Equities Fall Amid Emerging Market FEars
Stocks slid last week to their worst loss in more than two years, as measured by the Dow Jones Industrial Average, with the Dow and S&P 500 falling 3.5% and 2.6%, respectively. Friday was particularly ugly, with both the Dow and S&P 500 experiencing their biggest single-day decline since June 20, 2013. The week’s onslaught was largely sparked by currency woes in emerging markets and soft economic data out of China; US data was limited during the week.
According to Bloomberg, emerging market currencies experienced their worst decline in five years late last week. Countries such as Argentina, Turkey, South Africa, and Ukraine saw their denominations plunge amid political problems and waning investor confidence in the wake of the Federal Reserve’s step back from bond markets. These moves caused a broader flight-to-safety, as seemingly stable economies like Poland and Mexico sold off.
In China, last week’s flash PMI report indicated the country slipped back into a contractionary manufacturing phase with a reading of 49.6. This troubled many investors who were already sensitive to recent reports about the country’s banking system. In the latter case, Chinese authorities have reportedly warned financial institutions to be increasingly wary when lending to the coal-mining industry due to acute credit risks in some circumstances. These developments continue to feed into general fears that the world’s second largest economy is experiencing a material slow down.
In the US, the holiday-shortened week offered little new information on the health of the economy. Initial jobless claims on Friday were reported slightly ahead of expectations, at 326,000. This series has been particularly volatile of late, swinging wildly between 300,000 and 380,000 since September.
The four-week moving average, which is designed to smooth out the weekly volatility of the measure, did improve to just over 331,000 claims. This represents a strong improvement from four weeks ago, and may signal a better January jobs report following December’s disappointing release.
Econoday reported, however, that continuing claims are creeping higher, which suggests the labor market picture remains mixed.
In the week’s only other major US economic data report, the Census Bureau reported that existing home sales improved slightly in December to a seasonally adjusted annualized rate of 4.87 million homes. The month’s 1.0% month-over-month change was made possible by a negative November revision, from 4.9 to 4.82 million. Over the past 12 months though, the level of sales has actually declined by just under 1%. The absolute level of sales is also well below its peak of 5.39 million homes in August.
There are concerns that the housing market is facing several impediments at the moment, not the least of which is higher mortgage rates. Supply is also tight, with inventory falling sharply from 5.1 months to 4.6 months in December. Additional housing market data occurs next week, with the release of new home sales and the Case-Shiller Home Price Index.
An active management turning point?
Active managers faced a difficult road in recent years, leading to many questions about the efficacy of active versus passive investment management. There are signs that the tide is once again changing in favor of active managers and the road ahead could offer happier times.
Following the global financial crisis (GFC), the ability to differentiate between stocks, sectors or asset classes became increasingly challenged, leading to active management struggles. The dispersion of performance among multiple asset class shrank to historically tight levels in 2012, according to
S&P. As dispersion shrank, the number of active managers outperforming their indices declined.
Source: S&P Dow Jones
Indicative of the challenge active managers are facing, the National Association of Active Managers (NAAIM) recently announced a contest to find research proving that active management is superior. The winner will receive $10,000 and the distinct designation as having saved face for the active management industry.
But, research from Nuveen Investments demonstrated that the turning point may be nigh. After a period of struggles in 2010 and 2011, large cap equity managers, as an example, are outperforming the Russell 1000 Index in greater numbers. During 2011, a mere 21% of active managers outperformed the index, but during the third quarter of 2013, that number rose above 50%. It should not come as a surprise that performance dispersion rose across each quarter in 2013.
Source: Nuveen Asset Management
Over the same time, equity market correlations are declining. This is an added tailwind for active managers that looks set to continue.
Source: Credit Suisse
As exchange traded funds (ETFs) grow in importance at the expense of active managers, it is creating a unique market dynamic. ETFs are leading a growing number of investors to invest in a similar manner, leaving a smaller share of people to add alpha. Active managers represent 74% of assets, down from more than 80% as recently as 2009.
Source: Nuveen Asset Management
A segment of the active management industry facing an especially critical lens is hedge funds. Media coverage on hedge fund performance says they are highly correlated and offer disappointing performance, but at the same time, investors pushed hedge fund assets to a record high $2.63 trillion.
Hedge fund correlation are high for a very apparent reason - nearly 30% of assets are long/short equity funds and another 27% are in event driven strategies. Those categories are generally highly correlated to equity markets by design and have a great deal of influence on overall hedge fund correlation figures.
Active managers will continue to face attack from ETF providers and various corners of the media. In many cases, the criticism is rightly warranted for managers that charge too much and add too little value. Equally penalizing all active managers is a shortsighted exercise however, particularly as we enter an environment that should provide the ideal backdrop for active managers to thrive.
The week ahead
The coming week brings a busy schedule of economic data for investors to digest. The marquee event of the week, however, is the regularly scheduled FOMC meeting set to take place Tuesday and Wednesday. Most analysts believe the Fed will continue its reduction of asset purchases.
Economic data reported this week includes new home sales, the Case-Shiller index, the advance estimate of Q4 GDP, and person income & outlays. Consensus expects a 3.2% print for Q4 economic growth.
Earnings season continues this week, with major results due from Apple, AT&T, Pfizer, Boeing, Dow Chemical, Novartis, Yahoo!, Amazon, ExxonMobil, Google, Visa, MasterCard, and Chevron, among others.
On the central bank front, rate decisions are slated from India, Malaysia, South Africa, New Zealand, Colombia, and Mexico. Turkey’s central bank announced Monday that it would hold an un-scheduled meeting to help alleviate the steep decline in its currency.
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