The QS proprietary leading economic indicator remained in positive territory for July, with the prospects for U.S. stocks to outperform U.S. investment-grade bonds and non-U.S. developed market equities remaining intact.
July 2019 Market Commentary1
Global equity markets had mixed performance in July, after a robust rally in June. U.S. large cap posted the highest return out of the major global equity regions, returning +1.4%, and reached an all-time high. U.S. small cap rose a marginal +0.6%; this came after a strong month of June where the asset class returned +7.1%. U.S. equity volatility, as measured by the VIX index, modestly rose +6.9% and ended the month at the 16.1 level. Abroad, developed outperformed emerging markets, returning +0.7% and -0.9%, respectively.
The U.S. dollar (USD) rose +1.8% and was the best performer out of the G10 currencies. This was a large rebound versus the prior month, where it was the worst performing G10 currency. The currency was supported by strong U.S. economic data (ISM Manufacturing, non-farm payrolls) and rising concerns around global growth, weakening the other G10 currencies relative to the U.S.
At the end of the month, the U.S. Federal Reserve (Fed) cut interest rates for the first time in eleven years2, lowering its target rate by twenty-five basis points (bps). Chairman Jerome Powell stated that it was a “mid-cycle adjustment to policy”; this was considered less dovish than the market anticipated and boosted the USD.
In the U.K., Boris Johnson was elected Prime Minister and promised to lead the U.K. out of the European Union by the end of October “no matter what”. This rhetoric sparked concerns around a hard Brexit and led to the British pound (GBP) reaching a multi-year low versus the USD.
Crude oil had a relatively muted month, finishing with a negligible +0.2% gain. Crude oil was supported by the news of an extended supply reduction from OPEC. However, this was offset by a weak global demand outlook and the U.S. announcing that Iran was ready to enter negotiations over its missile program, easing concerns around supply risks tied to Iran.
Gold rose +0.9% and reached a multi-year high; supported by fears of a global cyclical downturn and geopolitical tensions in the Strait of Hormuz. After Chairman Jerome Powell gave his speech announcing the Fed rate cut, which the market interpreted as less dovish than expected, gold sold off and moderated returns for the month.
Market Outlook for August
Our proprietary leading economic indicator remained in positive territory. This view is supported by global trade data and the change in initial unemployment claims.
Our outlook for U.S. stocks outperforming investment grade bonds remains in positive territory. Valuation, as measured by comparing U.S. equities earnings yield to the ten-year treasury yield, continues to be the largest driver of this preference, as the factor’s strength ranks in the top quartile on a historical basis.
In U.S. fixed income, we believe that high yield bonds could outperform investment grade bonds over the next month. This is supported by the yield differential between high yield and investment grade and the level of U.S. equity volatility.
We strongly believe that U.S. stocks are positioned to outperform their international developed market counterparts. The model’s preference is driven by stronger price momentum in the U.S. and yield curve dynamics. Yield curves in other developed markets are flattening at a faster rate than in the U.S. which we interpret as a sign of lower economic prospects. However, options market data, for the first time this year, shows greater demand for price protection in the U.S. versus international-developed markets.
European stocks are expected to outperform European bonds in our model, however this has moderated over the past month. Four of the six explanatory variables in our model point to this conclusion, including European stock price momentum, valuation, and European government yields.
Asset Class Preferences are based on QS Investors proprietary quantitative factor models. These rules-based financial models use a combination of indicators that analyze asset valuations, investor sentiment, and the broad economy.
1 All data source Bloomberg, as of 7/31/19, unless otherwise noted. Global Equities represented by the MSCI ACWI Gross Total Return Local Index; Emerging Market Equities represented by the MSCI EM Gross Total Return Local Index; International Equities (developed markets) represented by the MSCI EAFE Gross Total Return Local Index; U.S. Equities represented by the S&P 500 Total Return Index; U.S. Small Cap Equities represented by Russell 2000 Total Return Index; and U.S. Dollar (USD)represented by the Bloomberg Dollar Spot Index.
2 Source: JP Morgan, as of 7/31/19.
Developed markets refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.
The Group of Ten (G-10 or G10) refers to the group of countries that agreed to participate in the General Arrangements to Borrow (GAB), an agreement to provide the International Monetary Fund (IMF) with additional funds to increase its lending ability
The Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI) for the US manufacturing sector measures sentiment based on survey data collected from a representative panel of manufacturing and services firms. PMI levels greater than 50 indicate expansion; below 50, contraction.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
The European Union (EU) is an economic and political union established in 1993 by members of the European Community. The EU now comprises 28 countries after its expansion to include numerous Central and Eastern European nations.
"Brexit" is a shorthand term referring to the UK vote to exit the European Union.
The British pound (GBP) is the national currency of the United Kingdom.
The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its member countries.
The earnings yield is the earnings per share for the most recent 12-month period divided by the current market price per share.
High yield bonds have below investment-grade ratings (BB, B, CCC for example) are considered low credit quality and have a higher risk of default.
The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.
U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
QS Leading Economic Indicator Index is a proprietary composite of economic data that QS Investors believes are significant in determining financial and economic conditions in the U.S. Past performance or any prediction or forecast is not indicative of future results. QS Leading Economic Indicator Index inception date is 1/2/1970.