The first quarter saw persistent levels of elevated volatility as both macro and micro issues combined to engender swings in both debt and equity securities. From January through March, markets were faced with the prior quarter’s earnings reports, the start of an aggressive quantitative easing program by the European Central Bank (“ECB”), a last minute Greek bailout extension, new military tensions in the Middle East, comments from the Federal Reserve about the future of domestic interest rates and continued commodity price volatility. Against this backdrop, fixed income and equities posted mixed results.
The first quarter saw continued improvement in the domestic economy and labor markets. The overall unemployment rate in the US dipped to a new post-crisis low of 5.5%. GDP growth for the fourth quarter clocked in at 2.2%. More importantly, the underlying fourth quarter data revealed that consumer spending (which represents over 60% of overall US economic activity) was accelerating at the fastest pace since 2006. This positive data point potentially indicates that the economy has a basis for sustained further improvement this year and beyond. However, it is worth noting that data releases from later in March were generally uninspiring and expectations for first quarter GDP growth have largely been revised to the downside.
The Federal Reserve was once again front and center as market participants anxiously awaited guidance as to the level of future interest rates. March brought with it a much-anticipated FOMC statement which was largely dovish in tone. As anticipated, the Federal Reserve governors removed the word “patient” from their official statement; however, the statement and Yellen’s subsequent press conference explicitly indicated that the Fed remains focused on seeing “further improvement” in both the labor market and inflation before actually increasing interest rates. While Chair Yellen’s comments leave the door ajar for rate increases in June, most market participants believe that an eventual hike is unlikely to occur until the September FOMC meeting or possibly even later. However, as evidenced by volatility through quarter end, it is clear that the timing of the Fed’s “liftoff” still represents a burden on risk assets.
On the micro front, earnings announcements in the first quarter were largely positive. According to data from JP Morgan, approximately 74% of S&P 500 companies beat EPS estimates with Q4 EPS growing at +5% year-over-year. It is worth noting that company guidance was largely tempered or negative in tone as companies frequently alluded to the broader market uncertainty. Additionally, a common refrain among management teams was the impact of the dollar’s strength on foreign based revenues.
Perhaps unsurprisingly given the continued rally in the dollar, oil and energy markets continued to experience volatility. The below chart highlights the increased volatility in oil prices starting in the fourth quarter of 2014 as tracked by the relevant CBOE index (via Bloomberg):
M&A activity also remained front and center throughout the first quarter as companies continue to take advantage of the low rate environment to boost growth prospects via acquisition. According to the Financial Times, deal activity in the first quarter of 2015 was the fastest start to a year since 2007. The healthcare sector in particular has continued to remain extremely active in this arena with several high profile deals coming across the tape in Q1. We expect continued merger activity as companies scrounge the marketplace for ways to augment growth.
Europe dominated the news in the first quarter. Markets were shocked on January 15th when the Swiss National Bank decided to unpeg its currency from the euro, a decision that caused the Swiss franc to rally in excess of 25% relative to both the dollar and euro immediately following the announcement. Then, on January 25th, ECB head Mario Draghi finally announced his much-anticipated quantitative easing plan wherein the European Central Bank committed to purchasing €60B in assets per month in an effort to spur growth and boost inflation towards Draghi’s stated 2% goal. The euro and sovereign yields across the EU tumbled lower throughout the quarter with several sovereign debt issues now offering negative yields to investors.
On the geopolitical front, familiar stories from 2014 continued to remain among the headlines with Russian military tensions and ISIL hostilities each working to engender volatility. In addition to these worries, Greece featured prolifically in the news cycle as the beleaguered peripheral economy struggled under its debt load and the potential for an outright exit from the European Monetary Union. After several failed meetings with core EU nations and the IMF, Greece finally reached an agreement to extend its bailout for four months. This last minute compromise staved off a “Grexit” though the situation remains far from resolved. Additionally, at the end of March, markets were further whipsawed by Saudi Arabia and Egypt launching attacks against Yemen, an action that spurred aggressive “risk off” behavior and additional volatility.
US stocks were not immune to the quarter’s volatility. However, the S&P managed to finish Q1 in the black (+0.95% on a total return basis); the index as a whole has not posted a down quarter in approximately two years. Nevertheless, while the index’s overall result was positive, there was generally a high degree of dispersion among underlying sectors. Healthcare, on the back of the aforementioned M&A activity, continued to be a market leader, yielding gains of +6.5% in Q1. In contrast, the Energy sector continued to struggle under the weight of continued commodity price volatility to close the quarter down -2.8%. These negative results were surpassed to the downside by Utilities, a market leader in 2014, which knee-jerked downward by over -5% to start the new year in response to growing interest rate concerns.
Small and mid-cap domestic equities fared better than their larger cap counterparts with the Russell 2000 and Russell Mid Cap indices gaining +4.3% and +3.9% to start the year. Many pundits have espoused that the relative outperformance of smaller capitalization companies can be attributed to the fact that their businesses are more exclusively focused on domestic markets and, therefore, aren’t as exposed to the currency headwinds from the stronger US dollar.
International developed markets generally fared well relative to their domestic counterparts. In particular, European markets were among the best performing asset classes in the first quarter and continued the recent trend of equities benefitting from aggressive quantitative easing measures. In dollar terms, the MSCI Europe Index advanced +3.6% for the first quarter. Asian equities also yielded positive results, gaining +7.4% as measured by the MSCI AC Asia Index. Japan was once again a market leader in the region as the Bank of Japan’s aggressive quantitative easing measures continued to push investors towards risk assets.
After struggling in 2014, emerging market equities started the year off on a positive note, gaining +2.3% as measured by MSCI. After outperforming their emerging peers for most of 2014, frontier markets maintained their fourth quarter reversal to shed -2.9% in Q1.
The following chart highlights first quarter performance for various equity markets:
Bottom Line: We believe equities remain an attractive source of long term growth for client portfolios. Additionally, we continue to emphasize active management in less efficient arenas such as smaller capitalization equities and emerging markets as we believe higher return dispersion will likely engender fruitful hunting ground for active management. We expect recent levels of higher volatility to persist throughout 2015.
Fixed income markets saw volatility alongside their equity market counterparts as divergent monetary policy and oil market price swings all factored into first quarter performance. Considering the yield on the 10 Year US Treasury throughout the first quarter provides a glimpse into the swings in fixed income investor sentiment and volatility. After beginning the year at a yield of 2.17%, the 10Y yield declined to a low of 1.64% on January 30th before rising steadily to 2.24% by March 6th only to decline again to close the quarter at 1.86%. It is our belief that interest rates are going to be a key driver of fixed income performance this year.
Generally riskier high yield bonds seesawed back and forth to close the quarter up a modest +0.6%. Somewhat surprisingly, this result exceeded the performance of the broader Barclays Global Aggregate Index which actually declined approximately -2% to start the year. Municipal bonds and Mortgage Backed Securities were both up during the quarter as real estate assets continued to appreciate and the demand for tax-exempt bonds remained strong.
The following chart summarizes credit market performance in the first quarter:
Bottom Line: We continue to approach credit markets with extreme caution. While we favor credit risk over duration risk across the board, we realize that even shorter duration assets could experience principal volatility as the Fed increases short term rates, albeit slowly, at some point in 2015. Additionally, we believe a close monitoring of the efficacy of quantitative easing in Europe is warranted.
On the whole, hedge funds generated positive results to start the year in 2015 with many strategies actually exceeding the broader equity and fixed income markets. Long/short equity managers yielded positive results with the HFN Equity Hedge Index gaining over +3.6% in the first quarter as volatility returned to the markets and return dispersion among individual securities ticked upward after declining significantly following the massive distortion created by central bank easing activities in the aftermath of the 2008 financial crisis.
As measured by HFN, event driven strategies (+3.6%) continued to benefit from increased levels of corporate financial engineering and M&A activity as companies look for ways to boost organic growth and earnings. Macro funds benefitted from increased volatility and the strengthening of the dollar to gain over +3.5%. Distressed managers generally lagged other asset classes (though results were still positive for the quarter) as less liquid, deep value situations saw higher levels of volatility coincide with the broader market.
The following chart summarizes quarterly performance for select hedge fund strategies:
Bottom Line: While one quarter does not represent a meaningful trend, the performance of alternative strategies to start 2015 was encouraging after a period of extended underperformance. We continue to believe that hedge funds represent a risk- managed component to client portfolios.
Conclusion and Outlook
We maintain our view that the investing environment is changing after a substantial bull market rally. Our focus remains grounded in a dedicated, disciplined asset allocation framework for each client portfolio. We continue to believe that portfolio diversification across asset classes facilitates a broad opportunity set for delivering returns in an environment of increasing uncertainty.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Massey, Quick & Co., LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Massey, Quick & Co., LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Massey, Quick & Co., LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. If you are a Massey, Quick & Co., LLC client, please remember to contact Massey, Quick & Co., LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Massey, Quick & Co., LLC’s current written disclosure statement discussing our advisory services and fees is available upon request.
This presentation and the accompanying discussion include forward-looking statements. All statements that are not historical facts are forward-looking statements, including any statements that relate to future market conditions, results, operations, strategies or other future conditions or developments and any statements regarding objectives, opportunities, positioning or prospects. Forward-looking statements are necessarily based upon speculation, expectations, estimates and assumptions that are inherently unreliable and subject to significant business, economic and competitive uncertainties and contingencies. Forward-looking statements are not a promise or guaranty about future events.
Historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings correspond directly to any comparative indices
Indices included in this report are for purposes of comparing your returns to the returns on a broad-based index of securities most comparable to the types of securities held in your account(s). Although your account(s) invest in securities that are generally similar in type to the related indices, the particular issuers, industry segments, geographic regions, and weighting of investments in your account do not necessarily track the index. The indices assume reinvestment of dividends and do not reflect deduction of any fees or expenses.
Please Note: (1) performance results do not reflect the impact of taxes; (2) It should not be assumed that account holdings will correspond directly to any comparative benchmark index; and, (3) comparative indices may be more or less volatile than your account holdings.
Please note: Indices are frequently updated and the returns on any given day may differ from those presented in this document.
Index data is supplied from various sources and is believed to be accurate but Massey Quick has not independently verified the accuracy of this information.