Markets in perspective – October 2016 in review

Capital Market Returns October 2016 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: Bloomberg 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 themes affecting market performance in October 2016. All data is as of October 31, 2016. Sources and indexes used to represent asset classes can be found in the disclosures at the end of this post.


  1. Earnings season improved globally
With Q3 earnings season still underway, early results have been encouraging. S&P 500® Index net income is up 3% after five consecutive quarters of negative growth. European earnings ex-financials are even stronger and profit margins are on an upward trajectory in that region.
  1. Central bankers stood pat
The Fed continued to guide the market towards a December rate hike and on the back of these policy expectations and firmer inflation numbers, the 10-year U.S. Treasury yield ended October at its highest level since May. The trade-weighted dollar appreciated 3% over the month. Neither the European Central Bank nor Bank of Japan made changes to their policy mix.
  1. Global economic data met modest expectations
Business activity surveys in the U.S., Eurozone, Japan, and China all showed a modest improvement in October. The global cycle continued to chug along.


  1. Rate-sensitive assets reacted sharply
While more than half of all global sovereign bond yields remained at or below zero, U.S. interest rates (as measured by the 10-year Treasury) rose another 24 basis points to end the month of October at 1.84%. This is close to 40 basis points above 2016 lows experienced in late July. Multi-asset portfolios were helped in multiple ways from this move:
  • underweight positions to real estate investment trusts which returned -5.7% in absolute terms during the month, underperforming global equities by 3.8%;
  • underweight duration positions in bond portfolios;
  • overweight positions in areas like the financials sector that typically benefit from rising rates. For example, in Q3, European financials beat their earnings expectations more times this quarter than they did in the last 10 years.
  1. Emerging markets continued to outperform
Emerging market equities continued to show resiliency in October, outperforming global equities by 1.9% and large cap U.S. equities by 2%, confounding fears by external commentators that U.S. dollar strength would further impede emerging market growth. Positioning in multi-asset portfolios reflects a thesis that much of the U.S. dollar strength has already been priced into EM markets and currencies, although we are watchful for any short-term downside risk following the U.S. presidential election.


  1. Larger cap and pro-cyclical stocks win in a down market
In October, investors gravitated toward larger cap, higher beta stocks despite the market decline. Defensive stocks and midcap stocks had become expensive and bore the brunt of the sell-off along with small cap. Value stocks were unusually cheap and generally held up better than their growth counterparts.
  1. Sector divergence continues
Financials, including bank stocks, rallied as the Fed moved closer toward a December rate hike and the yield on the 10-year Treasury hit its highest level since May. The materials sector rallied outside of North America benefitting from currency effects. Utilities outperformed across the cap spectrum. Healthcare stocks sold off. Biotech led the decline as political uncertainty around access to, and the cost of, healthcare weighed on stocks, as did slower than expected sales growth in the sector. REITs also lagged.
  1. Enthusiastic non-U.S. markets
With Chinese Purchasing Managers’ Index (PMI) data surprising on the upside in October and attenuated concerns on China hard landing risk, resource-oriented countries like Russia and South Africa fared well despite the risk of a rate hike. Brazil continued its spectacular run in 2016 and, together with generalized strong performance from emerging market large cap names, helped the emerging markets index outperform U.S., Europe and global markets. Japan performed well relative to the other regions, however, helped by currency appreciation.


  1. Global government debt had worst month since 2013 Taper Tantrum
The global investment grade government bond market lost 1.23% in USD hedged terms in October, as concerns about inflation returned to the fore along with doubts about central bank policy efficacy. The U.S. treasury yield curve steepened noticeably, with the 10-year yield surging 24 bps to reach 1.84%. The futures-implied probability of a December Fed hike jumped from 59% to 71%, as 3Q GDP was revised upward to a better-than-expected 2.9%.  
  1. Energy-related high yield corporates, loans and mortgage credit outperformed
While global investment grade credit struggled with higher interest rates (returning -0.97%), the U.S. high yield corporate sector stood out with a 0.39% return. This was driven in large part by the 7% intra-month surge in WTI oil, which caused the U.S. high yield independent energy sector to return 0.73%. The U.S. bank loan sector returned 0.83%, driven in part by its floating rate nature making it preferable to fixed rate debt in a rising rate environment. Likewise, non-agency mortgage credit performed well, supported by the improving U.S. economy and housing market.
  1. USD surged versus G10 currencies
The USD outperformed major developed market currencies on the expectation of higher U.S. government yields and increased prospects of a Fed rate hike in December, beating the euro by 2.28% and the Japanese yen by 3.33%. British pound sterling lost 5.59% against the dollar during October on concerns of a ‘hard’ Brexit, as British prime minister Theresa May confirmed that she will trigger Article 50 (official action kicking off Brexit) in March 2017. The Brazilian and Mexican currencies outperformed the USD by over 3% aided by the surge in oil, with the latter currency also aided by Trump’s slump in the polls.


  1. December rate hike priced in
The REIT market appears to have largely priced in a December Fed hike, though REITs continued to display shorter-term rate sensitivity, down over 5% and lagging most other segments of the equity market, as the U.S. 10-year Treasury yield trended upward 24 bps.
  1. Commodities were mixed
Oil fell in October as doubts about OPEC’s ability to reach a deal in November weighed on prices, while the industrial metals sector rose on signs of a surge in Chinese industrial activity. Grain prices recovered from their sharp Q3 decline thanks to strong export demand for soybeans. The 3% decline in WTI prices prompted a sell-off in energy-related listed infrastructure companies, which fell 5%.
  1. Indexes declined in spite of stable earnings
REIT earnings were largely in line with expectations, though stable operating results and upbeat management commentary were not enough to stem the sell-off through the second half of the month. The FTSE/EPRA NAREIT Index was down -5.7%. Despite the headwind of the U.S. 10-year Treasury yield increase, both electric and multi-utilities sectors in listed infrastructure outperformed the S&P Global Listed Infrastructure Index, partly due to strong Q3 numbers for some of the larger companies. Overall, the S&P Global Listed Infrastructure Index fell -2.8%.


For the fifth month in a row, all asset classes – with the exception of cash – tracked in the Asset Class Dashboard had a 12-month return within their historical typical range. Cash continued to fall below its 12-month historical typical range. Half of the asset classes in the Dashboard posted gains in their 12-month returns in October. Emerging market equities and high yield bonds stood out for rising above their historical average 12-month returns in October. Asset Class Dashboard October 2016 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: Bloomberg 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. AN ORANGE MARKER represents the most recent 12-month return of the asset classes.
All data is as of October 31, 2016 Corresponding indexes/sources by section: Economic factors:
  • Developed Europe represented by the Russell Developed Europe Large Cap Index
  • Global sovereign high yield bonds represented by Treasuries sector of the Bloomberg Global Aggregate Bond Index
  • REITS represented by FTSE EPRA/NAREIT Developed Real Estate Index
  • Global equities represented by Russell Global Index
  • European financials represented by financials sector of the Russell Developed Europe Large Cap Index
  • Emerging market equities represented by Russell Emerging Markets Local Index
  • Large cap U.S. equities represented by Russell 1000® Index
  • Defensive stocks represented by the Russell 1000® Defensive Index
  • Midcap stocks represented by Russell Midcap Index
  • Small cap stocks represented by Russell 2000® Index
  • Value stocks represented by Russell 1000® Value Index
  • Growth stocks represented by Russell 1000® Growth Index
  • Sectors represented by Russell 1000® Index sectors: Financials, materials, utilities, health care, biotech, REITS
  • Countries represented by country indexes of the Russell Global Index: Russia, South Africa, Brazil, Japan
  • Emerging markets represented by Russell Emerging Markets Index
  • Europe represented by Russell Europe Index
  • Global markets represented by Russell Global Index
Fixed income
  • Global investment grade credit represented by Bloomberg Global Corporates.
  • S. high yield represented by the Bloomberg U.S. Aggregate Bond Index
  • S. bank loan sector represented by bank loan sector of the Bloomberg U.S. Aggregate Bond Index
  • Non-agency mortgage credit represented by the sector within the Bloomberg U.S. Aggregate Bond Index
  • Oil represented by WTI crude prices.
  • REITS represented by FTSE EPRA/NAREIT Developed Real Estate Index
  • Equity market represented by Russell Global Index
  • Oil represented by WTI crude prices.
  • Commodities represented by Bloomberg Commodities Index Total Return
  • Infrastructure represented by S&P Global Listed Infrastructure Index