Developed Markets Rebound
In the month of March, international developed stock markets returned 1.16%. Pacific ex Japan and Canada recorded returns of 6.92% and 5.30%, respectively. Japan and Europe ex UK lagged other markets. International developed markets are down -4.81% YTD while the U.S. market is down -5.31%. Continued geopolitical risks, high inflation, and central bank tightening proved to be headwinds for global stock markets through the first quarter. Investors are expecting the Federal Reserve to reduce its holdings of Treasury bonds and mortgage-backed securities, which could cause long-term interest rates to increase. A rising rate environment could negatively impact stocks with long durations, such as growth stocks.
Geopolitical Risks Remain
Broader emerging markets posted a -2.00% return for the month after declining in February. Brazil and Mexico recorded positive returns of 14.86% and 9.25%, respectively. Russia and China lagged other markets in March. Russian markets were impacted by Russia’s invasion of Ukraine and the responding punitive sanctions imposed by the international community. Russia’s stock market has lost most of its value, with many institutional investors still waiting to sell their Russian holdings. Given Russia’s low weight in emerging market funds, investors may benefit from rebalancing into emerging markets as their market valuations relative to the US market are near 15 year lows. Financial markets have historically bounced back from market drawdowns caused by wars.
Energy and Infrastructure Outperform
Energy and infrastructure recorded positive returns of 7.56% and 5.90%, respectively, in March. Telecommunications and consumer staples lagged other sectors. Energy continues to do well after a strong 2021 performance. The energy sector is up 31% YTD and 52.39% over the past year. Oil supply and demand dynamics would continue to be favorable in the short and medium term even if Russian oil sales were to resume. The materials sector has benefited from the market turmoil given its exposure to gold producers, fertilizer producers, and miners.
DOMESTIC EQUITY FACTORS
Value Outperforms in the First Quarter
In March, value underperformed growth in the large-cap space but outperformed in the small-cap space. Momentum recorded a return of 3.31%. Small-cap value stocks continue to outperform small-cap growth stocks. Their ten-year annualized return is now at 10.54%, slightly below small-cap growth’s ten-year return. Even after value’s strong performance, value stocks are still very cheap relative to growth stocks. Value-oriented sectors such as energy, financials, and materials may still have much more room to run.
FOREIGN EQUITY FACTORS
Value Outperforms in the International Markets
In the international developed markets, value outperformed growth in the large-cap and small-cap space in the first quarter. Momentum recorded a return of -5.96% YTD while small-cap emerging market stocks posted a return of -4.39%. Valuations of value stocks are still very low relative to growth stocks in both international developed and emerging markets, which is consistent with the US market. The rotation from growth into value may resume as investors become wary of high valuations in growth stocks. Rising interest rates may also pose more of a risk to growth stocks than value stocks.
Multiple Interest Rate Hikes Expected in 2022
In March, the three-month Treasury bill index returned 0.03% for the month. Investors expect multiple rate hikes this year due to the recently high inflation numbers and labor scarcity. However, savers will still face low real interest rates for the foreseeable future. The CPI has increased by 7.91% over the past year through the end of February.
DISINFLATION DEFLATIONARY HEDGES
Fixed Income Investments Drop in March
The returns of deflationary hedges were mostly negative for the month. Long-term government bonds returned -5.34% in March. The Bloomberg Barclays U.S. Agg Bond Index returned -2.78% for the month. High-yield bonds are down -4.51% YTD. If interest rates continue to rise, less creditworthy borrowers may face difficulties meeting their financial obligations. Among the deflationary hedges, only the SwissRe Global Catastrophe Bond index has a positive performance YTD. Catastrophe bonds are up 4.72% over the past year, providing a competitive yield without the equity-like volatility of leveraged loans and high-yield bonds. Real yields continue to remain around historical lows.
INFLATION SENSITIVE INVESTMENTS
Gold Bullion Rebounds
Inflation-sensitive investment returns were mostly positive for the month except for inflation-indexed bonds. U.S. natural gas and U.S. REITs were up 27.7% and 6.71%, respectively. The Bloomberg Commodity index posted a return of 8.65% in March. WTI crude and US natural gas are up 38% and 58%, respectively, YTD. Gold bullion and gold miners are also up YTD, providing a nice hedge against Russian geopolitical risks. The standing of gold among central banks may grow as other countries observe how Russia uses its gold to withstand the impact of sanctions. Like oil’s future supply prospects, the future supply of gold may be constrained as exploration and capital expenditures have been muted.
U.S. Dollar Mixed Versus Other Currencies
Over the past three months, the U.S. dollar appreciated against the Yen, Euro and Swiss Franc. The U.S. dollar depreciated against the Australian dollar, Canadian dollar and Mexican Peso over the same period. However, the continuation of large U.S. fiscal deficits may weigh on the U.S. dollar in the medium-term to long-term. Gross federal debt to GDP stands at 123% and is forecasted to increase through the decade.
Brandon Yee, CFA, CAIA – Research Analyst
Brandon conducts investment due diligence for Versant Capital Management, and designs and implements tools and processes to support the firm’s research. His background in biology and finance help him to look at challenges from multiple angles, resulting in unique and well-rounded approaches and solutions.
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