September was a mixed month, with politics seemingly trumping economic and fundamental developments. Specifically, North Korean and U.S. tensions dominated headlines, whilst rumblings in Europe resurfaced. This included a mixed result in the German election, speculation over the future of the UK’s prime minister Theresa May and the controversial vote for Catalonian independence from Spain.
Intriguingly, despite the political woes, there was little evidence of a flight to safety; in fact, gold was down almost 3% in US dollar terms. Instead, the month was dominated by currency volatility, with rather dramatic shifts that saw sterling and the US dollar shift higher whilst the Japanese yen fell against the majors.
Currency markets are undoubtedly being shaped by central bank murmurs, with Donald Trump thought to be contemplating a new Federal Reserve chairperson that could change the rate hiking course set by current chair Janet Yellen. The U.K. faces different challenges, with the Bank of England’s Mark Carney hopeful to raise rates despite GDP annual growth being revised down to a four-year low.
What Impact Did This Have?
From an asset class perspective, the developments are creating a rather interesting backdrop. In sterling terms, the majority of equity and fixed income markets posted negative returns in September, largely due to the currency impact. Yet, even when we remove the influence of currency, there are some interesting themes evolving. For instance, emerging markets underperformed developed markets in September, breaking an eight-month losing streak for developed markets and came despite significant strength in the energy sector.
On a look-through basis, the outperformance of developed markets over emerging markets was also reasonably consistent in local currency terms. US equities were up 2%, Japan rose 4% and Europe climbed 4% in local currency terms – all beating emerging markets that fell 0.2% in aggregate. The UK was a notable laggard though, although this was principally driven by weakness in the export-heavy FTSE 100 rather than the domestically-focused FTSE 250.
It was a more challenging month for fixed income, with modest negative returns across the board. Bond yields continue to grind higher from very low levels and are reflecting a gradual shift in policy stance among the major central banks. Notably, corporates slightly outperformed government-issued debt again in September as defaults hover near historic lows. Emerging market government debt, both in hard and local issuance) also proved resilient in relative terms, while inflation-protected instruments failed to add value.
Looking Forward – the Bigger Picture
Looking forward, there are several developments at play which requires careful consideration. Prominently, September proved once again that currency exposure can have a meaningful impact on returns and must be fundamentally managed.
Yet investors also need to contemplate the long term, with very strong performance from core equity markets that continue to outstrip the fundamentals. When presented with such a scenario, prudence eclipses greed and we will continue to carefully select pockets of opportunity that offer a contrarian bent and attractive valuation-implied returns.
