Kai W. Hong, CFA
Managing Director & Chief Investment Strategist
While the last few days of June saw a large dose of Brexit-induced volatility, the market recovery was well on its way by the start of July as many of the consequences investors feared failed to materialize. There will be meaningful impacts from the coming change, but the scope and magnitude of those will only become clearer in the months and years ahead. While broad global macroeconomic metrics continued to be mixed, the US remained a relative bright spot with a strong rebound in US job growth, an accommodating US Fed, and good company earnings pacing the markets upwards. However on the risk-side, US consumer sentiment and spending were seeing some softening, corporations were stockpiling cash, valuations in many markets continued to be elevated, and expectations for an interest-rate increase in the US before year-end grew. August was a period of relative calm as competing macro considerations left investors wondering how to position portfolios. Volatility and trading volumes were unusually low, and there appeared to be few catalysts to drive either bullish or bearish sentiment. Q2 US GDP came in at a modest 1.2% as robust consumer spending was offset by retrenchment in business investment. This followed a downwardly revised Q1 GDP reading of 0.8%. While this made the possibility of near-term tightening by the US Fed less likely, growing support within the Fed for a rate increase combined with declining forward growth expectations and elevated valuations served to restrain broad-based buying. In the absence of any notable catalysts, ongoing anxiety regarding potential monetary policy tightening drove a brief swoon in the markets prior to the Fed’s mid-September meeting. The meeting ended up being one of the more contentious in recent memory with three Fed members dissenting from the decision to keep rates on hold. Interpretations of the comments from the meeting pointed to a probable rate increase in December. Political uncertainty in the US added to investor unease as polls tightened and the exchanges between the campaigns became more heated.
For the quarter, the US broad market Russell 3000 Index finished at +4.4%, primarily on the strength of a robust July. US small cap stocks were dramatically better as the Russell 2000 Index returned +9.1%. Outside of the US, developed markets shrugged off the Brexit concerns from Q2 with the MSCI World ex USA Index returning +6.3%. Momentum in developing markets continued as the MSCI Emerging Markets Index returned +9.0%.
Volatility for the quarter was lowest during the robust July period and steadily increased into a largely range-bound August and September. However, both daily price volatility and implied volatility remained at the lower end of their ranges for the last twelve months. Average volumes traded continued to decline from their levels of Q1. At the factor level, Smaller size was strongly positive with Quality also favored. The former market leaders of Stability, Low Volatility, and Yield all lagged as did Momentum. Value as a factor was largely neutral. At the sector level, Technology was a strong outperformer while Utilities and Consumer Staples lagged meaningfully.