August was a much more difficult month compared to July as both bonds and equities produced losses for investors. Following July’s sizeable rally in riskier assets, investors had to contend with a broadening range of potentially damaging issues, the "wall of worry" had returned.
Amid the typical low holiday volumes and higher volatility, the main equity markets drifted lower in August while corporate bonds at least offset some of the rise in government yields with narrowing spreads. Elsewhere, EU peripheral debt performed well but emerging market debt plummeted accompanied by sizeable currency devaluation in a number of major emerging market countries.
Commodities were the best performing asset by far as the Chinese economy rebounded and Syria became increasingly important to the oil market. UK property again produced positive gains contributing to a three month annualised return of 10%.
Stock Markets
Following such strong prior gains, August’s mild correction in equitymarkets was no great surprise. As noted last month, leading market the S&P 500 was already overbought and vulnerable to a setback. The S&P 500 then had to deal with a widening range of increasingly contentious issues during the month, ranging from emerging market instability and Syria through to rising bond yields and the Fed’s tapering decision.
With this background, the US led stock markets lower, with the MSCI AC World Equity index falling 3.6% from its August 2nd high. It should be noted, however, that despite all the media focus on another potential emerging market financial crisis, it was emerging markets and the Asia Pacific region that headed the regional performance tables in August, even outperforming the World index in common currency terms.
Inside the markets, cyclical sectors continued recent outperformance as PMIs signalled a substantial upturn in global industrial production and Chinese economic data provided a boost to the materials sector. The revival in domestic economies in the UK and Europe also contributed to further outperformance from mid-/small-capitalisation stocks.
Bond Markets
In fixed income, main market government bond yields returned to their upward trend. The US 10-year yield broke above 2.9% to hit its highest level in two years as markets continued to fret over the Fed’s tapering decision due on September 18th. UK yields surged by even more, as benchmark yield changes, allied to much stronger-than-expected economic data, caused a 40 basis point jump to US levels. While German bond yields matched the rise in US yields, those in Italy and Spain declined substantially. Economic recovery has certainly helped lower EU peripheral risk premiums, but political issues will move to the fore once again over the next month or so.
Corporate bonds performed much in line with governments – a reasonable performance given the weakness in equities. The scale of decline in UK spreads was distorted by the composition change to the gilt benchmark, but the economic background is certainly now more conducive to narrower spreads.
Emerging markets were by far the worst performing debt markets with the main indices losing nearly 3% over the month. Bond outflows accelerated as investors, for so long attracted by the higher “carry”, decided that the risks of further currency losses and rising yields in high current account deficit countries could have graver consequences.
Commodities
Commoditieshave staged something of a comeback, with the main CMCI Composite index recouping around half of the losses incurred in the first six months of 2013. Most of the recovery occurred in August and all of the sub-sectors generated positive returns.
Gold and silver prices rebounded supported by increased physical demand from China and India and short covering. The leading energy sector, meanwhile, benefited from seasonal strength, supply disruptions and developments in Syria. Improving economic data from China sparked a revival in industrial metals, aided by short closing in copper. Most grain prices eased again in August, but the sector as a whole was buoyed by a 12% surge in soybean prices as recent dry weather lowered expected crop yields.
Currencies
The main headlines in the currencymarkets were all generated by developments in emerging markets, although selling only erupted in the latter part of the month. During this period investors reduced exposure to high current account deficit countries and those with the highest levels of foreign debt. Towards the end of August, however, action by the authorities in India and Indonesia – the major losers – had begun to provide some support. In contrast, countries with current account surpluses, such as South Korea, Taiwan and Singapore, barely moved against the dollar.
Although receiving little publicity amidst all the emerging market turmoil, sterling outperformed all the major crosses by around 2% over the month. Improving economic data brought forward market expectations of the first rise in interest rates to about a year ahead of the forward guidance recently provided by BOE Governor Mark Carney - a first test.
UK Commercial Property
The UK commercial property marketconsolidated the previous month’s gains as capital values recorded another modest rise. Offices and industrial properties continued to lead the recovery with retail still lagging. News flow surrounding commercial property continued to improve throughout the month: the UK economic rebound is a considerable boost, investment funds are returning to the sector and confidence is building that a sustainable turn in the property cycle is underway.
Allocating Assets
From an asset allocationreturnsperspective, there was little to choose between equities and bonds last month with the latter losing slightly less than the former. As for longer term relative returns, however, Mark Tinker of Axa Framlington recently pointed out that "UK and US equities have now outperformed bonds on 1, 2, 3, 5, 10 and 25 years. Even adjusted for volatility they are ahead 1, 2, 3 and soon to be 5 years."
