Summary
- Technology drove strong US returns.
- Emerging Markets lead global returns, despite negative Chinese returns.
- Strong earnings have allowed market to climb the “wall of worry”.
US Sectors: Technology Back in a Big Way
Table 2 (below) shows US sector performance. Technology was the leader by a wide margin, after posting close to a double-digit negative return last quarter. As we discussed in our most recent earnings recap, Technology earnings have continued to be very strong, driven by AI spending and efficiency gains. Similarly, the Industrials sector had a strong quarter, riding similar tailwinds as the Technology sector.
At the bottom of the returns table sits Energy. In the first quarter, the Energy sector was able to generate market-leading returns with oil prices peaking above $100 per barrel. However, as oil prices fell in the second quarter, oil returns also lagged the remainder of the market. Even with this negative quarter, the sector only trails technology from a trailing twelve-month standpoint.
The only other negative sector for the quarter was Utilities. There are two dynamics working here, in our view. First, due to the steady cash flows of the sector, Utility equities often behave like bonds. As such, in a quarter where rates rise, as they did in Q2, utilities will struggle to produce positive returns. Second, Utilities are often viewed as a defensive sector. In a quarter when investors begin to take a more risk-on posture, we would expect the sector to lag.
International Stocks: Emerging Markets Lead the Way, Despite Poor Chinese Returns
Moving to Table 3 below, we see Emerging Markets (EM) leading all global equities. This result is somewhat surprising, especially when peeking at the bottom of the table and seeing China posting a negative return for the second quarter in a row. Over the past decade, China has been viewed as the growth engine of Emerging Markets, with the broad regional returns following China. However, both South Korea and Taiwan have stepped in as growth-oriented market drivers for EM. Both of these countries posted returns over 50% this quarter, allowing EM to overcome negative Chinese returns, as well as sluggish returns in Latin America.
On the currency front, we saw a continuation of dollar strengthening. Specifically, the yen and Canadian dollar lagged the most. For the yen, this currency cross is often seen as a risk-on/risk-off measure. The dollar strengthening here could be a reflection of the market’s more risk-on stance this quarter. For the Canadian dollar, we believe weakening oil prices was the culprit, with the Canadian economy being heavily tied to commodities. In our view, this dollar strengthening is a double-edged sword for US-based investors; a strengthening dollar is a lag on returns for US investors, but for more export-focused countries, a weaker local currency could represent a tailwind for local equity returns.
Looking Forward: We Continue to be Cautiously Optimistic
In this section of our quarterly recap, we have been continuously championing the importance of earnings analysis. This quarter will be no different. Tying back to the “wall of worry,” in our view, earnings are what allows the market to climb this wall. While headlines can often focus on potential market headwinds, unless those headwinds are able to cause earnings deterioration, the market will often continue to climb. We believe that this is what we saw in the second quarter; in spite of soft macro data and geopolitical worries, earnings remain broadly strong, allowing the market to climb the wall.
Even with this constructive view on earnings, we remain vigilant in our risk processes. As a refresher from last quarter, in our shorter-horizon portfolios, our risk processes emphasize technical analysis and price momentum; in our longer-horizon portfolios, the risk focus is more heavily weighted towards deterioration in market fundamentals — though all portfolios draw on a mosaic of both disciplines. Currently, both technical and fundamental momentum remain broadly positive by our measures; however, a Federal Reserve likely on hold and elevated investor sentiment after such a strong quarter have our shorter-horizon team cautiously monitoring tactical indicators.
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Technology and internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market.
Artificial intelligence, or AI, refers to the simulation of human intelligence by software-coded heuristics. Nowadays this code is prevalent in everything from cloudbased, enterprise applications to consumer apps and even embedded firmware.
Standard & Poor’s (S&P) 500 Index TR USD (US Large Cap) measures the performance of 500 large cap stocks, which together represent about 80% of the total US equities market.
Standard & Poor’s (S&P) 1000 Index (US SMID Cap) – the S&P MidCap 400 Index and the S&P SmallCap 600 Index are combined to form the S&P 1000.
MSCI EAFE Net Total Return (NR) USD Index: The index captures large and mid-cap representation in 21 developed markets around the world, excluding the US and Canada. The index covers approximately 85% of the adjusted free-float market capitalization in each country. For net returns, the regular cash dividend is reinvested after deduction of withholding tax by applying the maximum rate of the company’s country of incorporation applicable to institutional investors.
MSCI Emerging Markets Index captures large and mid cap representation across approximately 26 Emerging Markets (EM) countries.
MSCI Europe Index represents the performance of large and mid-cap equities across approximately 15 developed countries in Europe.
MSCI Japan Index designed to measure the performance of the large and mid cap segments of the Japanese market.
MSCI China Index captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs).
MSCI United Kingdom Index (USD) is designed to measure the performance of the large and mid cap segments of the UK market.
MSCI Canada Index is designed to measure the performance of the large and mid cap segments of the Canada market.
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MSCI ACWI Index (Global Equities) is designed to represent performance of the full opportunity set of large- and mid-cap stocks across approximately 23 developed and approximately 25 emerging markets.
MSCI ACWI ex USA Index (Global ex US Equities) captures large and mid cap representation across approximately 22 of 23 developed markets (DM) countries (excluding the US) and approximately 25 emerging markets (EM) countries.
ICE BofA High Yield Index TR USD (High Yield) tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market. Index constituents are capitalization-weighted based on their current amount outstanding times the market price plus accrued interest.
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The Bank of Japan (BOJ) is headquartered in the Nihonbashi business district in Tokyo. The BOJ is the Japanese central bank, which is responsible for issuing and handling currency and treasury securities, implementing monetary policy, maintaining the stability of the Japanese financial system, and providing settling and clearing services. Like most central banks, the BOJ also compiles and aggregates economic data and produces economic research and analysis.
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In a rising interest rate environment, the value of fixed-income securities generally declines.
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