September 2018

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

Trade was once again the most conspicuous concern for the markets in the quarter. With the posturing from each party becoming more and more confrontational, it was hard to see any “winners” emerging for all the “losses” of comity and shared beliefs in the benefits of free trade, hallmarks of what used to mark these discussions. However, with consumer and business confidence strong in the US, supported by an exceedingly robust job market and healthy corporate performance, investors were largely able to look past the negative news. Towards the end of the quarter, what started to weigh on the markets more was the upward move in interest rates that accompanied this good economic outlook. The yield on the US 10Y moved consistently above 3% which began to dent investor enthusiasm for risk assets.

Despite this myriad of geopolitical tensions, US markets posted strong results for the third quarter. The Russell 3000 Index finished the quarter with a return of +7.1%, one of the strongest quarters of the last several years. In a reversal of the second quarter, small cap stocks lagged meaningfully with the Russell 2000 Index returning +3.6% versus the Russell 1000 Index returning +7.4%. Markets outside of the US were more mixed. The developed market MSCI World ex USA Index returned +1.3% while the developing market MSCI Emerging Markets Index returned -1.1%. Fixed income markets were fairly muted with the Bloomberg Barclays US Aggregate Index returning +0.0%.

In the US at the Sector level, Health Care (+13.2%) was by and far the best performer for the quarter as investor enthusiasm for growth stories returned. Returns in Producer Durables (+8.9%) and Technology (+8.8%) were also strongly positive. While all sectors were positive for the quarter, the cyclical sectors of Energy (+0.0%) and Materials (+0.5%) were relative laggards.

Outside of the US, Health Care (+4.5%) also led but with a much more modest return. Unlike in the US, Energy (+4.1%) was actually another strong sector in non-US markets. The growth sectors of Consumer Discretionary (-2.8%) and Technology (-1.8%) were the main negative performers. At the country level, the best and worst performers were once again some of the smaller markets. On the positive side were Luxembourg (+16.2%), Thailand (+13.0%), and Poland (+12.5%) while Turkey (-20.9%), Greece (-19.3%), and Macau (-19.2%) led decliners.

Market volatility fell to even lower levels in the quarter with implied and actual price volatility measures both close to a full standard deviation lower than their historical averages. At the factor level, Smaller Size and Value were both strongly negative while Stability and Low Volatility rebounded from the weak performance of the prior quarter. Momentum was also positive while Quality was neutral. An equal-weighted portfolio underperformed the market-cap weighted portfolio as market breadth narrowed once more.