Real Assets bested broader markets in wild week

Market index returns

Week to date since July 31, 2024 as of Aug 07, 2024

Index definitions: Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global Infrastructure = Dow Jones Brookfield Global Infrastructure Index; Natural Resource Equities = S&P Global Natural Resources Index; Commodity Futures = Bloomberg Commodity Index; TIPS = Barclays US TIPS Index; Global Equities = MSCI World Index; Real Assets Index = 30% FTSE EPRA/NAREIT Developed Index, 30% Dow Jones Brookfield Global Infrastructure Index; 15% S&P Global Natural Resources Index; 15% Bloomberg Commodity Index, 10% Barclays TIPS Index. Source: Bloomberg, DWS. Past performance is not indicative of future results. It is not possible to invest directly in an index.

Market commentary:

Global equities were hit hard during our review period, which we remind you runs Wednesday-to-Wednesday. Losses started when new jobless claims in the U.S. jumped higher and accelerated the following day on newfound recession fears when nonfarm payroll data came in meaningfully below expectations. The equity selloff picked up more steam over the weekend and through Monday’s trading as Japan’s yen strengthened to a high against the U.S. dollar, hitting a level not reached since early January of this year, following the Bank of Japan’s (BoJ’s) hawkish rate hike on July 31. The violent yen move stoked concerns of an unwinding of the yen carry trade and Japan equity markets were pummeled (more on this below). Equity market volatility in the U.S. (as measured by the VIX Index) soared to levels not seen since the early days of the Russian invasion of Ukraine and some market pundits were calling for emergency rate cuts from the U.S. Federal Reserve (Fed). Markets calmed (somewhat) in the following days, but questions on the health of the U.S. (and global) economy remain forefront on many investors’ minds.

Against this backdrop, all Real Assets classes, aside from Natural Resource equities, outperformed the broader equity market this week. Treasury Inflation-Protected securities (TIPS) were the leaders with flat returns and were followed by Global Infrastructure securities and Global Real Estate securities, which saw only minor losses. Commodities fell a bit more but far less than the 5.6% loss seen in the MSCI World Index. Natural Resource equities very narrowly trailed global equities as metals & mining names weighed heavily on the group.^[1]

Why it matters: When volatility comes back after a lull, it can do so with vengeance. While markets have settled down in recent days, volatility remains uncomfortably high and any additional flaring would resume the forced selling from systematic trading strategies. Ukraine has struck inside the Russian border at least twice this week, almost daring Russia’s President Putin to escalate the war. We have yet to see the threatened retaliation from Iran on Israel for recent (alleged) assassinations, one of which occurred on Iranian soil. The stage is set for the November U.S. presidential election with the candidates chosen, but rhetoric is high, and the immediate results will almost assuredly be challenged by the losing party. It looks like we could be in for a rocky road (and not the ice cream variety) for the rest of the year. Next week will bring us Consumer Price Index (CPI) and Producer Price Index (PPI) data in the U.S., which will give us an indication of where inflation lies and could tilt the Fed’s hand at its September meeting. Retail sales in the U.S. will be released too, giving another read on the health of the U.S. consumer.

Macro Dive: In addition to equity returns, bond yields were whipped around this week, and we’ll start with a look at those. Next, we’ll review the latest Institute for Supply Management (ISM) Services data and then give a recap of what went on in Japanese capital markets this week.

Bonds took the curvy road: In addition to equities, fixed-income securities and yields were jolted as well. For starters, the MOVE Index (a measure of U.S. bond market volatility) jumped above 122 on Monday, having ended our last review period below 100. The yield on the U.S. 10-year Treasury bond ended our last review at 4.03%, then dipped as low as 3.67% during Monday’s turmoil, which briefly un-inverted the 2s-to-10s yield curve, a condition that hasn’t been present since July 2022, only to invert again and end this review at 3.94%. Credit spreads widened too, with BBBs ending 9 bps higher for the week at 1.36% and high yield blowing out over 50 bps on Monday from our previous review but ending just 26 bps higher at 3.80% by Wednesday’s close. Other sovereign bonds saw elevated action as well, such as Japan’s 10-year JGBs, which closed on Monday at 0.78% after ending July at 1.05%, although sovereigns in Europe and the UK behaved much more tamely. It appears sovereign bond yields may be undergoing a topping process and the market response could be amplified, especially around central bank policy meetings, and as always, the movements in credit spreads are keenly worth watching.^[1]
Still the bright spot: Following dismal manufacturing data last week (also contributing to the selloff), ISM’s services data, released this past Monday, showed encouraging news. The ISM Services PMI registered at 51.4 for July, better than expectations of 51.0 and a rebound from the 48.8 contraction seen in June. In fact, Business Activity at 54.5, New Orders at 52.4, and Employment at 51.1 all rebounded to expansion territory in July from contraction in June, all positive signs. If there was any concern in the numbers, it was that Prices Paid rose to 57.0 in July from 56.3 in June, indicating inflation is still sticking around in the services sector. In a positive sign for the jobs market (but not for those who build things), construction contractors, subcontractors, and general labor were noted as being in short supply, with their prices all rising. When this data was released on Monday, the most brutal day of the global equity selloff, it was viewed positively and briefly stunted the market decline, but ultimately other factors weighed more heavily, with the MSCI World Index registering a 3.1% loss from Friday’s close.^[2]
Japan’s market whiplash: Monday August 5th will certainly be a day to remember, as Japan’s Nikkei plunged 12.4%, the worst day for the index since 1987’s Black Monday crash that ravaged global markets. The tone was set with a broader global selloff the previous Friday, following the weak U.S. jobs print, which fueled recession fears and further vindicating market expectations for rate cuts by the Fed. Given this and the BoJ’s decision to raise rates on July 31st, we saw an unwinding of the crowed Japanese yen carry trade, which resulted in a sharp yen appreciation against the U.S. dollar. Japanese stocks subsequently fell into correction territory, given concerns that the yen rally could cloud corporate earnings and investor allocations as well as damage export activity. The Nikkei rebounded strongly on Tuesday and Wednesday, clawing back much of its losses, after the BoJ struck a dovish tone alleviating investor angst by reaffirming that there would be no changes to rates amid the market volatility.^[3]

Real Assets, Real Insights: We’ll start with a look at a judgment against Spain requiring them to hand over a UK airport. Then we’ll give an example of why the same commodity can trade for different prices in different places. Finally, we’ll conclude with an overview of artificial intelligence’s (AI’s) potential impact on Real Assets as viewed by some of our own portfolio managers.

Getting an airport for a bad solar panel deal (Infrastructure): In what we can only describe as a bizarre series of events, Aena was informed by the Kingdom of Spain that partial ownership (26%) of London’s Luton Airport has been seized by a UK court to satisfy a 2019 judgment from the International Centre for Settlement of Investment Disputes (ICSID). The judgment stems from actions the Kingdom of Spain took in 2016 to cut premiums for renewable energy, which allegedly harmed two subsidiaries of NextEra Energy Inc., who had recently constructed two solar power plants in Spain. The ICSID awarded NextEra €291M plus accrued interest from the Kingdom of Spain to resolve the matter. Aena, an airport operating company, owned a controlling 51% of Luton Airport, and Aena itself is 51% owned by the Kingdom of Spain; hence, the pro rata share of Spain’s ownership of Luton was embargoed to partially fulfill the judgment. This leaves Aena in a precarious position, as it was not a party in the judicial proceedings for the recognition and enforcement of awards and has not yet directly been notified of the interim charging orders but has vowed to fulfill all regulatory obligations until the matter can be sorted out.^[4]
Location, location, location – natural gas edition (Commodities): Overall, natural gas prices saw a modest increase during our review period, but depending on the location of delivery, there was a wide divergence in performance. Starting on July 26 through August 7, the first month future contract for U.S. natural gas delivery to Henry Hub (located in Louisiana, U.S.) saw a negative total return of -7.6%, while TTF natural gas (Netherlands trading) rose by 19.4% (in USD), and NBP gas (UK delivery) climbed 23.2% (in USD). Some of this disparity could be assigned to the weather, as U.S. temperatures are expected to cool drastically in the coming weeks during what is typically one of the hottest periods of the year. Oversupply, full storage, and weak LNG exports from the U.S. would also be to blame for the price slide in the U.S. In response, multiple natural gas producers in the U.S. are expected to cut production for the remainder of 2024 and possibly into 2025 until the oversupply situation reverses.^[1]
The AI Explosion (Real Assets): We recently released a paper highlighting how the rise of AI is expected to significantly impact the need for Real Assets such as natural resources, commodities, real estate, renewable energy, and the development of midstream infrastructure. Utilities, natural gas, and midstream companies are strategically positioned to potentially benefit from this trend through increased production and transportation needs to meet rising energy requirements. Renewables should also play a major role, leveraging the desire of technology giants to rely on sustainably sourced power sources. The on-going development of energy infrastructure and the adoption of energy-efficient technologies will be critical in supporting the AI boom and its associated energy requirements. The energy sector must adapt to these changes quickly to ensure a balanced and sustainable energy transition. We believe that active management is the best approach for distinguishing between companies poised to benefit from the continued increases in power demand driven by AI and machine learning, as not every company will be affected similarly by these technological advancements. To read the full paper, click here.^[5]

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