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Peter Hardy, Senior Client Portfolio Manager of Global Value Strategies at American Century Investments. My team manages the Renaissance Equity Income Fund.
What occurred in the fourth quarter, in that the increased volatility and then which sectors became more or less attractive. Let’s start first by kind of talking about the sell-off. The market sell-off and increased volatility has been caused by several things.
What we’ve discussed on some of our previous pod casts is a change from super accommodative monetary policy to something more normal and less accommodative. And the Fed raised interest rates 4 times in 2018 and discontinued its asset purchasing program, ultimately letting bonds roll for the first time since quantitative easing began.
Additionally the ECB reduced and discontinued their asset purchasing program during the fourth quarter, just not allowing their bonds to roll like the Federal Reserve.
These two mechanisms are in essence removing liquidity from the market, and that is putting pressure on asset prices and it came in the form, specifically in stocks, of a market sell-off. Central banks could eventually come in and support the market, but normalization and monetary policy is likely to lead to increased volatility in the future.
What changed from the previous quarters or previous several years, was that investors started to question global growth, in part, due to concerns about trade-wars and tariffs. So less accommodative monetary policy, concerns about global growth and trade-wars coupled with less caught bad earnings from Bellwether tech companies, and you got a very aggressive sell-off.
From Sept 21st to December 24th, the S&P500 was off over 19%, so that’s the Peak to Trough of the sell off, and the Russell 1000 value benchmark, one of the value benchmarks we compare ourselves to, was off almost 18%.
We’re broadly diversified and we’re higher quality oriented and yield oriented as investors, so we really think about things on an individual stock basis as opposed to a sector. And then we’re typically buying companies while they’re cheap as value investors. So, that cheapness usually comes with risk, we’ve just assessed that risk prior to investing in the company.
However, with that in mind, as value investors, we’re seeing a couple of specific factors impacting the securities we look at during the sell-off. The first would be rates, and the second would be commodity prices.
In the quarter, while the Federal Reserve raised it’s Fed funds rate to a range of 225 to 250, the interesting part of the sell-off was, yields, while they went up, at the beginning of the quarter fell. So you saw the Fed raising interest rates and yields broadly falling during the quarter, the 10 year treasury yield fell from a high of 323 during the fourth quarter to a low of 256.
This led to a vast divergence in the performance of securities that are interest rate sensitive. While the S&P500 was down 19% during this sell-off Utilities and REITs, sectors that tend to have higher yields and therefore tend to be more interest rate sensitive, were down only 1.64 and 9% correspondingly. So, those yield oriented sectors got a little richer from evaluation perspective relative to the market, and at the margin would appear less attractive within the context of our process.
Banks, on the other hand, have their earnings pressured by falling rates due to the fact that they earn less money, less net interest margin, in a low rate environ. By virtue of that, financial stocks under perform the broad market falling over 22%.
And so, as an active investor, the under performance in banks would make them appear more attractive and we would have gotten more constructive on them and the under performance in REITs and utilities would have made them less attractive in the context of our process.
Consumer staples was another sector that benefited from this interest rate mechanism, as they have higher interest rates and are perceived to have greater degrees of stability.
So that would really encapsulate some of the interest rate impacts on sectors that we saw in the fourth quarter and the market sell-off.
The other thing that occurred that impacted our stocks from a factor perspective was falling commodity prices. Due to the previously stated concerns about global growth and trade-wars, as well as the impacts of those on supply demand within the energy sector, we saw commodity prices fall substantially during the quarter.
Brent crude oil prices fell from a high of over $85 a barrel during the fourth quarter to a low of almost $50 a barrel. As such, energy was the worst performing sector in the S&P500 in the Russell 1000 value, having a negative 28% return during the period.
Many of those energy names that fell now appear more attractive within the context of our process. That being said, there is risk in this sector, some of these businesses are more volatile, and we offset that risk by buying the best businesses, the highest quality names in the sector to offset the risk.
We would’ve added some weights to other names outside of these two sectors based on company specific events, but I would say that those broad themes of falling treasury yields and commodity prices would be a major impact to securities.