The so-called “September Effect” held true in 2021, with nearly all major asset classes ending the month in negative territory. Broad-basket commodities were the lone asset to produce positive returns, +4.98%, with cash investments remaining flat. While there are many theories to why September tends to be a poor month for markets (traders returning from vacation and tax loss harvesting, retail investors freeing up funds to pay schooling costs, etc.), the rationale for this year’s selloff was a bit clearer cut. Markets were faced with a culmination of headwinds ranging from legislative gridlock over infrastructure and the debt ceiling, to higher-than-expected inflation, to a meaningful uptick in interest rates. The end result was a drop of more than -4.5% for U.S. large caps, their first monthly decline since January, and an -87 bps drop in U.S. investment grade bonds. Results for the quarter, while not spectacular, were a different story. In Q3 investors saw a gain of 0.58% for the S&P 500 and generally flat returns for the Barclays Aggregate Bond index.
Higher interest rates, which came as a byproduct of heightened inflation expectations and somewhat hawkish language from the Fed, put the summer’s growth rally on hold. For the month, large value stocks outperformed their growth counterparts by more than 200 bps (-3.48% vs. -5.60%) and regained their leadership position for 2021 (+16.14% vs. +14.30%). Value stocks also outperformed within the small cap arena, with small value stocks losing just -2% on the month and gaining 22.92% YTD. We can attribute a large percentage of 2021’s strong performance to a disproportionate allocation to the financials sector, as well as outsized returns of more than 1,000% for both Gamestop and AMC Entertainment.
Non-U.S. market performance has been primarily driven by two factors, not just recently, but for much of 2021 -- the U.S. dollar and China. For developed markets, the dollar has been one of the greatest headwinds affecting relative performance, appreciating by nearly 600 bps on a YTD basis. While it’s difficult to pinpoint the exact cause of the sharp move higher, many point to interest rate differentials between the U.S. and the rest of the developed world, as well as the relative pace of the U.S.’s economic recovery. Taking the dollar out of the equation, the MSCI EAFE is positive by a respectable 14.23% YTD and 1.32% in Q3. When we introduce the impact of the currency, the index’s return flips negative on the quarter, -0.45%, and comes in at a much more modest 8.35% YTD.
Within emerging markets, the major storyline has surrounded China, where worries over unexpected regulations dominated headlines, only to be overtaken by concerns around the potential collapse of the nation’s largest real estate developer, Evergrande. This has resulted in disappointing performance for the asset class, particularly over the last quarter (-8.09% in USD), as China accounts for more than 30% of the benchmark MSCI index. The value-side of the market, which has much less exposure to Chinese mega-cap growth names, has been far less impacted, gaining 4.43% thus far this year versus a -1.25% loss for the core index.
September was a difficult market for fixed income investors, as higher rates impacted duration-sensitive assets and equity market volatility negatively affected credit-sensitive bonds. The result was a -0.87% loss for the benchmark Barclays Aggregate Bond index, which is now lower by -1.55% in 2021. As expected, treasuries have taken the brunt of the pain, declining by over -1.00% during the month, as rates increased by nearly 20 bps at the 10-year portion of the curve. Rates have had an even greater impact over the YTD period, climbing from just 0.93% at the start of the year to over 1.50% at quarter end, resulting in a decline of -2.50% for the treasury index.
High yield credit finished the month relatively flat, which only served to add to the asset class’s YTD advantage, now more than 600 bps (+4.53% vs. -1.55%). It should be noted that such gains could not have been accomplished without the help of spreads, which sat at less than 290 bps over treasuries at quarter-end, some of their lowest levels on record. Looking ahead, this makes coupon clipping a best-case scenario for high yield investors, leaving little room for further capital appreciation and meaningful risk to the downside.
Commodities continued to be a standout asset class in September and throughout the quarter, benefitting from both supportive supply/demand dynamics and continued inflation pressures. The Bloomberg index ended the month nearly 5% higher, outperforming the S&P 500 by 963 bps during September alone. This margin stretches to more than 13% over the YTD period and is even more exaggerated for those indices with greater allocations to the energy sector.
Energy-related commodities, in particular crude oil, are benefitting from not just fundamental tailwinds, but technicals as well. Throughout the year, WTI futures have been trading in a state of backwardation, meaning that front end contracts are trading at prices higher than those contracts in the future. This has the potential to benefit investors, as spot and futures prices converge at expiration.
Closed End Funds
As would be expected, heightened equity market volatility and higher interest rates caused closed end funds to struggle during the month. At a universe level, CEFs now trade at an aggregate discount-to-NAV of just under 2%, roughly 1% wider than where they ended August. However, on a YTD-basis, closed end funds have still performed exceptionally well, with the average fund benefiting from 400 bps of discount narrowing. Our Tactical Income Closed End (TICE) strategy has been a clear beneficiary of this trend, declining by roughly -2.50% in September, but advancing by over 11.50% YTD, more than double the return of its blended index.
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