At the asset class level, trends in October were fairly similar to the previous month, with nearly all the main assets producing positive returns. The exception was commodities, but elsewhere the general rule was the riskier the asset the higher the return. From a performance perspective, equities topped the tables followed by corporate bonds led by high yield. Government bonds also produced very decent returns as yields retreated but UK commercial property is now recording monthly gains in excess of 1% for the first time this cycle. After a sizeable advance lasting several months, sterling drifted lower adding to returns on overseas investments for UK-based investors as can be seen in the following table:
Corporate and Government Bonds
October produced a second consecutive month of decent returns for fixed income markets. A growing belief that the Fed might not begin curtailing bond purchases until next March, alongside weaker economic data, kept US 10-year Treasury yields tumbling to around 2.5%. Treasuries were followed downwards by yields in the other main government bond markets. Returns were broadly similar amongst the main markets at 0.5%, but EU peripheral governments staged another strong rally as carry trades resumed and confidence in the recovery grew.
As would be expected in a period in which government yields fell and equities rallied strongly, corporate bonds benefited from lower yields and tighter spreads. UK investment grade returned 2.0% and US high yield 3.1%, a level of return nearly matched by emerging market debt as bond traders returned in force.
Stock Markets
As noted, equity markets led the performance tables aided by the short-term resolution to the US debt-ceiling/budget deadlock, falling bond yields and hopes of more distant Fed tapering. Interestingly, although the 4% rally by the World index was of similar magnitude to the previous month, the internal dynamics were completely different. In October, money was invested in all the major stock markets, with the exception of Japan, and across all the main sectors. Additionally, there was the rare event of large-cap stocks outperforming both mid and small caps in all the leading markets, albeit not by large margins.
Commodities
Despite the general rally in riskier assets, commodities failed to participate once again and indeed, all of the main subsectors declined over the month. WTI fell back to below $100/barrel for the first time since July as crude oil stockpiles built and, despite improving economic reports from China and the strongest pick-up in global industrial production for two years, industrial metals were unable to garner any real interest from traders let alone investors. Concerns that both Chinese demand and IP will fade in the new year hardly helped. Gold holds little attraction other than for those who feel they need diversification against Armageddon, while bumper harvests kept grain prices—especially corn—under pressure.
Currencies
For the much of October, disillusionment with the dollar and a resurgent euro were the main trends in the currency markets. By month-end, however, the move had largely unwound following more bullish interpretations of the Fed statement on behalf of traders, while very low eurozone core inflation figures certainly justified a further cut in interest rates. Sterling also returned some of its recent gains, the BOE trade-weighted sterling index declined 1.2%, while emerging market currencies continued to rebound from oversold levels as volatility declined and carry trades were reinstated.
UK Commercial Property
The underlying trends in the UK commercial property market continued to strengthen as capital values grew by 0.6% in September, following 0.4% in August; this was the highest monthly rise since April 2010, according to IPD data. Other features from the latest IPD report included capital growth overtaking income as the principal component of performance and rental values rising again, while the average prime yield for All Property fell by 12bp to 6.08%, according to CBRE. IPD also published Q3 figures showing All Property gained 2.8%, an annualised return of 11.2%!
Sentiment towards the property sector is gathering momentum and one of the more interesting investment propositions is gaining more adherents. The song remains the same, according to Savills: across the board there “is strong demand for primary and good secondary assets with limited available stock.”
Asset Allocation
From an asset allocation perspective, equity returns in October were once again considerably higher than those from government bonds. So far this year, equities have outperformed bonds by around 27% in the US and 22% in the UK, and yet equity volatility has remained relatively low. Just because the VIX volatility index is close to its low, however, doesn’t mean that equity risks aren’t rising, indeed they are, and principally as a result of equity revaluation being the main source of stock market returns.
Wondering where to invest in 2014? Read Andy Brunner's outlook for the major asset classes here.
