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Institutional Perspectives

Improving economic data and enhanced support from key central banks, especially the U.S. Federal Reserve (Fed), helped lift markets late in the quarter, confounding the doomsayers. 

 

In Brief:

  • Embedded in the market’s performance over the past year has been a laundry list of global worries.
  • Despite all the uncertainty, investor sentiment started to shift for the better in September 2019, reflecting, in large part, the Fed’s decision to support the markets with another rate cut in September.
  • There was also growing recognition of strengthening U.S. economic data although, interestingly enough, the improving data went almost unreported by the financial media.

 

Despite a sharp pullback in August, risk assets rose almost across the board in the third quarter ended September 30, 2019. The S&P 500® Index was up 1.7% for the quarter. Bonds, as measured by the Bloomberg Barclays U.S. Aggregate Bond index, rallied 2.3%.  

The positive third quarter returns added to what has been a really strong year through the nine-month period ended September 30, 2019, as illustrated by a globally balanced portfolio (see Chart 1) returning 14.5% year-to-date.

 

Chart 1. Asset Prices Rose Broadly in the Third Quarter as Bond Yields Declined

Source: Bloomberg. YTD as of September 30, 2019. As represented by S&P 500 Index, MSCI EAFE Index, Bloomberg Barclays U.S. Corporate Investment Grade Index, Bloomberg Barclays US Corporate High Yield Index, Bloomberg Barclays U.S. Aggregate Index, Credit Suisse Leveraged Loan Index, and Bloomberg Barclays 1-3 Year U.S. Corporate Index. *45% S&P500 Index, 15% MSCI ACWI ex U.S., and 40% Bloomberg Barclays U.S. Aggregate Index (rebalanced monthly). Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Of course, the strong returns so far in calendar 2019 reflect a considerable bounce-back from the poor performance of the 2018 fourth quarter. The S&P 500, for example, peaked at an index value of 2931 on September 20, 2018, which means that the equity benchmark had risen only 1.6% from that peak as of September 30, 2019.

Because markets in the United States have been trading in a narrow range for the past year, it would be incorrect to say, therefore, that 2019 to date has been a year when investors fundamentally changed their expectations for the market. In fact, until very recently, valuations in the United States have adjusted downwards for most of the past 18 months. And investor sentiment has been largely pessimistic.

Trade Concerns and “Cyclitis”
Embedded in the market’s performance over the past year has been a laundry list of global worries. The biggest worry, in our opinion, has been, and continues to be, concerns about a worsening global trade conflict between the United States and China. On the consumer side, rising tariffs on Chinese imports to the United States threaten to increase prices on consumer goods. Corporations face the potential for increased costs and lower profits if they are forced to redirect supply chains from China and shift production to other countries. Trade uncertainties may cause companies to delay expansion plans and lead to an even sharper slowdown in global economic growth. This turbulence is already proving disruptive to global trade (see Chart 2), which shows a recent growth rate of below zero—a very rare degree of weakness outside of global recession.

 

Chart 2. Uncertainty about Tariffs and Trading Relationships Has Caused a Sharp Slowdown in Global Trade

Source: Bloomberg. Data as of July 31, 2019 (3-month moving average). Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

But the uncertainty surrounding issues of global trade, while significant, is not the only factor that has been feeding investor concerns.  There is also a phenomenon which we will call “cyclitis”—i.e., a fear that the decade-long expansion phase of the current U.S. credit cycle is near an end and that a recession is nigh. The markets have started to price in some things which are typically (although not always) characteristic of the end of an economic expansion, such as the dreaded inverted yield curve, whose reliability as a predictor of recessions we have discussed here.  The large amount of “BBB”- rated corporate debt now residing in ETFs and comingled funds, and the $17 trillion in negative-yielding debt (largely in Europe and Japan) are also factors troubling investors.  

The fundamental problem has been that many of the concerns we face today are new to our collective experience—particularly negative-yielding debt. Bonds yielding below zero were thought to be impossible, and the consequences of negative yields going back to positive values are fraught. The risk presented by negative-yielding debt is, therefore, totally unknown; it cannot be priced into the market with a probability distribution that we are familiar with. And such uncertainty is very damaging to business confidence and financial behavior.

A Shift in Investor Sentiment
Despite all the uncertainty, however, investor sentiment started to shift for the better in September 2019, reflecting, in large part, the Fed’s decision to support the markets with another rate cut in September, following the first one in July.    

There was also growing recognition of strengthening U.S. economic data although, interestingly enough, the improving data went almost unreported by the financial media. But the JP Morgan Economic Activity Surprise Index (see Chart 3) captured the point at which the data started to exceed investor expectations during the third quarter.

 

Chart 3. Economic Data Have Started to Outperform Forecasts After a Long Stretch of Shortfalls
JP Morgan Economic Activity Surprise Index*, (July 2014-September 2019)

Source: Bloomberg. Data as of September 30, 2019. *The JP Morgan Economic Surprise Index captures shifts in economic growth projections by looking at the recent history of economic activity that digresses from consensus expectations. Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

In September, with a shift in market sentiment, we also witnessed a rotation in market leadership, as noted in Chart 4. You can see the change most dramatically in short gold positions. Gold is an asset that trades with systemic risk concerns, i.e., gold tends to rally when risk concerns are high. Short gold (i.e., short positions in the metal) was down 18.5%, meaning that if you were long gold in the first eight months of the year, you made 18.5%. But that reversed in September, when the price of gold fell—and being short paid off.

You can see the shift in other risk assets as well. The Japanese yen typically rallies against the U.S. dollar in a risk-off environment, which it did through the first eight months of the year, by 3.1%. That reversed in September. High yield versus investment-grade corporates, small cap versus large cap, value versus growth—all the internals of the market started to shift in September versus their performance in the prior eight months.

 

Chart 4. Market Leadership Changed as Investors’ Outlook Shifted from Negative to Positive
Sector leadership as measured by returns of respective benchmarks, (as of September 30, 2019)Source: Bloomberg. Data as of September 30, 2019. Returns shown represent the difference between indexes.
U.S. Value - Growth as represented by Russell 1000 Value Index and Russell 1000 Growth Index. U.S. Small Cap - Large Cap as represented by Russell 2000 Index and Russell 200 Index. Emerging - Developed Markets as represented by MSCI EM and MSCI World. U.S. High Yield – Corporate as represented by Bloomberg Barclays US Corporate High Yield Index and Bloomberg Barclays US Agg Corporate Index. 1-3Y Corporate - U.S. Treasury as represented by ICE BofAML U.S. Corporate 1-3 Year Index and Bloomberg Barclays US Treasury Index. Short Gold as represented by the returns an investor would have realized by taking a short position in gold. A short, or a short position, is created when a trader sells a security first with the intention of repurchasing it or covering it later at a lower price.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

It is in times such as these, when perceived reality wrestles with the actual data, that we believe investment opportunities arise. In next week’s Market View, we examine how such a divergence in market opinion has been creating new investment avenues for active managers to explore.  

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Glossary of Terms

The Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market.

The Bloomberg Barclays U.S. Corporate Investment Grade Index is the corporate component of the U.S. Credit index. The U.S. Credit index is defined as publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements.

The Bloomberg Barclays U.S. Corporate High Yield Bond Index is a market value-weighted index which covers the U.S. non-investment grade fixed-rate debt market. The index is composed of U.S. dollar-denominated corporate debt in Industrial, Utility, and Finance sectors

The Bloomberg Barclays 1-3 Year U.S. Corporate Investment Grade Index is a component of the U.S. Credit index. The U.S. Credit index is defined as publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements.

The Bloomberg Barclays U.S. Aggregate Corporate Index is the corporate component of the U.S. Aggregate Bond Index, which represents securities that are SEC-registered, taxable, and dollar denominated.

The Bloomberg Barclays U.S. Treasury Index is the U.S. Treasury component of the U.S. Government Index. The index includes public obligations of the U.S. Treasury with a remaining maturity of one year or more.

The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market.

The ICE BofAML 1-3 Year U.S. Corporate Index is an unmanaged index comprised of U.S. dollar denominated investment grade corporate debt securities publicly issued in the U.S. domestic market with between one and three years remaining to final maturity.

Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN "AS IS" BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD, ABBETT & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.

 The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada.

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

The MSCI ACWI (All Country World Index) ex-US is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets, excluding the United States.

The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Russell Top 200® Index measures the performance of the 200 largest companies in the Russell 1000 Index, which represents approximately 68% of the total market capitalization of the Russell 1000 Index.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.  If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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