Hagai Netser, Portfolio Manager
The third quarter of 2016 can be characterized by two contradictory market forces: On the one hand volatility was very low, dropping to near record lows for recent years (the VIX index hitting levels of 11-12% during August and September), while on the other hand - market participants and as a result markets themselves, were extremely edgy, fearing each burst of volatility might be the signal of a lurking market correction.
The quarter started positively as markets rebounded post Brexit (June 23rd), returning 4.31% during July as measured by the MSCI All Countries World Index. This recovery however, was not supported by significant fundamental data. Weak data releases such as the IMF cutting its 2016 US growth forecast from 2.4% to 2.2% based on a weak Q1, kept investors anxious.
During August and September, markets were relatively quiet - equities returned +0.5% and +0.2% respectively, as measured by the MSCI AC World index in USD terms. However, the combination of minimal volatility levels paired with weak fundamental data resulted in concerns over an elusive market correction. The volatility we did see in markets was mostly generated as momentary spikes resulted from a few key events in the quarter. For example, on September 9th, Federal Reserve Bank President Eric Rosengren said that he thinks it might be appropriate to start raising rates. The fact that Rosengren who is generally considered a dove (supporter of lower interest rates) might have changed his tone, was enough to throw markets to their second worst day of the year (after Brexit). On that day, the S&P500 index fell almost 2.5%. Eventually, the Fed left the policy rate unchanged post its September meeting, and markets remained calm with a return to their business as usual of low volatility.
On the back of Brexit concerns, the Pound crashed to a 31-year low vs the Dollar, trading as low as $1.2721 - the weakest point since 1985, on growing concerns that the UK was heading for a hard Brexit. Concerns over additional countries leaving the EU are still significant, as the next milestone for the EU’s stability would be Italy’s constitutional referendum vote, which will take place on December 4. While the referendum focuses mostly on domestic reforms to the country’s notoriously inefficient legislative system, a vote to reject it may push Pro-EU Prime Minister Matteo Renzi to resign according to his previous statements. By quitting, the PM could effectively empower Italy’s Eurosceptic Five Star Movement.
In commodities, the quarter ended with a big splash as the OPEC September meeting ended with a provisional agreement to cut production. The agreement sets a goal for 32.5 to 33 million barrels with three nations, Iran, Libya, and Nigeria, being exempt. This is the first agreement in OPEC for oil production cuts since the Great Financial Crisis in 2008. With the news of the production cuts the price of oil surged with WTI rising 5.3% in a day and by the quarters end WTI was up 8%. However, it still stands to be seen if OPEC can iron out the details and get its members to stay the course.
Overall, Equity markets as measured by the MSCI AC World index were up +4.6% for the quarter in local currency terms. Bonds were up +0.5% in US Dollar terms, as measured by the Barclays US Aggregate Total Return index. This market environment has proven to be beneficial for Hedge Funds as well, which concluded the quarter up +2.4%, based on the HFRI Fund-of-Funds index.