Sources: U.S. Equity: Russell 3000® Index, Non-U.S. Equity: Russell Developed ex-U.S. Large Cap Index, Emerging Markets: Russell Emerging Markets Index, U.S. Bonds: Barclays U.S. Aggregate Bond Index, Global REITs: FTSE EPRA/NAREIT Developed Real Estate Index, Commodities: Bloomberg Commodity Index, Balanced: 30% U.S. Equity, 20% Non-U.S. Equity, 5% EM, 35% Bonds, 5% REITs, 5% Commodities.
The following is the Russell Investments Chief Investment Officers’ views of the key themes affecting market performance in March 2016. All data is as of March 31, 2016. Sources and indexes used to represent asset classes can be found in the disclosures at the end of this post.
1. Fed slows pace of tightening
Concerns about market volatility, global growth and inflation expectations led the Federal Reserve (Fed) to adopt a more cautious approach to hiking rates. While hawkish members have voiced disagreement, Fed leadership appears content to now raise rates twice in 2016 – a view that is consistent with our own Global Market Outlook - Q2 Update Report.
2. Recession fears drop as U.S. economic data strengthens
The U.S. economy proved resilient again
at the start of 2016. The labor market added over 200,000 jobs per month in the face of significant uncertainty. The manufacturing sector showed signs of bottoming out. The U.S. economy continued chugging along, and that was good enough to drive a rebound in investor sentiment for March.
3. U.S. dollar weakens
The U.S. dollar depreciated 4% over the first quarter of the year. We view this behavior as consistent with the dollar peaking as expensive valuations and a slower pace of Fed rate hikes (from four to two) limited further upside.
1. Equities fell, but then rebounded intra-quarter
First quarter was a tale of two halves -- the first half was a risk-off environment with stocks following energy prices lower as investors feared a global slowdown. Mid-quarter, oil prices stabilized, and central bankers took note of market volatility. This reassured investors and helped shift the tide by boosting equities to be slightly positive for the quarter. Emerging markets was the most notable recovering segment rising 13% in March alone.
2. Macro-driven market overshadows security selection
With the market’s macro focus, bottom-up stock selection strategies were less effective as investors panicked and gravitated toward perceived safety. Consequently, defensive stocks overtook dynamic stocks and outperformed by approximately 5% in large cap and 9% in U.S. small cap. Growth stocks typically lagged value stocks by a small margin as higher growth and momentum stocks rolled over. Industry payoffs showed big deviations as well with U.S. large cap banks underperforming by 13%, while the energy sector rose 9% globally. Utilities rallied across all regions with U.S. large cap utilities outperforming by 1,400 basis points, the best quarterly performance since 1998. Biotechnology stocks were down significantly with the most acute underperforming the Russell 2000 by 28%.
3. U.S. dollar weakens and commodities rally
The U.S. dollar weakened due to diminished expectations of interest rate hikes. As a result, non-U.S. equity returns moved higher in U.S. dollar terms. Returns associated with currency gains were further amplified in commodity-rich regions, such as Canada and Australia, as materials and energy sectors bounced back. During the quarter, the Canadian dollar appreciated by approximately 7% while the Australian dollar appreciated by approximately 6% versus the U.S. dollar. A much stronger Japanese yen coupled with policy challenges meant Japan significantly lagged other markets.
1. Rates lower globally
Government bonds rallied amid sluggish global growth, a dovish U.S. Fed, and the announcement of further stimulus from both European and Japanese central banks.
2. Credit recovers
Credit markets outperformed globally. This was led by industrials and driven by a bottoming oil price, central bank accommodation and a firming U.S. economic outlook.
3. Emerging markets bounce back
Emerging market bonds and currencies outperformed most sectors as commodity prices and negative investor sentiment appeared to bottom out. This was combined with modest U.S. dollar depreciation given a more dovish Fed and an uptick in inflation.
1. Equities rebound
Real Estate Investment Trusts (REITs) and listed infrastructure experienced acceleration in total return. This coincided with a shift in market sentiment from defensive to more risk tolerant. Long-biased, equity-oriented hedge funds benefited from the rally in emerging markets and global equities.
2. Global central bank policies diverge
Slower Fed tightening and signals of dovish outlook affected rate-sensitive REITS and listed infrastructure. This also contributed to strong utilities performance. Listed infrastructure continued to be affected by the spread between U.S. and Eurozone short-term yields, which is close to historic highs. Negative rates in Japan, combined with Bank of Japan (BOJ) stock purchases created significant divergence in performance of Japanese REITs versus Japanese developers.
3. Commodity prices stabilize
Commodities rebounded in March. There were gains across most sectors in the Bloomberg Commodity (BCOM) Index. Energy was the best performing sector, up almost 8% thanks to rallies in oil and natural gas. The surge put the BCOM Index into slightly positive territory for the year, +0.42% year-to-date, but questions remain around the fundamental and macro drivers for the underlying sectors. Increased crude prices in the first quarter helped boost the listed infrastructure pipelines sector by over 14%.
Asset Class Dashboard – March 2016
Compared to the first two months of the year, the March reading of the Asset Class Dashboard shows the 12-month return for most asset classes are now well within their typical range and are getting much closer to their historical averages.
Following the rebound in March, several asset classes are now showing positive returns for the last 12 months, with emerging market debt and large cap defensive equities leading the way. Only small cap equities, commodities and cash have 12-month returns that falls outside of their historical typical range, compared to seven asset classes in February and five in January.
Large cap U.S. equity: Russell 1000® Index, Large cap Defensive U.S. equity: Russell 1000 Defensive Index, Large cap dynamic U.S. equity: Russell 1000 Dynamic Index, Small cap U.S. equity: Russell 2000 Index, Non-U.S. Equity: Russell Developed ex-U.S. Large Cap Index, Global equity: Russell Developed Large Cap Index, Emerging markets: Russell Emerging Markets Index, Commodities: Bloomberg Commodity Index, Global infrastructure: S&P Global Infrastructure Index, Global real estate: FTSE EPRA/NAREIT Developed Index, Cash: Citigroup 3-Month U.S. Treasury Bill Index, Global high yield bonds: Bank of America Merrill Lynch (BofAML) Global High Yield Index, Emerging markets debt: JP Morgan Emerging Markets Bond Index Plus, U.S. bonds: Barclays U.S. Aggregate Bond Index.
How do I read this chart?
This dashboard is intended as a tool to set context and perspective when evaluating the current state of a sample of asset classes.
The ranges of 12 month returns for each asset class are calculated from its underlying monthly index returns. The stated inception date is the first full month of an index's history available for the dashboard calculation.
Here is how to read the graphic on this page:
FOR EACH INDICATOR, THE HORIZONTAL BAR SHOWS FOUR THINGS
A GRAY BAR shows the full range of historical rolling 12-month returns for a sample of asset classes.
A BLUE COLOR BAND represents the typical range (one standard deviation away from the mean, i.e. 68% of historical observations) of rolling 12-month returns for these asset classes.
The bottom line
The rebound that the markets saw in March serves as a great reminder to investors of the importance of staying focused on their long term investment strategy and not overreacting to short-term market volatility.