U.S. Equity Up Modestly

The S&P 500 Index was up a modest 0.6% in 3Q21, with results mixed across sectors. Industrials (-4.2%) and Materials (-3.5%) were at the bottom of the pack while Financials (+2.7%) was the best-performing sector. Energy (+43%) is up the most YTD. In the large cap space, growth stocks outperformed value (Russell 1000 Growth: +1.2%; Russell 1000 Value: -0.8%) but lag YTD (+14.3% vs. +16.1%). In small caps, the reverse occurred (Russell 2000 Growth: -5.7%; Russell 2000 Value: -3.0%), and value is ahead YTD by more than 20 percentage points (Russell 2000 Growth: +2.8%; Russell 2000 Value: +22.9%) as “meme” stocks posted sharp gains. Small cap underperformed large cap in 3Q (Russell 2000: -4.4% vs. Russell 1000: +0.2%) and now lags YTD (12.4% vs. 15.2%).

Global Equity Falls

The MSCI ACWI ex-USA Index lost 3.0% for the quarter, hurt primarily by U.S. dollar strength and the benchmark’s exposure to emerging markets. The best-performing sector was Energy (+7%), while Consumer Discretionary (-11%) and Communication Services (-10%) posted steep declines. These sectors include some of the Chinese stocks that have been hit hard by the country’s regulatory crackdown (Alibaba, Tencent, and Baidu all fell more than 20%). The MSCI EAFE Index (Europe, Australia, and Far East) lost 0.4% but in local terms it was up 1.3%. Japan (+4.6%) performed relatively well while many of the larger constituents were down for the quarter.

Emerging Markets Plunge

The MSCI Emerging Markets Index sank 8.1%, making it the worst-performing asset class for the quarter. Within emerging markets, Brazil (-20%), China (-18%), and Korea (-13%) fell sharply while India (+13%), Russia (+10%), and Colombia (+10%) were up strongly.

Slight Gains for U.S. Fixed Income

U.S. Treasury yields were relatively unchanged from 6/30/21, masking intra-quarter volatility. The 10-year U.S. Treasury closed the quarter at 1.52%, up sharply from early August when it traded at 1.19%. The Bloomberg US Aggregate Bond Index returned 0.1% for the quarter. Investment grade corporates underperformed U.S. Treasuries by 15 bps on a duration-adjusted basis as spreads widened modestly. TIPS outperformed nominal Treasuries (Bloomberg US TIPS Index: +1.8%; Bloomberg US Treasury Index: +0.1%) and 10-year breakeven spreads widened 5 bps to 2.37%. The Bloomberg High Yield Index rose 0.9% and leveraged loans (S&P LSTA Lev Loan: +1.1%) also performed well. The high yield default rate declined to 0.9% in September, the lowest since March 2014, according to data from J.P. Morgan.

Tax-Exempts Underperform Treasuries

Municipals (Bloomberg Municipal Bond Index: -0.3%) underperformed Treasuries for the quarter though the supply/demand picture was positive. Supply was modest and demand was fueled by expectations for higher tax rates and strong credit fundamentals. Lower-quality bonds continued their trend of outperformance as investors sought yield. The BBB sector returned +0.1% vs. -0.4% for AAAs.

Strong Dollar Erodes Unhedged Returns

Overseas, developed market returns were muted and U.S. dollar strength eroded returns for unhedged U.S. investors. The Bloomberg Global Aggregate ex-US Bond Index fell 1.6% but was flat (+0.1%) on a hedged basis. The dollar gained roughly 2% vs. a basket of developed market currencies.

Losses for EM Debt

Emerging market debt posted negative returns; the JPM EMBI Global Diversified Index fell 0.7% and the local JPM GBI-EM Global Diversified Index lost 3.1%, most of which was due to currency depreciation. In local terms, this index was down only 0.2%. Latin America (-7.2%) was the worst-performing region within the index, with Brazil, Chile, and Peru declining more than 10%. Asia (+0.3%) performed best, led by China (+2%) and Indonesia (+4%).

Most Real Assets Sees Gains, Some Quite Big

The Bloomberg Commodity Index rose 6.6% for the quarter and is up 29.1% YTD, but what lies under the hood is more interesting. Natural gas prices soared nearly 60% for the quarter, and those gains were relatively muted compared to the experience in Europe, where prices tripled. WTI Crude Oil was up 4% and other broad sectors were relatively flat to down. TIPS (Bloomberg TIPS Index: +1.8%) performed well relative to nominal U.S. Treasuries. REITs posted more muted results, with the MSCI US REIT Index up 1.0%. Gold (S&P Gold Spot Price Index: -0.8%) and infrastructure (DJB Global Infrastructure: -0.9%) posted negative returns. Copper fell more than 4% on worries over slowing demand from China.