. In July, industrial metals prices moved higher on surprising macroeconomic, construction, and manufacturing data from China—the world’s largest consumer of many base metals. Meanwhile, precious metals prices advanced due to continued subdued inflation and increasing speculation that the Federal Reserve may increase rates at a slower pace than previously expected.