Research & Insights

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

The year started with alternating periods of rally and reversal as the markets struggled for direction.  Strong returns in the prior quarter left valuations at less attractive levels and mixed economic data left plenty of ammo for both bulls and bears to act upon.  By February, the price of oil stabilized, and things were generally more sanguine on the macro front.  Although US GDP growth for Q4 2014 fell short of expectations, growth for the overall year was still the highest in four years.  A surge of M&A activity in the pharmaceuticals space also helped to stoke investor sentiment, and February turned out to be an exceptionally strong month for most equity markets.  Despite the inception of QE by the ECB, volatility returned in March as mixed economic data was perceived as either good (decreasing the likelihood of a Fed rate hike) or bad (slower long-term growth less supportive of robust valuations) for the markets.

The US broad market Russell 3000 Index finished the quarter up +1.8%.  US small cap stocks continued their recovery from the underperformance of early 2014 with the Russell 2000 Index returning +4.3%.  Outside of the US, developed markets showed good strength with the MSCI World ex USA Index returning +3.8% while emerging market stocks as represented by the MSCI EM Index were slightly weaker at +2.2%.

Performance for active managers was generally negative during the quarter.  Despite some meaningful moves up and down, overall market volatility continued to remain low.  On a factor basis, smaller size and non-US exposure were beneficial while value and stability were significant negatives.  Quality and momentum were incrementally positive at different points in the quarter.  The strength of Health Care aside, sector spreads were below average.  From a manager style perspective, value and core managers held up better in small cap while growth managers did better in large cap.

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

Following the choppiness seen in January, February turned out to be an exceptionally strong month for most equity markets.  Although US GDP growth for Q4 2014 fell short of expectations, growth for the overall year was still the highest in four years.  The price of oil stabilized, and things were generally more sanguine on the macro front.  A surge of M&A activity in the pharmaceuticals space also helped to stoke investor sentiment.  That said, China was notable for a number of data points indicating some economic weakness.

The US broad market Russell 3000 Index finished the month at +5.8%.  US small cap stocks were marginally better with the Russell 2000 Index returning +5.9%.  Outside of the US, returns were comparable in the developed markets as the MSCI World ex USA Index returned +6.0%, but developing markets were relative laggards with the MSCI Emerging Markets Index returning +3.1%.

After a stretch of several challenging months, active manager performance was finally broadly positive.  Sector spreads increased, and the leadership of Technology was likely beneficial for many managers.  Volatility, either measured by the VIX or cross-sectional indexes, was still near the low end of historical ranges so outperformance may have been due more to positioning than security selection.  Trade volumes continued to move lower.  On a factor basis, underweights to low volatility, value, stability, and momentum were helpful while size was largely neutral.

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

January saw alternating periods of rally and reversal as the markets struggled for direction.  Strong returns in the prior quarter left valuations at less attractive levels and mixed economic data left plenty of ammo for both bulls and bears to act upon.  While the price of oil continued to fall, the rate of decline eased and a near-term floor of $45 appeared to be set.  A surprise decision by the Swiss National Bank to abandon a 3-year-old currency cap, victory for an anti-austerity party in Greece, and the ongoing armed conflict in Ukraine added to macro uncertainty.  On the liquidity front, the ECB became the latest member of the QE club with a €60 billion a month bond-buying program while the Fed indicated that interest rates likely won’t be increased before June.

The US broad market Russell 3000 Index finished the month at -2.8%.  US small cap stocks lagged slightly with the Russell 2000 Index returning -3.2%.  Outside of the US, returns were better with the developed market MSCI World ex USA Index returning -0.4% while the MSCI Emerging Markets Index returned +0.6%.

Active manager performance for the month was challenged by the same market dynamics that have been at work for the past 12-18 months – narrow markets and lower cross sectional volatility.  Volatility as measured by the VIX and 20 day price movements did increase, but trading volumes remained lower than historical averages.  On a factor basis, underweights to value and overweights to momentum and lower volatility were helpful with quality and stability largely neutral.

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

Starting the quarter, October looked like a perfectly reasonable recovery from the declines of the prior month.  However, end-point results masked significant intra-month volatility as the markets swung from bearishness to bullishness in the blink of an eye.  Macroeconomic concerns in Europe and China gave the bears reasons to sell mid-month, but better US data and strong US company earnings reports reignited the rally. November saw a consolidation of the market rally, and most days saw steady if unspectacular gains.  The most meaningful macro story of the quarter was the acceleration of the collapse in the price of oil which had started in earnest in July.  By the end of the quarter, the price of oil was down close to 50%.  Bears saw the decline as a reflection of weaker global growth, but Bulls focused on the on-going accommodative stance of the Fed (despite the end of the latest round of QE).  Volatility increased and the quarter (and year) ended on an uncertain note.

The US broad market Russell 3000 Index finished the quarter up +5.2%.  US small cap stocks staged a strong recovery from the underperformance of the past 12 months with the Russell 2000 Index returning +9.7%.  Outside of the US, developed markets were again negative with the MSCI World ex USA Index returning -3.7% while emerging market stocks as represented by the MSCI EM Index were worse at -4.5%.

Performance for active managers was mixed during the quarter.  While overall market volatility did increase, cross-sectional volatility remained near historical lows.  On a factor basis, small size was significantly positive as were the defensive characteristics of stability and low volatility.  Value and quality were largely neutral, and momentum was slightly negative.  Of note, any type of Energy overweight was a major detractor as the sector underperformed the broader market by close to 20%.  From a manager style perspective, defensively-oriented managers held up best while performance of most small cap managers was challenged regardless of style.

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

November saw a consolidation of the market rally which began in mid-October.  Market volatility continued to decline, and most days saw steady if unspectacular gains.  The price of oil accelerated its collapse towards $60/barrel, a level last seen in during the depths of the recession in 2009, and correspondingly energy and energy-related stocks underperformed the broader market dramatically.  Q3 GDP growth for the US was revised upwards (from +3.5% to +3.9%), but globally the trend was towards lowering growth expectations.

The US broad market Russell 3000 Index finished the month at +2.4%.  US small cap stocks lagged meaningfully with the Russell 2000 Index returning +0.1%.  Outside of the US, returns were more modest with the developed market MSCI World ex USA Index returning +1.2% while the MSCI Emerging Markets Index returned -1.1%.

Active manager performance was once again variable with stronger relative performance coming from overweights to larger size, growth, quality, and low volatility.  Market volatility remained low from both a VIX and cross sectional volatility perspective, and after a spike in October, volumes returned to the low levels seen most of the year.  In this environment, Core managers did quite well with Growth managers struggling and Value managers mixed.

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

On the whole, October looked like a perfectly reasonable recovery from the declines of the prior month.  However, end-point results masked significant intra-month volatility as the markets swung from bearishness to bullishness in the blink of an eye.  Despite the Fed’s re-affirmation of their guidance to keep interest rates low for a “considerable time”, macroeconomic concerns in Europe and China gave the bears reasons to sell mid-month.  Better US data (capped by a 3.5% GDP growth reading for Q3) and strong US company earnings reports reignited the rally, and a surprise increase in monetary easing in Japan sustained it.

The US broad market Russell 3000 Index finished the month at +2.8%.  US small cap stocks rebounded strongly from the prior month’s underperformance with the Russell 2000 Index returning +6.6%.  Outside of the US, returns were weaker with the developed market MSCI World ex USA Index returning -1.6% while the MSCI Emerging Markets Index returned +1.2%.

Active manager performance was mixed with the best relative performance coming from overweights to smaller size, low volatility, and stability.  Market volatility as measured by the VIX spiked significantly mid-month before falling back while cross sectional volatility inched up slightly.  That said, at month end both measures remained fairly below their long-term averages.  Volumes increased quite a bit month-over-month but were also below their long-term averages.  In this environment, style was not strongly predictive of relative results as portfolio positioning and individual security selection was more relevant.

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

The month of July was thirty days of relative calm in the markets punctuated by a sharp selloff on the last day.  Economic data was generally positive, but deflation once again became a concern in Europe along with the realization that the ECB will likely have to stay accommodating for much longer than their UK and US peers.  By August, the tragic downing of a Malaysian Airlines flight over Ukraine, Argentina’s default, and the rescue of Portuguese bank Banco Espirito Santo raised investor anxiety.  Economic news turned weak with the US unemployment rate edging up slightly and data disappointing in both China and Europe.  However, as in many recent rallies, central bank accommodation fueled a mid-month recovery as the ECB moved closer to quantitative easing and central bankers worldwide generally affirmed the appropriateness of easy monetary policy given current economic conditions.  By mid-September, concerns regarding global growth, voiced most notably by the IMF, served to highlight the limits of monetary policy and a meaningful market sell-off closed out the quarter.

The US broad market Russell 3000 Index finished the quarter essentially flat at +0.0%.  US small cap stocks were significantly worse with the Russell 2000 Index returning -7.4%, bringing the underperformance of small cap versus large cap to over 15% in the past 12 months!  Outside of the US, developed markets were generally negative with the MSCI World ex USA returning -5.7%.  Emerging market stocks held up slightly better, finishing the quarter at -3.5%.

Following a difficult first half of the year, active manager performance was generally positive as the incremental return of volatility along with broader sector performance spreads provided opportunities for differential results.  That said, while overall market volatility did increase (particularly towards the end of September), cross-sectional volatility remained at the lower end of historical ranges.  On a factor basis, small size was significantly negative, value and momentum were somewhat negative, and quality and stability were positive.  From a manager style perspective, core managers performed well as did value managers with a more relative value bias.  Growth managers had mixed results.