Market & Performance Update: Quarterly
Monthly Market Commentary January 2016
Stormy conditions ― from central-bank measures to economic reports and financial markets ― defined January. Global equities declined steeply, while most fixed-income market segments fared well in U.S. dollar terms amid an investor flight to quality. We believe the proper course is to maintain exposure to risk assets and continue buying selectively on the dips, but are mindful of headwinds ranging from rising interest rates to low earnings growth and commodity-related weakness.
Economic Backdrop January hosted a rather stormy set of conditions in terms of economic developments, central-bank interventions and financial market turbulence. Oil prices fell to their lowest level in 13 years before rebounding sharply, as China’s reported economic growth for 2015 slid to 6.9%, a 25-year low. Trading on mainland Chinese stock markets was halted several times in early January when stocks fell by their daily limits, and capital outflows persisted as the People’s Bank of China made the largest capital injection into its banking system in three years after adjusting the yuan-U.S. dollar exchange rate downward earlier in the month. The Bank of England, European Central Bank (ECB) and U.S. Federal Open Market Committee (FOMC) made no changes, but ECB President Mario Draghi indicated a willingness to increase monetary stimulus in March if needed. Finally, in what was somewhat of a surprise to observers, the Bank of Japan (BOJ) announced the introduction of a negative-interest-rate policy, which joins its recently-expanded asset-purchase program in an effort to stimulate economic growth and spur inflation. U.K. retailers reported above-average year-over-year sales growth in January; the pace of new orders slowed to a threeyear low, yet non-specialized sectors reported significant gains. Manufacturers reported a further erosion of business confidence in the three months to January. New domestic and international orders slipped further into negative territory, while output improved. Consumer prices rose by more than-anticipated in December, and were slightly positive year over year, while producer prices remained in negative territory over both time frames. The unemployment count unexpectedly decreased in December following a downward revision to November’s data. Average earnings growth for the SeptemberNovember period declined to 2.0%, while the unemployment rate edged down to 5.1%. The U.K. economy expanded by 0.5% in the fourth quarter, according to provisional data. Hotels and restaurants contributed most, followed by business services and finance, while service-sector output reached a 12-month peak. However, year-over-year growth fell to a three-year low. Advance data from eurozone purchasing managers indicated decelerating manufacturing and services output growth in January. Both sectors reported multi-month lows, with a four-month trend of slowing new orders and price deterioration weighing on manufacturing. Producer prices fell for the sixth straight month in December and remained negative year over year, while consumer prices rose to a 15-month peak in January year over year, according to preliminary data. Retail sales disappointed in November, falling for the third consecutive month and year over year, with discretionary spending detracting most. Industrial production was also negative in November, falling substantially short of expectations, yet remaining positive year over year. The labor market continued to improve in December as the unemployment rate dropped to 10.4%, its lowest level since 2011. Preliminary data indicated that U.S. services-sector growth remained buoyant in January, but slowed due to energy-sector weakness and economic uncertainty. Manufacturing data for January indicated a greater-than-projected advance as new orders solidify amid stabilizing backlogs, and production accelerated for the first time in three months. Industrial production had contracted for the third straight month in December, attributable to weakness in utilities and mining. Core (ex-energy and food) consumer prices rose in December by less than during the previous month, but gained 2.1% in the year over year. Producer prices contracted in December and the year over year; energy prices continued to slide, and trade service prices, which appreciated in recent months, recorded zero growth. In December, labor market participation advanced to 62.6% and the unemployment rate remained at 5.0%, while average hourly earnings were unchanged. The U.S. economy grew at a 0.7% seasonally adjusted annualized rate in the fourth quarter, below the third quarter’s 2% rate. Net exports and inventory investment each detracted, while spending on services, goods, government purchases and residential investment contributed. © 2016 SEI
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Market Impact Fixed-income market performance was positive in January, as measured by the Barclays Global Aggregate Index, amid an investor flight to quality that resulted in negative performances for higher-risk market segments. U.S. Treasurys were the top performer as risk aversion proliferated, followed closely by U.S. dollar-hedged (which seeks to reduce U.S. dollarrelated volatility) global sovereign securities. U.S. mortgage-backed and Treasury Inflation-Protected Securities performed quite well and closely in line with each other, trailed by unhedged global sovereign securities. U.S. asset-backed securities also delivered notably positive performance, followed by global non-government debt (dollar-hedged and then unhedged). U.S. investment-grade corporate fixed income and local-currency-denominated emerging-market debt were also positive, while foreign-currency-denominated (external) emerging-market debt declined slightly and U.S. high-yield bonds were more steeply negative. Global equity markets, as reflected by the MSCI AC World Index (Net), declined sharply during January. Country-level performance ran a gamut of losses, although there were a few bright spots, particularly in Southeast Asia, Eastern Europe and South America. Thailand delivered January’s most impressive returns, trailed by Malaysia, Hungary and Indonesia. Peru, Turkey and Chile also had positive performance. Greece delivered the deepest losses, followed by Egypt, Italy and China. Global sectors declined with the exception of utilities. The telecommunications and consumer staples sectors were only slightly negative, and energy sector losses, while still significant, were mild relative to the remaining sectors as well as its own recent struggles. Financials had the sharpest drop, trailed closely by materials. Healthcare also declined steeply, followed by consumer discretionary, information technology and then industrials. Index Data
The Dow Jones Industrial Average Index declined by 5.39%. The S&P 500 Index fell by 4.96%. The NASDAQ Composite Index retreated by 7.82%. The MSCI AC World Index (Net), used to gauge global equity performance, declined by 6.03%. The Barclays Global Aggregate Index, which represents global bond markets, advanced by 0.87%. The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, increased in the month as a whole, moving from 18.21 to 20.20, and hit an intra-month high of 27.59 on 20 January. WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $37.04 a barrel on the last day in December to $33.62 at the end of January, and fell to $26.55 on 20 January, its lowest level in almost 13 years. The U.S. dollar strengthened against the euro, sterling and yen. The U.S. dollar ended January at $1.08 against the euro, $1.42 versus sterling and at 121.1 yen.
Portfolio Review The U.S. equity market declined in January, led downward by smaller companies. Growth and value were roughly matched among large caps, while value fared considerably better than growth among small caps. Selection within largecap technology names weighed on growth managers, while large-cap value managers struggled with style headwinds in a risk-off environment. Small-cap allocation was mixed, with a beneficial underweight to healthcare offset by an underweight to utilities. Selection detracted overall, as small-cap healthcare and energy names performed relatively well, but not by enough to overcome adverse selection in industrials and technology. Internationally, regional allocation contributed, but was partially offset by stock selection. Overall positioning was beneficial in Japan, while holdings in Europe and the U.K. were challenged. Underweights to Japan and the broader Pacific Basin were slight positives given the region’s underperformance. Within emerging markets, selection was positive in Europe and the Middle East, and an overweight to Russia enhanced relative returns despite challenged selection. Selection in Korea contributed, while holdings in India and Thailand detracted. An underweight to Malaysia detracted as the country held up relatively well during the selloff, and an overweight to China also struggled. Results in Latin America were neutral, with a positive overweight to Mexico offset by selection, a slightly additive overweight to Peru, challenged exposure to Chile and beneficial exposure to Argentina. U.S. Treasury yields declined in January, reversing their fourth-quarter increase. Intermediate-term yields declined by more than both short- and long-term yields, so a slightly shorter duration posture and yield curve flattening bias detracted. Investor risk aversion continued, pressuring an overweight to corporate financials and selection within industrials. While the commercial mortgage-backed securities (MBS) sector fared better than others, it still underperformed, and thus an overweight was not beneficial. Non-agency mortgages continue to be supported by solid housing market fundamentals, enabling these securities to avoid the volatility of other sectors, benefiting an ongoing overweight. A continued underweight to agency mortgages was additive as the sector underperformed. Asset-backed securities (ABS) were the © 2016 SEI
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only outperforming sector, so an overweight enhanced performance. The high-yield market delivered its third consecutive monthly decline, the seventh of the past eight months, as the energy sector dropped sharply again. A defensive posture and cash holdings, along with an underweight and selection within energy, an allocation to structured credit, and selection within retail and services, enhanced returns. An overweight to media and selection within financial services and utilities detracted from performance. Within emerging markets, an overweight to Venezuela was the most significant detractor. An underweight to Malaysian local debt also detracted as Malaysia’s currency appreciated strongly against the U.S. dollar. An overweight to Brazilian external sovereign debt contributed, and an overweight to Indonesian local debt was also beneficial as Indonesia’s currency strengthened. Manager Positioning and Opportunities SEI’s portfolio managers rely on investment-manager selection and portfolio construction in an effort to deliver diversified sources of excess return for our portfolios. We believe U.S. equities are experiencing a correction, rather than the start of a bear market, driven by concerns around China, oil and emerging markets. Our expectation is that the market will see its way through this given continued positive longer-term trends within housing, employment and auto sales that show a strong consumer. The market does not appear overvalued on the whole, but is growth and outlook dependent. Stability and other forms of quality appear expensive, while risk premium (deeper value) and other risk-based assets (smaller cap, higher volatility) appear very inexpensive. While correctly predicting the exact timing of a turn is exceedingly difficult, we continue to slowly increase our risk premium exposure through deeper value managers under the expectation that concerns about domestic growth will ease. Overseas, despite the global selloff in equities, our outlook remains generally intact. We remain pro-cyclically positioned and favor higher-quality, more-profitable companies. We slightly increased overweights to the information technology and consumer discretionary sectors, trimmed an overweight to telecommunications and retained small overweight to health care and industrials. An underweight to consumer staples was increased, and underweights to utilities and financials remained. In emerging markets, overweights to the consumer sectors were increased, information technology and industrials remained overweight, and healthcare exposure was reduced to neutral weight. Underweights to financials, materials and telecommunications were increased, while an underweight to energy was eliminated. Core fixed income retains a yield curve flattening bias and slightly short-to-neutral duration stance. After narrowing during the latter part of 2015, credit spreads have widened again and we have been adding risk back selectively. We have an overweight to corporate credit and a slight overweight to the industrial sector. Within high yield, volatility and uncertainty are still elevated due to conditions in the energy and commodity-related sectors, which remain underweight. We maintain a defensive posture via bank loans and cash allocations, and managers will be selective in new purchases given the ongoing volatility. In emerging markets, we have increased an underweight to external debt, reduced an underweight to local debt and maintained an allocation to corporate bonds. Our largest external debt positions are in Mexico, Indonesia, Brazil, Turkey and Argentina, while the largest underweights are to the Philippines, Russia, Lebanon, Poland and China. We have significant local bond overweights in Indonesia and India, and the largest local bond underweights are in Thailand and Malaysia. Accordingly, the most significant currency overweights are in India and Indonesia, while the biggest currency underweights are in low-yielding Asian currencies like the Thai baht and Malaysian ringgit. Our View The volatility of the past year and the pain felt in certain asset classes reminds us more of the 2011 experience than the calamitous tumult of 2008. We believe that the proper course is to maintain exposure to risk assets and continue buying selectively on the dips. We still like the odds of equities outperforming fixed income. The much-anticipated “lift-off” move that raised the federal funds rate is more akin to launching a hot-air balloon than a rocket. Our base case for 2016 is for more of the same: we expect yields to move slowly higher (yields move inversely to prices), much closer to the market’s expectations than those expressed by the FOMC members. The first few hikes in the federal funds rate ordinarily are taken in stride by the equity market — and for good reason. The U.S. Federal Reserve has no desire to lean hard against the economic expansion. ECB President Mario Draghi claims that the central bank stands ready to do more, if necessary, but it all comes down to how the eurozone economy does in the coming months. Measures of economic activity and monetary indicators are improving, and Draghi has some grounds to claim that his policies are showing signs of success. We expect further recovery in 2016 given the impact of monetary easing and the big decline in the value of the euro against the U.S. dollar over the past 18 months. However, we expect the ECB to do what it must to push inflation closer to its target rate. We think this will entail a further expansion of the central bank’s quantitative-easing program. Although our conviction level is not as high as it was this time last year, we still view an additional decline in the euro toward parity against the U.S. dollar as more likely than not. © 2016 SEI
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Further afield, we would argue that investors have begun to factor in the impact of a sluggish Chinese economy. We see the weakening of the renminbi as a good news/bad news development. On the positive side of the ledger, it should improve the competitiveness of the industrial economy, but it shifts the pressure onto China’s neighbors. We may have already begun to see a round of competitive devaluations in the region with the BOJ’s latest accommodative measure tipping the country’s benchmark rates into negative territory. However, if China can build on the tentative signs of recovery we are seeing then we believe it would be a net positive for those neighboring countries (Australia, Korea, Japan) that export commodities and semi-finished manufactured goods. In particular, we maintain a positive stance toward the Japanese equity market. Weak commodity prices are a net positive for the country’s consumers and businesses, and the currency has recommenced its slide on a trade-weighted basis since the BOJ’s latest announcement after appreciating in recent months, so it remains at a far more competitive level than in 2012, before the advent of Prime Minister Abe’s wide-ranging “Abenomics” program for economic reform. Corporate earnings are still trending upward and stock valuations remain the most attractive of any major region. Finally, Abenomics reform efforts continue apace and should get an additional tailwind as the recently concluded Trans-Pacific Partnership agreement is put into place over the next few years. In some ways, the outlook seems more worrisome now than at the beginning of 2015. The damage in commodities, emerging-market debt and equity, and high-yield securities suggest a sharp deterioration in global economic fundamentals. We also concede that stock-market valuations remain problematic. The current expected price-to-earnings ratio on the S&P 500 Index for 2016 is close to its high for this cycle and above the reading in mid-2007, just months before the onset of the bear market. While the multiples may be similar, the economic fundamentals are far different. Treasury bond yields, for example, were spiking in July 2007, while they remain stuck at less than half those levels today. Oil was spiking on its way to a July 2008 peak almost four times current levels. Even if bond yields rise in sympathy with short rates, they would need to climb dramatically for stock prices to fall in significant fashion. Additionally, until central banks begin to pursue tighter money policies that raise interest rates to much higher levels and cause the yield curve to invert (short-term interest rates move above longer-term rates) we will give risk assets the benefit of the doubt. Although the U.S. has embarked upon a rising interest-rate phase, even Fed policy remains quite easy by the yardstick of previous cycles. As risk rises and dispersion increases, the benefits of active management should increase. Our equity investment managers maintain a pro-cyclical outlook, yet are mindful of headwinds such as rising interest rates, U.S. dollar strength, peak profit margins and low earnings growth. The fixed-income managers still seek to minimize the impact of commodityrelated exposure (particularly in high yield), while emphasizing emerging-markets debt in Latin America and Africa and sharply increasing exposure to local-currency debt. Benchmark Descriptions The Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 bluechip New York Stock Exchange stocks that are selected by editors of The Wall Street Journal. The S&P 500 Index is a capitalization-weighted index made up of 500 widely held U.S. large-cap companies. The NASDAQ Composite Index is a market value-weighted index of all common stocks listed on the National Association of Securities Dealers Automated Quotations (NASDAQ) system. The MSCI All Country World Index is a market capitalization-weighted index composed of over 2,000 companies, representing the market structure of 48 developed and emerging-market countries in North and South America, Europe, Africa and the Pacific Rim. The Index is calculated with net dividends reinvested in U.S. dollars. The MSCI EMU Index (European Economic and Monetary Union) Index is a free float-adjusted market-capitalization weighted index that is designed to measure the equity market performance of countries within EMU. The MSCI EMU Index consists of the following 10 developed-market country indexes: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Netherlands, Portugal and Spain.
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The Barclays Global Aggregate Bond Index (formerly Lehman Brothers Global Aggregate Index), an unmanaged market capitalization-weighted benchmark, tracks the performance of investment-grade fixed- income securities denominated in 13 currencies. The Index reflects reinvestment of all distributions and changes in market prices. The Chicago Board Options Exchange Volatility Index (VIX) tracks the expected volatility in the S&P 500 Index over the next 30 days. A higher number indicates greater volatility. Disclosures This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts. There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company (SEI). Neither SEI nor its subsidiaries are affiliated with your financial advisor.
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Stormy conditions ― from central-bank measures to economic reports and financial markets ― defined January. Global equities declined steeply, while most fixed-income market segments fared well in U.S. dollar terms amid an investor flight to quality. We believe the proper course is to maintain exposure to risk assets and continue buying selectively on the dips, but are mindful of headwinds ranging from rising interest rates to low earnings growth and commodity-related weakness.
Economic Backdrop January hosted a rather stormy set of conditions in terms of economic developments, central-bank interventions and financial market turbulence. Oil prices fell to their lowest level in 13 years before rebounding sharply, as China’s reported economic growth for 2015 slid to 6.9%, a 25-year low. Trading on mainland Chinese stock markets was halted several times in early January when stocks fell by their daily limits, and capital outflows persisted as the People’s Bank of China made the largest capital injection into its banking system in three years after adjusting the yuan-U.S. dollar exchange rate downward earlier in the month. The Bank of England, European Central Bank (ECB) and U.S. Federal Open Market Committee (FOMC) made no changes, but ECB President Mario Draghi indicated a willingness to increase monetary stimulus in March if needed. Finally, in what was somewhat of a surprise to observers, the Bank of Japan (BOJ) announced the introduction of a negative-interest-rate policy, which joins its recently-expanded asset-purchase program in an effort to stimulate economic growth and spur inflation. U.K. retailers reported above-average year-over-year sales growth in January; the pace of new orders slowed to a threeyear low, yet non-specialized sectors reported significant gains. Manufacturers reported a further erosion of business confidence in the three months to January. New domestic and international orders slipped further into negative territory, while output improved. Consumer prices rose by more than-anticipated in December, and were slightly positive year over year, while producer prices remained in negative territory over both time frames. The unemployment count unexpectedly decreased in December following a downward revision to November’s data. Average earnings growth for the SeptemberNovember period declined to 2.0%, while the unemployment rate edged down to 5.1%. The U.K. economy expanded by 0.5% in the fourth quarter, according to provisional data. Hotels and restaurants contributed most, followed by business services and finance, while service-sector output reached a 12-month peak. However, year-over-year growth fell to a three-year low. Advance data from eurozone purchasing managers indicated decelerating manufacturing and services output growth in January. Both sectors reported multi-month lows, with a four-month trend of slowing new orders and price deterioration weighing on manufacturing. Producer prices fell for the sixth straight month in December and remained negative year over year, while consumer prices rose to a 15-month peak in January year over year, according to preliminary data. Retail sales disappointed in November, falling for the third consecutive month and year over year, with discretionary spending detracting most. Industrial production was also negative in November, falling substantially short of expectations, yet remaining positive year over year. The labor market continued to improve in December as the unemployment rate dropped to 10.4%, its lowest level since 2011. Preliminary data indicated that U.S. services-sector growth remained buoyant in January, but slowed due to energy-sector weakness and economic uncertainty. Manufacturing data for January indicated a greater-than-projected advance as new orders solidify amid stabilizing backlogs, and production accelerated for the first time in three months. Industrial production had contracted for the third straight month in December, attributable to weakness in utilities and mining. Core (ex-energy and food) consumer prices rose in December by less than during the previous month, but gained 2.1% in the year over year. Producer prices contracted in December and the year over year; energy prices continued to slide, and trade service prices, which appreciated in recent months, recorded zero growth. In December, labor market participation advanced to 62.6% and the unemployment rate remained at 5.0%, while average hourly earnings were unchanged. The U.S. economy grew at a 0.7% seasonally adjusted annualized rate in the fourth quarter, below the third quarter’s 2% rate. Net exports and inventory investment each detracted, while spending on services, goods, government purchases and residential investment contributed. © 2016 SEI
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Market Impact Fixed-income market performance was positive in January, as measured by the Barclays Global Aggregate Index, amid an investor flight to quality that resulted in negative performances for higher-risk market segments. U.S. Treasurys were the top performer as risk aversion proliferated, followed closely by U.S. dollar-hedged (which seeks to reduce U.S. dollarrelated volatility) global sovereign securities. U.S. mortgage-backed and Treasury Inflation-Protected Securities performed quite well and closely in line with each other, trailed by unhedged global sovereign securities. U.S. asset-backed securities also delivered notably positive performance, followed by global non-government debt (dollar-hedged and then unhedged). U.S. investment-grade corporate fixed income and local-currency-denominated emerging-market debt were also positive, while foreign-currency-denominated (external) emerging-market debt declined slightly and U.S. high-yield bonds were more steeply negative. Global equity markets, as reflected by the MSCI AC World Index (Net), declined sharply during January. Country-level performance ran a gamut of losses, although there were a few bright spots, particularly in Southeast Asia, Eastern Europe and South America. Thailand delivered January’s most impressive returns, trailed by Malaysia, Hungary and Indonesia. Peru, Turkey and Chile also had positive performance. Greece delivered the deepest losses, followed by Egypt, Italy and China. Global sectors declined with the exception of utilities. The telecommunications and consumer staples sectors were only slightly negative, and energy sector losses, while still significant, were mild relative to the remaining sectors as well as its own recent struggles. Financials had the sharpest drop, trailed closely by materials. Healthcare also declined steeply, followed by consumer discretionary, information technology and then industrials. Index Data
The Dow Jones Industrial Average Index declined by 5.39%. The S&P 500 Index fell by 4.96%. The NASDAQ Composite Index retreated by 7.82%. The MSCI AC World Index (Net), used to gauge global equity performance, declined by 6.03%. The Barclays Global Aggregate Index, which represents global bond markets, advanced by 0.87%. The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, increased in the month as a whole, moving from 18.21 to 20.20, and hit an intra-month high of 27.59 on 20 January. WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $37.04 a barrel on the last day in December to $33.62 at the end of January, and fell to $26.55 on 20 January, its lowest level in almost 13 years. The U.S. dollar strengthened against the euro, sterling and yen. The U.S. dollar ended January at $1.08 against the euro, $1.42 versus sterling and at 121.1 yen.
Portfolio Review The U.S. equity market declined in January, led downward by smaller companies. Growth and value were roughly matched among large caps, while value fared considerably better than growth among small caps. Selection within largecap technology names weighed on growth managers, while large-cap value managers struggled with style headwinds in a risk-off environment. Small-cap allocation was mixed, with a beneficial underweight to healthcare offset by an underweight to utilities. Selection detracted overall, as small-cap healthcare and energy names performed relatively well, but not by enough to overcome adverse selection in industrials and technology. Internationally, regional allocation contributed, but was partially offset by stock selection. Overall positioning was beneficial in Japan, while holdings in Europe and the U.K. were challenged. Underweights to Japan and the broader Pacific Basin were slight positives given the region’s underperformance. Within emerging markets, selection was positive in Europe and the Middle East, and an overweight to Russia enhanced relative returns despite challenged selection. Selection in Korea contributed, while holdings in India and Thailand detracted. An underweight to Malaysia detracted as the country held up relatively well during the selloff, and an overweight to China also struggled. Results in Latin America were neutral, with a positive overweight to Mexico offset by selection, a slightly additive overweight to Peru, challenged exposure to Chile and beneficial exposure to Argentina. U.S. Treasury yields declined in January, reversing their fourth-quarter increase. Intermediate-term yields declined by more than both short- and long-term yields, so a slightly shorter duration posture and yield curve flattening bias detracted. Investor risk aversion continued, pressuring an overweight to corporate financials and selection within industrials. While the commercial mortgage-backed securities (MBS) sector fared better than others, it still underperformed, and thus an overweight was not beneficial. Non-agency mortgages continue to be supported by solid housing market fundamentals, enabling these securities to avoid the volatility of other sectors, benefiting an ongoing overweight. A continued underweight to agency mortgages was additive as the sector underperformed. Asset-backed securities (ABS) were the © 2016 SEI
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only outperforming sector, so an overweight enhanced performance. The high-yield market delivered its third consecutive monthly decline, the seventh of the past eight months, as the energy sector dropped sharply again. A defensive posture and cash holdings, along with an underweight and selection within energy, an allocation to structured credit, and selection within retail and services, enhanced returns. An overweight to media and selection within financial services and utilities detracted from performance. Within emerging markets, an overweight to Venezuela was the most significant detractor. An underweight to Malaysian local debt also detracted as Malaysia’s currency appreciated strongly against the U.S. dollar. An overweight to Brazilian external sovereign debt contributed, and an overweight to Indonesian local debt was also beneficial as Indonesia’s currency strengthened. Manager Positioning and Opportunities SEI’s portfolio managers rely on investment-manager selection and portfolio construction in an effort to deliver diversified sources of excess return for our portfolios. We believe U.S. equities are experiencing a correction, rather than the start of a bear market, driven by concerns around China, oil and emerging markets. Our expectation is that the market will see its way through this given continued positive longer-term trends within housing, employment and auto sales that show a strong consumer. The market does not appear overvalued on the whole, but is growth and outlook dependent. Stability and other forms of quality appear expensive, while risk premium (deeper value) and other risk-based assets (smaller cap, higher volatility) appear very inexpensive. While correctly predicting the exact timing of a turn is exceedingly difficult, we continue to slowly increase our risk premium exposure through deeper value managers under the expectation that concerns about domestic growth will ease. Overseas, despite the global selloff in equities, our outlook remains generally intact. We remain pro-cyclically positioned and favor higher-quality, more-profitable companies. We slightly increased overweights to the information technology and consumer discretionary sectors, trimmed an overweight to telecommunications and retained small overweight to health care and industrials. An underweight to consumer staples was increased, and underweights to utilities and financials remained. In emerging markets, overweights to the consumer sectors were increased, information technology and industrials remained overweight, and healthcare exposure was reduced to neutral weight. Underweights to financials, materials and telecommunications were increased, while an underweight to energy was eliminated. Core fixed income retains a yield curve flattening bias and slightly short-to-neutral duration stance. After narrowing during the latter part of 2015, credit spreads have widened again and we have been adding risk back selectively. We have an overweight to corporate credit and a slight overweight to the industrial sector. Within high yield, volatility and uncertainty are still elevated due to conditions in the energy and commodity-related sectors, which remain underweight. We maintain a defensive posture via bank loans and cash allocations, and managers will be selective in new purchases given the ongoing volatility. In emerging markets, we have increased an underweight to external debt, reduced an underweight to local debt and maintained an allocation to corporate bonds. Our largest external debt positions are in Mexico, Indonesia, Brazil, Turkey and Argentina, while the largest underweights are to the Philippines, Russia, Lebanon, Poland and China. We have significant local bond overweights in Indonesia and India, and the largest local bond underweights are in Thailand and Malaysia. Accordingly, the most significant currency overweights are in India and Indonesia, while the biggest currency underweights are in low-yielding Asian currencies like the Thai baht and Malaysian ringgit. Our View The volatility of the past year and the pain felt in certain asset classes reminds us more of the 2011 experience than the calamitous tumult of 2008. We believe that the proper course is to maintain exposure to risk assets and continue buying selectively on the dips. We still like the odds of equities outperforming fixed income. The much-anticipated “lift-off” move that raised the federal funds rate is more akin to launching a hot-air balloon than a rocket. Our base case for 2016 is for more of the same: we expect yields to move slowly higher (yields move inversely to prices), much closer to the market’s expectations than those expressed by the FOMC members. The first few hikes in the federal funds rate ordinarily are taken in stride by the equity market — and for good reason. The U.S. Federal Reserve has no desire to lean hard against the economic expansion. ECB President Mario Draghi claims that the central bank stands ready to do more, if necessary, but it all comes down to how the eurozone economy does in the coming months. Measures of economic activity and monetary indicators are improving, and Draghi has some grounds to claim that his policies are showing signs of success. We expect further recovery in 2016 given the impact of monetary easing and the big decline in the value of the euro against the U.S. dollar over the past 18 months. However, we expect the ECB to do what it must to push inflation closer to its target rate. We think this will entail a further expansion of the central bank’s quantitative-easing program. Although our conviction level is not as high as it was this time last year, we still view an additional decline in the euro toward parity against the U.S. dollar as more likely than not. © 2016 SEI
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Further afield, we would argue that investors have begun to factor in the impact of a sluggish Chinese economy. We see the weakening of the renminbi as a good news/bad news development. On the positive side of the ledger, it should improve the competitiveness of the industrial economy, but it shifts the pressure onto China’s neighbors. We may have already begun to see a round of competitive devaluations in the region with the BOJ’s latest accommodative measure tipping the country’s benchmark rates into negative territory. However, if China can build on the tentative signs of recovery we are seeing then we believe it would be a net positive for those neighboring countries (Australia, Korea, Japan) that export commodities and semi-finished manufactured goods. In particular, we maintain a positive stance toward the Japanese equity market. Weak commodity prices are a net positive for the country’s consumers and businesses, and the currency has recommenced its slide on a trade-weighted basis since the BOJ’s latest announcement after appreciating in recent months, so it remains at a far more competitive level than in 2012, before the advent of Prime Minister Abe’s wide-ranging “Abenomics” program for economic reform. Corporate earnings are still trending upward and stock valuations remain the most attractive of any major region. Finally, Abenomics reform efforts continue apace and should get an additional tailwind as the recently concluded Trans-Pacific Partnership agreement is put into place over the next few years. In some ways, the outlook seems more worrisome now than at the beginning of 2015. The damage in commodities, emerging-market debt and equity, and high-yield securities suggest a sharp deterioration in global economic fundamentals. We also concede that stock-market valuations remain problematic. The current expected price-to-earnings ratio on the S&P 500 Index for 2016 is close to its high for this cycle and above the reading in mid-2007, just months before the onset of the bear market. While the multiples may be similar, the economic fundamentals are far different. Treasury bond yields, for example, were spiking in July 2007, while they remain stuck at less than half those levels today. Oil was spiking on its way to a July 2008 peak almost four times current levels. Even if bond yields rise in sympathy with short rates, they would need to climb dramatically for stock prices to fall in significant fashion. Additionally, until central banks begin to pursue tighter money policies that raise interest rates to much higher levels and cause the yield curve to invert (short-term interest rates move above longer-term rates) we will give risk assets the benefit of the doubt. Although the U.S. has embarked upon a rising interest-rate phase, even Fed policy remains quite easy by the yardstick of previous cycles. As risk rises and dispersion increases, the benefits of active management should increase. Our equity investment managers maintain a pro-cyclical outlook, yet are mindful of headwinds such as rising interest rates, U.S. dollar strength, peak profit margins and low earnings growth. The fixed-income managers still seek to minimize the impact of commodityrelated exposure (particularly in high yield), while emphasizing emerging-markets debt in Latin America and Africa and sharply increasing exposure to local-currency debt. Benchmark Descriptions The Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 bluechip New York Stock Exchange stocks that are selected by editors of The Wall Street Journal. The S&P 500 Index is a capitalization-weighted index made up of 500 widely held U.S. large-cap companies. The NASDAQ Composite Index is a market value-weighted index of all common stocks listed on the National Association of Securities Dealers Automated Quotations (NASDAQ) system. The MSCI All Country World Index is a market capitalization-weighted index composed of over 2,000 companies, representing the market structure of 48 developed and emerging-market countries in North and South America, Europe, Africa and the Pacific Rim. The Index is calculated with net dividends reinvested in U.S. dollars. The MSCI EMU Index (European Economic and Monetary Union) Index is a free float-adjusted market-capitalization weighted index that is designed to measure the equity market performance of countries within EMU. The MSCI EMU Index consists of the following 10 developed-market country indexes: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Netherlands, Portugal and Spain.
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The Barclays Global Aggregate Bond Index (formerly Lehman Brothers Global Aggregate Index), an unmanaged market capitalization-weighted benchmark, tracks the performance of investment-grade fixed- income securities denominated in 13 currencies. The Index reflects reinvestment of all distributions and changes in market prices. The Chicago Board Options Exchange Volatility Index (VIX) tracks the expected volatility in the S&P 500 Index over the next 30 days. A higher number indicates greater volatility. Disclosures This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts. There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company (SEI). Neither SEI nor its subsidiaries are affiliated with your financial advisor.
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