Economic Data Watch and Market Outlook
Global equity markets rose modestly with the MSCI World rising 88 basis points and the S&P 500 rising 83 basis points. The Bloomberg US Aggregate Bond Index had its best month since 1985 rising 4.53%. The index has advance 1.64% on a year to date basis.
Earlier in the week, building permits exceeded expectations but new home sales declined 5.6% month over month. The average 30-year mortgage rate dropped 17 basis points from last week to 7.57%. The US Pending Home Sales Index has fallen approximately 44% from its peak, currently the largest drawdown in the index’s history.
The US trend in consumer spending is declining due to high interest rates and reduced savings, a trend echoed by major retailers like Walmart after experiencing a drop in sales. Government data and reports from various regional Federal Reserve branches indicate a cutback in discretionary spending and hiring, pointing towards a more widespread economic deceleration. Additionally, some of the stronger luxury brands are starting to trim their outlook leading to some widely publicized sell-side downgrades of luxury brands such as LVMH. Despite the job market’s current resilience, there are emerging signs of cooling, evidenced by the smallest wage increase of the year and an uptick in jobless claims. Later in the upcoming week we will see a series of data releases to the job market.
Powell spoke on Friday noting that the US economy is slowing with rates “well into restrictive territory”. The market’s perception of the comments is that the Fed is done raising rates with rate cuts entering the conversation. While inflation is still prevalent in places albeit modestly, deflation is occurring in some areas such as appliances and used cars.
Equities
Major indices ended the week higher, and the S&P 500 and the Nasdaq closed Thursday with their best monthly gain since July 2020. The American Association of Individual Investors’ Stock Sentiment Survey (AAII) released their recent survey on Thursday indicating that “bearishness is the lowest it’s been since 2018”. For the week the Dow Jones Industrial Average rose 2.4%, the S&P 500 gained 0.83% and the Nasdaq increased 0.4%. Small caps outperformed as the Russell 2000 Index gained 3.1% while the Russell 1000 Index returned 1.1%. Value stocks outperformed growth stocks on the week across market caps. The Russell 1000 Growth Index returned 0.4% and the Russell 1000 Value Index returned 1.95%. The Russell 2000 Growth Index rose 2.7% while the Russell 1000 Value Index gained 3.5%.
From a sector standpoint, most sectors finished the week higher but weakness in big cap tech names such as Meta Platforms and Alphabet impacted the tech sector. REITs, materials, industrials, consumer discretionary, and financial services outperformed. As we start off December, the S&P 500 and Nasdaq are coming off their longest consecutive weekly win streak since November 2021.
International equities were mixed through the week with developed markets slightly outperforming emerging markets. For the week the MSCI EAFE saw a positive return of 0.4% while the MSCI Emerging Market Index returned 0.2%. In Europe equities finished higher as the Euro STOXX 600 ended the week positive up 1.4%. Investor sentiment was boosted by declining inflation and falling bond yields. Germany’s DAX rose 2.3%, Italy’s FTSE MIB gained 1.7%, France’s CAC 40 Index increased 0.7%, and the UK FTSE 100 Index grew 0.3%. In Asia, equities were mostly lower. Japan’s Nikkei 225 Index declined 0.6% and the TOPIX Index dropped 0.4%. Japanese equity markets reflected some profit taking after rallying during the month on expectations that US interest rates have peaked coupled with strong corporate earnings and weakness in the yen. Chinese equities dropped during the week as indicators emphasized concerns about the country’s weak recovery. The Shanghai Composite Index fell 0.3% and the blue-chip CSI 300 lost 1.6%. In Hong Kong, the benchmark Hang Seng Index also declined 4.2%. Globally, the MSCI World rose 0.88%.
Fixed Income
Fed chair Jerome Powell spoke on Friday, cautiously signaling that officials are done hiking rates. Due to recent declines in inflation and slowing wage growth a higher bar has been set for any further rate hikes. It should be noted that the Fed is not in rate-cutting territory yet and that they are prepared to keep rates in restrictive territory until the economic data is in an acceptable place. In response, the 10-year Treasury yield slid over 10 bps throughout the day, while the 2-year Treasury yield fell 12 bps. Yields finished the week down across the board, seeing double-digit declines in maturities longer than 3 months. The 2-year Treasury yield finished the week down 36 bps, the 10-year Treasury yield fell 25 bps, and the 30-year Treasury yield fell 20 bps. Meanwhile, major bond indices climbed with the Bloomberg US Aggregate bond index rising +0.77%, and the Bloomberg US MBS Index rising +0.85% through Thursday, while the Bloomberg US Corporate High Yield Index finished the week up +1.30%. In response to the strong November for bond markets, investors are beginning to pull cash out of inflation-protected bonds as inflation pressures continue to moderate. Throughout the month $2.17B was pulled out of five major ETFs that target Treasury inflation-projected securities, according to Bloomberg. This is the largest set of outflows from said funds since October 2022. Traders are also adjusting their expectations for future Fed policy, with Fed Fund futures seeing a dramatic shift from only a month ago.
Managers such as Invesco Ltd. and Loop Capital Asset Management are turning bullish on regional bank bonds, betting that debt will begin to perform better as borrowing costs settle down. Spreads have come down by 65 bps since the regional banking crisis that took place in March of this year, but still 20 bps wider than the broad high grade bond indices. One sticking point for investors is regional banks’ exposure to the struggling commercial real estate industry, but according to some, these worries are overblown.
In a new report this week from Bloomberg. Asset management firms JPMorgan and Neuberger Berman have increased their bond positions in European countries that are typically seen as less attractive, such as Greece, Italy, and Portugal. Yields for the mentioned counties have come down significantly compared to those of France and Greece.
Hedge Funds
Hedge Fund (HF) performance was positive this week was positive for most strategies. The average global HF was up 16 bps against the MSCI +36 bps, which puts them +2.6% for November, and +5.5% YTD (vs. MSCI World +9.3% in November and +19.2% YTD). Americas-based long/short (L/S) equity funds were up more than the S&P 500 this week at +33 bps vs. the S&P 500 +24bps. For the month and the year, Americas L/S funds +5.0% for November and +9.2% YTD. EU-based HFs performed in-line with the Euro STOXX 600 (both up ~30 bps), which puts them up 2.1% in November and 5.7% YTD (vs. Euro STOXX +6.7% in November and +12.3% YTD). Asia-based HFs were the only group to not post gains this week as they were down 4 bps vs the MSCI Asia +47 bps, which leaves them +3.2% in November and +4.5% YTD (vs. the MSCI Asia +7.8% in November and +7.1% YTD).
HFs were net sellers of global equities this week as they sold longs across all regions while short flows were more muted across regions (except Japan). Starting with North America (NA), which made up ~75% of the global net selling, much of the selling was seen in consumer discretionary. This week ranked as the 2nd largest week of net selling within the sector YTD (trailing only the week ending January 6th). The sector saw an even mix of short additions and long selling. Financials was the next most net sold sector this week as long selling outweighed short additions, with the selling spread across financial services, banks, insurance, and capital markets in relatively equal amounts. Financial-related industries were some of the only ones to see short covering this week (the only other sector being real estate). TMT was also net sold via a mix of long selling and short additions in both communications services and tech, particularly across mega-cap tech names. Mega-cap TMT was sold in the 3rd largest amount since May 2022 on Thursday. Flows to the broader TMT universe also skewed towards being net sold as has been the case since August, though the magnitude was not as notable this week. For the week ending December 1st (hedge fund performance is as of November 30th) the other 493 S&P 500 stocks outside the “Magnificent Seven” outperformed those top names, signifying what can be viewed as risk off. Real Estate was net bought with this week ranking as the largest week of real estate net buying since February 2022. The buying within the sector came from long additions though HFs did also cover shorts in the sector as mentioned above. ETFs were also bought in small amounts in NA. Due to the long selling, US L/S net leverage dropped 2% to 48%, though gross leverage increased by 2% to 190% due to mark-to-market impacts.
Europe saw lighter directional flow on both sides of the book this week as volumes in Europe were in line with 12-month averages. The region ended up being slightly net sold as selling within EU energy and industrials outweighed net buying in EU materials. For Asia ex-Japan (AxJ), flows were similarly muted on both the long and short side, though volumes were above 12-month averages within the region. Within AxJ, the selling in AxJ real estate and ETFs slightly outpaced the buying in AxJ tech. Most of the net selling in the region was within China and Australia, whereas Korea and Taiwan were net bought. Japan saw the most outsized net flows as it was the only region to be net bought (driven by short covers). The covering was across most sectors, though the bulk came in consumer staples and tech. Japan staples ranked as the most net bought sector in the region followed by industrials, whereas Japan healthcare and tech were the most net sold.
Private Equity
PitchBook’s Quantitative Perspectives report suggests that private equity (PE) firms seeking fresh capital from limited partners may face increased competition from investment-grade and US Treasury bonds. The rise in interest rates and supply dynamics in the Treasury bond market has elevated their yields, making them more appealing to investors. The yield on the 10-year Treasury note reached 4.9%, surpassing the S&P 500 for the first time in over a decade. Cheaper long-term bonds are expected to persist as the Treasury is likely to issue a high volume of them in the next 12 to 15 months to fund increasing deficits.
PE funds are experiencing challenges as their one-year-horizon internal rates of return (IRRs) stood at 1% through Q1 2023, considerably lower than three- and five-year horizons with IRRs at 25.6% and 17.8%, respectively. The industry is also grappling with low exit rates for existing investments, with PE exit value reaching its lowest level in at least 30 years in Q3. The mean holding period for PE-backed companies has increased across various industries and deal types.
The reduced number of exits has led to lower distributions, with the trailing 12-month calculation of buyout fund distributions as a percentage of a fund’s starting net asset value dropping to 11%, down from 37% less than two years ago. The report suggests that these challenges, combined with lower distributions, could result in a 30% decrease in PE buyout fundraising in 2024 compared to recent trends. Investors may shift their capital towards Treasury bonds, seeking the stability and predictable returns they historically provide.
Authors:
Jon Chesshire, Managing Director, Head of Research
Elisa Mailman, Managing Director, Head of Alternatives
Katie Fox, Managing Director
Michael McNamara, Analyst
Sam Morris, Analyst
Josh Friedberg, Fall Associate
Data Source: Apollo, Barron’s, Bloomberg, BBC, Charles Schwab, CNBC, the Daily Shot HFR (returns have a two-day lag), Goldman Sachs, Jim Bianco Research, J.P. Morgan, Market Watch, Morningstar, Morgan Stanley. Pitchbook, Standard & Poor’s and the Wall Street Journal.