Returns diverged across markets during March. U.S. equities were relatively flat, but some asset classes posted strong gains and others declined modestly. The U.S. dollar (USD) fell relative to most foreign currencies. This provided a tailwind for non-U.S. investments, particularly those within emerging markets (EM). During the month, several domestic economic indicators exhibited positive trends and Federal Reserve representatives publicly indicated that a near-term rate hike was under consideration. As a result, markets increasingly raised expectations that a policy rate hike would occur in March. As expected, the Fed hiked rates by 25 bps at the March meeting, but investors were disappointed that Fed officials did not guide for a faster pace of policy normalization. Furthermore, as the hiking campaign continued to unfold, investor attention shifted toward the timing of Fed plans to alter the size of its balance sheet. The Fed continues to reinvest coupon payments and maturities of the bonds it holds, which has kept the overall size of its balance sheet constant at around $4.5 trillion. However, to move to a more restrictive policy stance, the Fed could look to slow or stop the reinvestment, which could cause financial conditions to tighten.
The U.S. dollar, as measured by the Dollar Spot Index, fell 0.8%. The USD fell against five of the six major developed market currencies that comprise the Index, with the 0.7% gain against the Canadian dollar being the sole outlier. In addition to a fall in the Canadian dollar, other developed market currencies that fared badly against the USD included the New Zealand dollar (−3.4%), the Norwegian krone (−2.7%), and the Australian dollar (−0.8%). A common theme impacting these developed market currencies was weakness in commodities, including falling prices in oil markets, industrial metals, and across the livestock category. The drivers of commodity weakness include a fragile macro economy, trade concerns, and rising geopolitical risks. While these factors help explain USD strength against a subset of developed market currencies, the broad weakness of the greenback against other currencies may be due to a few other factors. The Fed policy rate hike in the middle of the month is one potential factor. At the beginning of the year, markets did not expect a March rate hike. As it became increasingly evident the Fed would move earlier than expected, some investors felt the Fed may guide toward more rate hikes this year. However, Federal Open Market Committee projections continued to call for a total of three hikes in 2017, unchanged from projections made in December. This may have disappointed investors and removed optimism about the dollar. Another factor could be the failure of the GOP to repeal and replace the Affordable Care Act, which created uncertainty about the Trump administration’s goals for fiscal stimulus―both infrastructure spending and tax cuts―particularly since the failure to pass health care legislation largely stemmed from disagreements within the Republican ranks.
The market’s repricing of the potential benefits of the Trump agenda can be seen in the fluctuations of the Mexican peso. For 2016 and into January 2017, the peso was one of the worst performing currencies. However, the peso followed its 3.8% gain in February with a 6.2% rally in March. Although Mexico has taken steps to support its currency―such as unexpected central bank rate hikes and the launch of a large FX hedge program―fading fears of a border wall and a U.S. withdrawal of NAFTA were other factors that may have supported the peso. According to the U.S. Commodity Futures Trading Commission, hedge funds built up the largest bullish position in the peso since May 2016. As sentiment on the Mexican peso became bullish, other EM currencies rallied against the USD, including the Russian ruble (+3.7%), Polish zloty (+2.5%), Indian rupee (+2.8%), Thai baht (+1.6%), and South Korean won (+1.1%). However, there was divergence among emerging markets currency performance. The Egyptian pound fell 12.5%, retracing a large part of the 19.9% gain in February. The South African rand fell 2.5% due to political turmoil that included the dismissal of the finance minister and a reshuffling of President Jacob Zuma’s cabinet. Latin American currencies such as the Brazilian real (−2.0%), Chilean peso (−1.9%), and Uruguay peso (−1.5%) sold off amid rising geopolitical concerns in the region.
While the S&P 500 posted its largest quarterly gain since 2015, growing uncertainty over the Trump administration’s ability to enact his pro-growth agenda hurt certain portions of the market in March, and the S&P 500 was up only 0.1% in the month. Financials (−2.9%) and industrials (−0.8%), which have generated strong returns since the November election, were among the sectors negatively impacting the S&P 500 during the month.
International equity markets broadly outperformed U.S. equities. The MSCI EM Index was up 2.5% in USD and 1.9% in local currencies during March, ending the quarter with a strong showing (+11.4% USD, +7.8% local). Emerging markets shrugged off the Fed’s rate hike, as the move was widely expected. Mexico was the top performing market in the Index, gaining nearly 10% in USD terms and boosting YTD returns to 16%. Markets in Asia exhibited notable strength and were the largest drivers of the gains in the MSCI EM Index. Notable contributors included India (+6.0%) and South Korea (+5.3%). South Korea’s performance is noteworthy as the equity market showed resilience despite the impeachment and arrest of President Park Geun-hye in March.
The MSCI EAFE Index grew 2.8% during the month (+2.4% local), closing the first quarter up 7.2% (4.7% local). In March, Spain (+11.1%), Italy (+9.3%), and Portugal (+7.3%) were the top performers in the Index. The 56.2 final estimate of the Eurozone Manufacturing Purchasing Managers’ Index for March was the highest reading in six years and was consistent with the growth in annual industrial production. Also, euro area unemployment fell to its lowest rate in nearly eight years. While improving economic data points to a cautious recovery, the European Central Bank is expected to maintain its accommodative stance until the economic recovery is more firmly established and inflation is closer to the 2.0% target.
Global REITs declined 1.4% in March, as measured by the FTSE EPRA/NAREIT Developed Index, masking dispersion amongst regions. North American REITs (−2.7%) led the decline as the Federal Reserve raised policy interest rates and signaled multiple additional hikes in 2017. While domestic REITs reported solid fourth quarter earnings and underlying fundamentals appeared to remain in good standing, concerns about emerging pockets of weakness in fundamentals in select markets and sectors weighed heavily on REIT valuations. Notably, within the retail sector, concerns about the impact of e-commerce on certain brick and mortar retailers caused shopping center (−6.4%) and mall-focused REITs (−6.2%) to stumble. Recently, several major retailers, including Sears, J.C. Penney, and Macy’s, announced more store closings, potentially negatively impacting revenues for the sector.
Elsewhere, Asian real estate securities ended the month essentially flat (−0.4%), while European REITs advanced 1.0%. European REITs (ex-U.K.), which were up 1.3%, appeared to be buoyed by solid economic data and slightly lower bond yields across developed Europe. Within the U.K., REITs were also essentially flat (+0.4%) as Prime Minister Theresa May gave official notice that triggered the beginning of the country’s departure process from the European Union (EU). Post-Brexit, financial firms—a key component of the London and broader U.K. economy―may lose the “passporting rights” that currently allow them to sell products and operate freely across the single EU market. Immediately after the referendum vote in June 2016, U.K. REITs fell by 20% (local terms), but have recovered more than half of those losses. This is largely the result of fairly resilient underlying asset values that have been supported by solid leasing activity and a weaker pound, which has attracted foreign buyers. Some market observers believe the impact of Brexit on the London and U.K. commercial real estate markets may end up being less severe than originally thought. Financial corporations appear reluctant to relocate significant amounts of their London-based employees and many firms have existing European branches where they can add staff if necessary. Additionally, in recent years other sectors like technology, media, and telecom have accounted for a growing portion of space demand in the London economy.