Most risk assets posted positive absolute returns in September, as large central banks remained accommodative and the Fed continued to hold policy rates steady. After an extensive review, the Bank of Japan (BoJ) announced a new monetary policy initiative targeting a 0% ten-year sovereign yield. To achieve this yield target, the bank will continue to buy Japanese government bonds, but the amount could differ from its current annual pace of ¥80 trillion. As of month-end, the BoJ owned 36% of its sovereign bond market, according to Bloomberg. The BoJ also stated it will continue to increase its monetary base until inflation is stable and above the 2% target, which allows the measure to overshoot the target. On the month, the Japanese ten-year yield stayed relatively unchanged at −0.1%, but the local equity markets (−1.9%) underperformed broader global equities. Overall, non-U.S. developed and emerging markets (EM) equities outperformed U.S. equities in local and U.S. dollar (USD) terms, with the currency impact serving as a tailwind for U.S.-based investors. Energy equities and commodities both posted strong gains during the month, pushing year-to-date (YTD) returns to 24.6% and 8.9%, respectively.
Developed non-U.S. equities notched their third consecutive monthly gain as the MSCI EAFE Index rose 1.2% in USD terms. For U.S.-based investors, local returns (+0.4%) were bolstered by weakness in the dollar, which declined 0.6% against a basket of other major currencies as investors tempered expectations of a Fed rate hike. Commodity-linked currencies such as the Aussie dollar (+1.8%) received an additional boost from improving oil and precious metals prices. The yen (+2.1%) continued to rally relative to the USD and is now up 18.8% YTD. The notable exception was the British pound sterling, which fell 0.8% against the dollar and ended September down over 12% since the referendum vote to exit the European Union.
Sector returns across the MSCI EAFE Index were broadly positive. The one notable exception was financials, particularly European financials, which remained a source of investor concerns and market volatility. European financials had shown signs of recovery since the U.K. referendum vote, but retreated late in the month after German banking giant Deutsche Bank came under pressure following the announcement of a potential substantial legal settlement with the U.S. Justice Department related to a series of mortgage securities cases. The news exacerbated existing investor concerns over the company’s capital position, and prompted outflows from hedge fund clients. The troubles of Deutsche Bank rippled through an already fragile banking environment in Europe that has been plagued by low interest rates and a stagnant economy. For the month, Deutsche Bank declined over 12.0% in local terms, while European financials ended the month down 0.5%. Financials (−2.7%) were also the worst-performing industry in the S&P 500 Index amidst ongoing uncertainty regarding Fed action and the revelation that Wells Fargo employees established millions of unauthorized accounts in order to achieve sales goals.
Emerging markets equity momentum continued through September as the MSCI EM Index gained 1.3% and closed the quarter up 9.0%—well ahead of both S&P 500 (+3.9%) and MSCI EAFE (+6.4%) indices. A rally in commodity prices benefited a number of developing markets. South Africa and Russia returned 5.8% and 3.9% in U.S. terms, respectively, helped by the strength of both the rand (+7.0%) and the ruble (+3.7%). Commodity prices were supported in part by continued signs of stability in China (+2.5%). While other markets have garnered investor attention, fears over slowing growth in China have abated. Business activity in China, as measured by the FTCR China Business Activity Index, reached a three-year high in September, and exports have shown sign of recovery. The Chinese economy also benefited from fiscal stimulus, including reduced down payment requirements for real estate purchases, tax cuts for auto purchases, and increased infrastructure spending. The country’s property market has shown particular strength, as prices in the largest cities surged during the month.
Most marketable real assets posted strong returns, with diversified commodities (+3.1%), energy equities (+3.1%), and metals and mining equities (+7.9%) all advancing. Within the energy complex, crude oil (WTI) finished 7.9% higher thanks to a more than 9% advance in the last three trading days of the month following news of OPEC’s surprising preliminary agreement to cut aggregate production. Energy equities subsequently rallied 5.6% in the final three days of the month and finished in positive territory (+3.1%). Since 2014, OPEC has increased production as it competed for market share with producers around the world and sought to sideline higher-cost producers such as North American and offshore producers. OPEC is now producing at a historically high rate of approximately 33 million barrels per day, with limited capacity to increase production further in the near term. The initial plan calls for cuts in the cartel’s collective production of 200,000–700,000 barrels per day. Despite the immediate rally, there is significant skepticism around whether the agreement will actually come to fruition, if it can be enforced, and what impact it would have on global oil markets. OPEC meets again in late November, when it will seek to detail and agree upon which members will cut production, and ultimately finalize the agreement.
Elsewhere, industrial metals (+5.2%) and metals and mining equities (+7.9%) posted strong returns. Industrial metals advanced on stronger demand, supply reductions, and a weaker dollar, which makes commodities less expensive for foreign currency holders. Along with higher prices for metals, mining equities rallied on improved market sentiment around Chinese growth, particularly in the industrial sector. Sentiment improved on better-than-expected Chinese industrial production data, with the country’s official manufacturing Purchasing Managers’ Index measuring above the expansion level (50) for both August and September.
Long/short equity manager performance was mixed, but generally flat to positive in September. Managers with a focus on technology tended to fare the best given the strength in the sector. Top-performing positions included mega cap stocks such as Baidu, Amazon, and Facebook, as well as chip maker NXP Semiconductors, which Qualcomm was rumored to be interested in acquiring. Computer game maker Activision Blizzard, which is held by many technology investors, was also a top contributor in the month. Longs in the energy sector were also helpful, particularly for managers that maintained or built exposure to the beaten down pipeline operator Williams Companies earlier in the year. Strength in the technology sector was offset by weakness in the health care and financial sectors. Ongoing discussions involving drug prices trickled down from drug makers such as Teva, Mylan, and Allergan—which remained popular hedge fund holdings—to the middlemen in the drug supply chain. Among the hardest hit were drug distributors McKesson and AmerisourceBergen, both of which have become more widely held due to their predictable earnings, reasonable valuations, and strong competitive positions in the drug distribution channel. However, expectations of lower drug prices created fears of margin compression at the distributors, further depressing share prices.
Outside of long/short equities, mergers played a significant role in event-driven and multi-strategy manager returns. EMC/Dell closed successfully early in the month and shareholders approved the SAB Miller/AB InBev merger late in the month. These were two of the larger merger deals in many manager portfolios entering the month. Several companies that recently completed mergers and remain top holdings for managers also performed well, most notably Charter Communications and Ball Corp.