Market index returns

Key highlights:

Additionally, as we write, the Bank of England (BoE) remains in sharp focus as it seeks to end its temporary bond-buying program as planned on October 14th amidst the fallout from prime minister Liz Truss’s bungled mini-budget. Elsewhere, the war in Ukraine continues to loom large after the initial success of Ukraine’s counter-offensive prompted a brutal and seemingly indiscriminate bombardment from Russia and as mass mobilization of Russian troops gets underway.

Real Assets continued their slide into October, but outperformed broader equities overall. TIPS continued to exhibit the most relative resiliency, followed by Commodities and Natural Resources Equities - all registered gains on a month-to-date basis and outperformed broader equities markets despite slipping modestly for the most recent week. Global Real Estate trended lower while Global Infrastructure securities fell furthest, weighed down most significantly by the rate-sensitive U.S. Towers.

Turning back to economic data releases, while year-on-year headline CPI ticked down from 8.3% in August, peeling back the headline layer of the September CPI print revealed that Core CPI (excluding volatile food and energy prices) continued to move in the wrong direction. Core CPI increased 0.6% month over month, representing an annual increase of 6.6% (up from 6.3% in August) and validating fears that inflation is establishing a foothold and tightening its grip on the economy. Notably, the data came on the heels of last week’s similarly troubling Personal Consumption Expenditure (PCE) release. While Core CPI prices for some goods (such as automobiles and apparel) eased in September, an increase in the cost of services provided an offset; amongst the most concerning were rising rents and medical costs. Though concerns abound that such increases could herald a change in consumer habits and that higher borrowing costs could weigh on businesses, causing a recession, this apparent stickiness of inflation, taken together with comments the day prior from U.S. Federal Reserve officials characterizing the pace of inflation as alarming and warranting “a more restrictive policy stance”, prompted an immediate upward recalibration in rate expectations. Markets are now calling for another 75 bps increase in November and December. Accordingly, U.S. Treasury yields surged (the 2-year in particular touched a fresh high of 4.5%), a situation which has also pushed U.S. mortgage rates higher to deliver yet another blow to growth prospects. On the bright side, weekly jobless claims continue to paint a strong picture of the labor market – despite evidence of slight cooling, figures remain near historic lows (228k for the week ended October 8th).  As uncertainty and volatility increase and liquidity dries up, investors will be looking closely at earnings to gauge better the impact of rising rates on companies, a situation we will monitor in the coming weeks.

Outside the U.S., inflation continues to prove itself a formidable adversary for central banks around the globe. CPI data out of China revealed an increase of 2.8% in September (a 2-year high), though weak Core CPI and a deceleration in its Producer Price Index pointed to a slowdown in consumer demand in the region, which could have some positive implications for the global economy at large. Yet, the spotlight over the last several weeks has been focused squarely on the BoE after a disastrous mini-budget announced by the Truss administration sparked chaos across bond markets. After the pound sunk to record lows against the dollar, the BoE stepped in to restore stability with a series of support measures in late September. The central bank has so far held steadfast to its plan to remove one of those three support measures on Friday, October 14th - namely, its temporary purchase program – insisting that pension funds sort out their solvency issues. At the time of writing, markets are watching with bated breath as the deadline approaches. Meanwhile, Ms. Truss swiftly dismissed finance minister Kwasi Kwarteng on Friday and axed another central feature of her administration’s economic plan as she remains under intense pressure to correct course. Former foreign minister Jeremy Hunt, who was hurriedly appointed as the fourth finance minister this year, now joins her in the unpleasant task of restoring calm from calamity. In an incrementally positive sign, following her speech on Friday, the pound rallied against the U.S. dollar.

In other geopolitical news, Russia’s invasion of Ukraine continues to threaten destabilization on a global scale. After an explosion on the Kerch Bridge connecting Russia to the Crimean peninsula which acts as an important resupply route for troops positioned in the South of Ukraine, President Vladimir Putin responded with ferocious and indiscriminate attacks on civilian infrastructure sites. As NATO countries reiterated their commitment to Ukraine in the form of weapons deliveries, neighboring Belarus mobilized troops, ostensibly to prepare for a Ukrainian attack on Belarusian territory; suspicion abounds as to the true intent. Meanwhile, after OPEC+ Russian moved to slash oil production by 2 million barrels, U.S. President Joe Biden spoke of “consequences” for America’s relationship with Saudi Arabia.

Finally, turning to macro indicators we track, volatility (as measured by the VIX) spiked back above the 30 level as uncertainty contributes to an increasingly reactionary market environment. 5-year and 10-year breakeven rates rose off of month-end lows, ending the week at 2.37% and 2.30% respectively. Notably, high yield credit spreads corrected, ending the period at 5.67% down from a high of 6.13% on October 5th. Meanwhile, the U.S. Dollar (as measured by the DXY) bounced off the $110 level to end the period at $113. Gold prices, benefitting from pervasive uncertainty, pushed through the $1,700/oz ceiling before giving back some gains to end near $1,675/oz while Crude Oil benefitted from OPEC+ Russia’s move to decrease production, topping $90/bbl before settling near $87/bbl.

Looking ahead, we expect risk assets to remain challenged as central banks tighten into slowing economic growth in pursuit of taming inflation while geopolitical factors should keep volatility elevated. Nonetheless, we expect that a holistically-managed Real Assets allocation will continue to offer strategic benefits and tactical opportunities as the situation unfolds.

This is causing major gyrations in global capital markets, and yield spreads for commercial real estate have fallen below their long-term average in most markets - a more challenging backdrop for real estate investment. On the Continent, the Residential segment lead losses this week, followed by the Office sector and Diversified names while the Swiss and Retail names generally held up better. In the U.K., the smaller niche names saw larger losses than their Large Cap counterparts, though the Large Caps continue to lag on a year-to-date basis.

In the U.S., Data Center names pulled back the most this week, following the broader technology sector down. Elsewhere in the region, the Residential and Healthcare sector were amongst the weakest performers as the dampened growth outlook and concerns over higher leverage and floating rate debt among Diversified Healthcare players weighed. Conversely, Hotels continued to hold up well, supported by recovery trends.

Finally, in Asia Pacific, Australia continued to lag other regions, exhibiting marked sensitivity to rate news out of the U.S. and taking some directional cues from energy markets given the commodity-linked nature of the local economy. Elsewhere, Japan continued to outperform, with the Developers holding up best. Meanwhile, in Hong Kong, there was significant dispersion between the REITs (which were amongst the global laggards) and Developers/Investors.

Utilities were also pressured this week while North America Midstream Energy segment held up relatively well, as the US OST segment and the MLPs benefited from stable energy prices. Amongst Transports, performance was mixed. Latin American Airports were a bright spot, eking out a small gain for the week; however, this modest rise was eclipsed by lackluster performance from Americas Rail.

In Asia Pacific, Japan infrastructure stocks held up the best, continuing a trend identified in September while Asia ex Japan names saw the steepest declines in the region.

On the Energy front, front-month contracts of Heating Oil saw notable gains this week. Crude Oil and Gasoline ended the week down modestly while ever-volatile Natural Gas prices plummeted. While markets had initially reacted to rumors of 500K-2MM bpd production cuts from OPEC+ Russia, since the current quota has not been met for some time, without reallocation, the announced 2MM bpd cut is estimated to effectively remove only ~1MM bpd from the market. Meanwhile, Natural Gas prices have continued to decline after the initial shock of the damage to Nordstream (NS1) pipelines from undersea explosions. The decline in Natural Gas prices suggests the market is less concerned about the absence of Russian supply this winter, given the storage fill rate across Europe. Separately, according to Rystad, Russia is understood to be flaring 4.34 mcm of gas per day from its new liquified natural gas plant at Portovaya, NW of St. Petersburg. This is a direct result of a sustained period of only 20% capacity flow on NS1 to Germany. Unable to divert their natural gas supply to other clients, Russian producers will have to continue to flare the natural gas to keep the wells from degrading, resulting in an unintended release of carbon for some time to come.
 
Industrial Metals pulled back more as broad risk-off sentiment took hold this week, eating into month-to-date gains. All Industrial Metals were down for the week, with the steepest losses seen in Zinc, followed by Copper and Aluminum. However, Aluminum has been well-supported on a month-to-date basis as low inventories and supply curtailments in China have driven physical market indicators to tighten. From here, any announcement of measures to aid policy implementation in China would provide support for base metals prices into year-end, particularly as inventories remain very low.

Precious Metals fell furthest this week as a short-lived rebound by Silver, Platinum, and Palladium quickly reversed. Gold also ended the week lower – a strong U.S. dollar and increasing real rates are acting as sustained near-term headwinds. While uncertainty is supporting Gold at current levels, macroeconomic data continues to point to robust conditions for employment and inflation in the U.S., which should exert further downward pressure on precious metals prices. 

Within Natural Resource Equities, Agriculture fared best this week while Metals & Mining names were pressured most heavily. At a subsector level, the Bulk and Base categories within Metals & Mining underperformed Precious Metals & Mining name while Steel producers held up the best overall. Energy producers saw moderate losses while amongst the Agriculture equities, Agricultural Products and Chemicals held up better than Paper & Forestry names as demand for packaging and lumber prices softened amidst the slowing global growth backdrop. 

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