Research & Insights

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

The year began largely as the prior one had ended – with generally sanguine views on economic fundamentals leading to rationalization of asset valuations.  The boost of a significant fiscal stimulus in the form of US tax cuts also helped to stoke animal spirits in the markets.  Technology stocks continued to be major beneficiaries of positive sentiment and momentum, helping propel many US indexes to record highs.  After raising rates as expected in December, US Fed policymakers appeared in agreement as to the need for more increases but divided in the number of them.  Sharpening the debate were signs of a nascent pick-up in inflation.  On the geopolitical front, a short US government shutdown had only a modest impact on markets but once again served as a reminder of the current dysfunction in US politics.  As concerns over rising interest rates and some profit taking in the high-flying Technology sector emerged, the beginning of February saw an acceleration of the market decline which had begun late the prior month.  Yields on benchmark 10Y US Treasuries hit a four-year high, and volatility, both implied (VIX) and observed, rose dramatically.  However, the passage of another stopgap spending bill in the US along with reassuring comments from central bankers and the IMF (and some amount of FOMO) appeared to assuage investor fears, and the long-lived bull market continued its upward climb by mid-month.  However, by March, while consumer confidence and employment metrics continued to be robust and overall economic conditions were largely positive, markets were unsettled by ongoing political dysfunction in the US and the threat of an escalating trade war between the US and the rest of the world.  The potential impacts of tariffs on steel and aluminum may ultimately be mitigated as many of the largest exporters to the US (who also happen to be significant geopolitical allies) were eventually exempted.  That left China as the main target of those and other potential tariffs.  A widening data privacy controversy involving Facebook also served to rattle investor nerves a bit, particularly in the previously high-flying large cap tech sector.

After an impressive run of months with historically low volatility and scant negative results, the first quarter of 2018 saw two down months in a row.  For the quarter, the US broad market Russell 3000 Index finished at -0.6%.  Returns in US small cap stocks were modestly better at -0.1%.  Outside of the US, performance was mixed as developed markets lagged the US while developing markets continuing their recent leadership.  The MSCI World ex USA Index returned -2.0%, and the MSCI Emerging Markets Index returned +1.4%.

Market volatility spiked up during the quarter with the VIX climbing over 80% and realized volatility at multiples of the levels from the prior year.  Trade volumes picked up incrementally but still remained at the lower ends of the historical range.  At the factor level, Value and Yield were meaningfully negative as Momentum and Quality continued to lead.  Equal-weighted portfolios underperformed market-cap weighted portfolios which, despite the late quarter reversal in large cap Tech, highlighted the ongoing narrowness of the markets.  At the sector level, Technology and Consumer Discretionary were once again the best performers for the quarter, and the only positive sectors to boot.  Yield and cyclical areas such as Consumer Staples, Energy, and Utilities were fairly negative.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

The beginning of February saw an acceleration of the market decline which had begun late the prior month. Concerns over rising interest rates and some profit taking in the high-flying Technology sector, paced the initial declines. Yields on benchmark 10Y US Treasuries hit a four-year high, and volatility both implied (VIX) and observed rose dramatically. However, the passage of another stopgap spending bill in the US along with reassuring comments from central bankers and the IMF (and some amount of FOMO) appeared to assuage investor fears, and the long-lived bull market continued its upward climb by mid-month. Given the market gyrations, there were some concerns over the influence of volatility-linked investment products, but the impacts were mostly confined to the liquidation of a few ETNs and a general realization of the weakness of the VIX as a gauge of market volatility. Economic growth globally continued to be good, not great, while signs of higher inflation began to manifest. Employment metrics in the US were robust which gave support to the US Fed’s plan for several further rate hikes this year.

Although a robust rally in the second half of the month cut losses, the Russell 3000 Index finished the month down with a return of -3.7%. Despite the market reversal, the Technology sector (+0.2%) continued its leadership and was the only positive sector for the month. Energy (-11.2%) was dramatically lower, and defensive/yield categories such as Consumer Staples (-7.5%), Materials (-5.7%), and Utilities (-5.5%) lead decliners. Size was not a significant factor as US small cap stocks were only incrementally worse than large caps with the Russell 2000 Index returning -3.9% and the Russell 1000 Index returning -3.7%. Outside of the US, returns were modestly more negative. The developed market MSCI World ex USA Index returned -4.8%, and the developing market MSCI Emerging Markets Index returned -4.6%.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

The year began largely as the prior one had ended – with generally sanguine views on economic fundamentals leading to rationalization of asset valuations. The boost of a significant fiscal stimulus in the form of US tax cuts also helped to stoke animal spirits in the markets. Technology stocks continued to be major beneficiaries of positive sentiment and momentum, helping propel many US indexes to record highs. After raising rates as expected in December, US Fed policymakers appeared in agreement as to the need for more increases but divided in the number of them. Sharpening the debate were signs of a nascent pick-up in inflation. Corporate M&A activity followed the positive trends of last year with particular energy in the Health Care space as the first few days of the year saw $11 billion in bids for biotech firms. After the astounding rise of cryptocurrencies in the last several months, the voices of skeptics grew louder and bitcoin entered a bona fide correction of greater than 40%. A $534 million loss at Coincheck, a Japanese cryptocurrency exchange, did not help sentiment. On the geopolitical front, a short US government shutdown had only a modest impact on markets but once again served as a reminder of the current dysfunction in US politics. Brexit negotiations inched along, and China re-affirmed a 6.5% GDP growth target for the year. The initial reading for US GDP growth for Q4 2017 was an annualized 2.6%, with the full-year value coming in at 2.3%. Eurozone GDP rose 2.5% over the last year which was the fastest pace since 2007.

The Russell 3000 Index finished the month up +5.3%, continuing the robust market performance of the prior year. Leadership came from the traditional growth sectors of Consumer Discretionary (+8.1%), Technology (+7.1%), and Health Care (+6.7%) while defensive/yield categories such as Utilities (-2.1%) and Consumer Staples (+0.8%) lagged. US small cap stocks once again failed to keep pace with large caps with the Russell 2000 Index returning +2.6% versus the Russell 1000 Index returning +5.5%. Outside of the US, the developed market MSCI World ex USA Index returned a more modest, but still healthy, +4.7% return while positive perceptions of growth and valuation in developing markets drove the MSCI Emerging Markets Index to a buoyant +8.3% return.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

The quarter started with the absence of any major economic or geopolitical news. That left investors to contemplate the generally sanguine and oddly complacent nature of the markets. In the US, the Republican tax plan was the main political story as people assessed both the substance of the legislation (potential elimination of various tax preferences, permanent reduction in the corporate tax rate) and likelihood of passage. Meanwhile, US Fed policy continued along the same path of gradual reduction of its balance sheet, support for periodic and modest rate increases, and copious amounts of messaging regarding this approach. Outside of the US, Brexit negotiations continued to be halting with little progress made between the UK and the EU. Optimism propelled the markets forward as investors anticipated a continuation of steady economic growth, good corporate performance, and accommodative monetary policy. As markets pressed upwards, discussions shifted from a focus on valuations to justifications for continuing bullishness. Corporate M&A activity was robust as corporate and private equity cash supported transactions. A lot of attention was also given to the remarkable rally in bitcoin (over +1,300% this year!) as option exchanges launched futures contracts but policymakers warning of risk. With people lined up on both sides of the debate, only time will tell whether bitcoin can live up to the hype that has driven its value to such lofty levels. The US Fed raised interest rates for the third time in the year and re-iterated its guidance for further increases in 2018. As the year ended, the Republican tax plan passed the US Congress with the headline change being a decrease in the corporate tax rate from 35% to 21%.

For the quarter, the US broad market Russell 3000 Index finished at +6.3%, bringing the full year return to +21.1%. More impressively, this was all accomplished with historically low volatility and no negative monthly returns during the year. Returns in US small cap stocks were also robust for the year, but not nearly as strong as their large cap counterparts. The Russell 2000 Index returned +3.3% for the quarter and +14.7% for the year. Outside of the US, performance in developed markets rebounded from several years of lackluster performance to finally outpace the US. The MSCI World ex USA Index returned +4.2% for the quarter and +24.2% for the year. Developing market performance was even better with the MSCI Emerging Markets Index returning +7.4% for the quarter and +37.3% for the year.

Market volatility remained at the low end of historical ranges on both an implied (VIX-based) and realized basis. Trade volumes remained quite low, particularly in the second half of the year. At the factor level, Smaller Size and Value were significantly negative for the quarter and the worst performing factors for the full year period. Momentum and Quality were positive for the quarter and the best performing factors for the full year period. Equal-weighted portfolios underperformed market-cap weighted portfolios for the quarter and year, which continued to highlight the leadership of a handful of mega-cap Technology names during this period. At the sector level, Consumer Discretionary and Technology were the best performers for the quarter. The Technology sector’s +35% return for the year was well over 10% better than the return of the next best sector, Consumer Discretionary, which returned +22%.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

With little in the way of substantive news events, optimism propelled the markets forward as investors anticipated a continuation of steady economic growth, good corporate performance, and accommodative monetary policy. US consumer confidence rose to its highest levels in nearly 17 years as various market indexes hit record highs. Corporate M&A activity was robust as corporate and private equity cash supported transactions. As expected, the US Fed left its policy rates unchanged but signaled a likely increase in December. The progression of work on the Republican tax plan also served to buoy investor sentiment with market movements sometimes influenced by changing assessments of the likelihood of passage. Should the tax plan pass, investors would have to determine how much of any potential positive impact is already priced in. A lot of attention was also given to the remarkable rally in bitcoin (+1,200% this year!) as option exchanges prepared for the launch of futures contracts. With people lined up on both sides of the debate, only time will tell whether bitcoin can live up to the hype that has driven its value to such lofty levels. On the geopolitical front, Brexit negotiations made slow and uneven progress, Saudi Arabia commenced a sweeping crackdown on corruption, and Venezuela was declared in default on its sovereign debt.

The Russell 3000 Index finished the month at +3.0%, extending the run of positive performance for the broad US equity market to thirteen months. The high-flying Technology sector took a breather for the month ending as the worst performer with a +0.8% return, with Consumer Discretionary (+5.0%) and Consumer Staples (+4.4%) leading. US small cap stocks lagged large caps slightly with the Russell 2000 Index returning +2.9% versus the Russell 1000 Index returning +3.1%. Outside of the US, the developed market MSCI World ex USA Index returned a more modest +1.0% while the robust rally in developing markets this year paused for the month with the MSCI Emerging Markets Index returning +0.2%.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

In the absence of any major economic or geopolitical news, investors were left to contemplate the generally sanguine and oddly complacent nature of the markets. In the US, the Republican tax plan was the main political story as people assessed both the substance of the legislation (potential elimination of various tax preferences, permanent reduction in the corporate tax rate) and likelihood of passage. Meanwhile, US Fed policy continued along the same path of gradual reduction of its balance sheet, support for periodic and modest rate increases, and copious amounts of messaging regarding this approach. The nomination of current Fed Reserve Governor Jerome Powell to be the next Fed chair was seen as a vote for continuity. The only wrinkle to the Fed’s plan was the persistence of low inflation despite tight labor markets. Outside of the US, Brexit negotiations continued to be halting with little progress made between the UK and the EU. Odds rose for a “hard” Brexit, but markets mostly shrugged it off. Employment figures were positive as the unemployment rate fell in both the US and Eurozone. Other economic measures showed continued improvement which resulted in the IMF raising its 2017 growth forecast. In China, the Party Congress cemented President Xi Jinping’s control over the country and elevated him to the level of former leaders Mao and Deng.

The Russell 3000 Index finished the month at +2.2%, marking the twelfth consecutive month of positive performance for the broad US equity market. In fact, there has only been one negative month (October 2016) in the past 20! Sector performance was dominated by Technology as the +7.6% return in that sector was double the +3.4% return of next best sector of Materials. After the brief rebound of September, US small cap stocks reverted to lagging large caps with the Russell 2000 Index returning +0.9% versus the Russell 1000 Index returning +2.3%. Outside of the US, the developed market MSCI World ex USA Index returned +1.4% while developing markets continued their strong performance for the year with the MSCI Emerging Markets Index returning +3.5%.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

After several months of modest gains shadowed by questions over potential central bank tightening, investors interpreted US Fed Chair Yellen’s July testimony to Congress as somewhat more “dovish” on the outlook for inflation and the pace of further monetary policy action. The European Central Bank was more reticent, but EU officials tried to calm concerns regarding potential reduction in accommodation. On the corporate front, earnings growth continued to impress and mergers and acquisition activity remained robust. On the geopolitical scene, US politics continued to be roiled with each new revelation while tensions over North Korea increased with bombast coming from both sides. Given all of the macro and political drama of the last several months, the month of August was relatively quiet as volatility remained low and US 10 year yields declined, reflecting a sanguine if not jaded view of things. While consumer spending and factory activity showed some softening, corporate results continued to be strong and broader macroeconomic growth was steady if unspectacular. Low inflation readings clouded the outlook for further US Fed action, but the consensus view was still one of balance sheet reduction and an additional rate hike before year end (although there appeared to be more dissention than normal on this point). September saw the return of the bulls as a mostly benign macro environment gave optimists reasons to believe the market rally still had legs. A debt-limit deal in the US produced a brief moment of bipartisan action, but those feelings would prove to be short-lived. At the US Fed meeting, the group expressed enough confidence in the strength of the US economy to start reducing its $4.5 trillion balance sheet in October. Outside of markets, the hacks on consumer credit reporting firm Equifax and the US SEC highlighted the growing potential risk of lax cybersecurity throughout the business community.

For the quarter, the US broad market Russell 3000 Index finished at +4.6% extending year-to-date returns to nearly +14%. Returns in US small cap stocks finally outpaced their large cap counterparts as the Russell 2000 Index returned +5.7%. Outside of the US, performance in developed markets continued to outpace the US with the MSCI World ex USA Index returning +5.6%. Performance in developing markets was even stronger with the MSCI Emerging Markets Index returning +7.9%, increasing its advantage over developed markets to over 8% on a year-to-date basis.

Market volatility remained quite low with the VIX hitting its lowest level in decades. Despite the strength of market performance, trade volumes were well below long-term historical averages. At the factor level, Value, Stability, and Low Volatility were fairly negative. Momentum, Quality, and Smaller Size were positive factors. Equal-weighted portfolios underperformed market-cap weighted portfolios, highlighting the outsized contribution a few larger cap Technology names continue to have on index performance for the year. At the sector level, Technology and Energy led while Consumer Staples was the only negative performer for the period.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

Given all of the macro and political drama of the last several months, the month of August was relatively quiet. Of course there was posturing around trade deals, budget/debt-ceiling negotiations, and administration-created controversy (this time around protests in Charlottesville), but volatility remained low and US 10 year yields declined, reflecting a sanguine if not jaded view of things. While consumer spending and factory activity showed some softening, corporate results continued to be strong and broader macroeconomic growth was steady if unspectacular. US market indexes hit record highs, but the gains were being driven by a more and more narrow segment of mega cap leaders. Low inflation readings clouded the outlook for further US Fed action, but the consensus view was still one of balance sheet reduction and an additional rate hike before year end (although there appeared to be more dissention than normal on this point). The tension between the US and North Korea remained, but the incalculable cost of any direct conflict made it difficult to price into the markets.

The Russell 3000 Index finished the month at +0.2%. While the result was modest, it was notably the tenth month in a row of positive performance for the broad US market. Sector performance was quite mixed as Technology and Health Care were strongly positive while Energy, Consumer Discretionary, and Consumer Staples were correspondingly negative. US small cap stocks continued to underperform large caps with the Russell 2000 Index returning -1.3% versus the Russell 1000 Index returning +0.3%. Outside of the US, the developed market MSCI World ex USA Index was essentially flat at -0.0% while the developing markets added to their strong performance for the year with the MSCI Emerging Markets Index returning +2.2%.

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

After several months of modest gains shadowed by questions over potential central bank tightening, investors interpreted US Fed Chair Yellen’s testimony to Congress as somewhat more “dovish” on the outlook for inflation and the pace of further monetary policy action. The European Central Bank was more reticent, but EU officials tried to calm concerns regarding potential reduction in accommodation. On the corporate front, earnings growth continued to impress and mergers and acquisition activity remained robust. Global manufacturing indicators were generally positive, and China’s Q2 GDP of +6.9% exceeded most forecasts, giving a boost to many other emerging Asian economies as well. On the geopolitical scene, US politics continued to be roiled with each new revelation – a meeting in Trump Tower with Russian nationals, potential investigations into Trump finances, more personnel turnover at the White House, uncertainty over the fate of US health care legislation. Meanwhile, tensions over North Korea increased with bombast coming from both sides.

At the end of all of this, the Russell 3000 Index finished the month at +1.9%. All sectors were positive for July with Technology and Utilities as the leaders for the month. US small cap stocks underperformed large caps with the Russell 2000 Index returning +0.7% and the Russell 1000 Index returning +2.0%. Outside of the US, market performance was much stronger as weakness in the US dollar boosted the USD-denominated returns of the developed market MSCI World ex USA Index to +3.0% and the developing market MSCI Emerging Markets Index to +6.0%.