August’s sell off was largely influenced by Chairman Jerome Powell’s comments at the Fed’s Jackson Hole Symposium on August 26th. While he mentioned that the Fed’s future policy decisions would be data dependent, his overall tone was generally hawkish. Most concerning to markets was the Chairman’s stated commitment to taming inflation via higher-for-longer interest rates and his warning around the subsequent “pain” this could create for households and businesses. This led both equity and fixed income markets lower for the month, with the S&P 500 declining by -4.00%, while the Bloomberg Aggregate Bond index lost -2.83%. Commodities were one of the few asset classes to end the month in the black, gaining 9 bps on the back of a more than 10% spike in natural gas prices.
August marked a pause in the growth rally that began mid-June, which was largely driven by a retracement in interest rates and hopes that the Fed would pivot to more accommodative monetary policy in the near-to-intermediate term. A combination of hawkish Fed speak and disappointing earnings reports caused this trend to reverse course in August, leading to a decline of more than -4.5% for U.S. large growth stocks, compared to a loss of -2.98% for value stocks. This left the Russell 1000 Growth index squarely in bear market territory for the year (-23.19%), while the Russell 1000 Value index ended the month with a YTD loss of -9.85%.
Non-U.S. equities continued to face the headwind of a strengthening U.S. dollar., which (on a trade-weighted basis) ended August at its strongest level since the 1980s. This detracted -2.48% from MSCI EAFE returns during the month and -10.78% on the year. Emerging markets were somewhat less affected, experiencing an impact of -0.79% during August and a -4.94% headwind on a YTD basis. However, despite August’s volatility and the currency headwind, EM equities still ended the month in positive territory (+0.42% in USD-terms), as returns were buoyed by encouraging macro-economic and geo-political trends in Brazil, as well as new stimulative measures announced in China.
Fixed income markets gave back -2.83% on the month, as bond markets digested the reality that interest rates may need to be higher-for-longer to tame inflation. This view manifested itself in a 56 bps increase at the 2-year point of the U.S. treasury curve and a 48 bps increase in the 10-year yield. On a spread basis, the curve ended the month inverted by 30 bps (10 minus 2), which historically has been a strong predictor of an impending recession. However, investors have yet to see the likelihood of an economic slowdown reflected in credit markets, where spreads remained relatively stable on a month-over-month basis. In fact, despite the negative message being sent by the bond market and the volatility seen in equities, high yield bonds were an unlikely outperformer on the month, declining by -2.30%. Unfortunately, with spreads near their long-term average in the face of our current economic uncertainties, high yield bonds appear to be a risky proposition as we look ahead.
Broad-basket commodities were generally flat in August (+9 bps), as the Fed reaffirmed its commitment to price stability, even at the cost of a recession. Investors interpreted this message to mean that weaker demand for commodities may be on the horizon. As a result, nearly all commodities fell, notably crude oil, which was down nearly 8%, with copper and other economically sensitive items also suffering. Natural gas prices, which advanced by more than 11%, were an outlier. Prices for the major index component, were supported by several factors, including record high temperatures across parts of the U.S., as well as below average inventory levels.
Closed End Funds
Closed end funds had a somewhat benign month, with discounts remaining relatively flat from where they ended July. While at its surface this appears to run counter to what one would expect from CEFs in a negative month for equities and fixed income, two of the key factors that largely impact universe-wide discounts were generally stable in August. More specifically, credit spreads remained relatively flat on the month, which supported taxable bond fund discounts, while equity market volatility (as measured by the VIX), moved up only a few ticks, despite broad equity market declines.
iCM Tactical Strategies
iCM’s tactical strategies, which utilize ETFs and/or mutual funds, had a strong month relative to their respective benchmarks, as the more speculative assets that fueled July’s rally gave background. Most notably, our overall fixed income strategy benefitted from a slight underweight to duration, as rates increased meaningfully during the month. Our general equity strategy also performed relatively well, supported by out-of-benchmark positions in commodities and emerging markets value, as well as a sizable overweight to value within our U.S. equity allocation.
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