September 2018 Monthly Market Commentary
US stock performance was strong in August and several major US indexes reached all-time highs despite
continued concerns around global trade and pressures in emerging markets (more on this later). Larger-cap US stocks gained 3.2 percent in the month (Vanguard 500 Index) while small caps jumped 4.3 percent (iShares Russell 2000 ETF). Strong gains in recent months have brought year-to-date returns well into positive territory—with large-cap stocks now up 9.8 percent and small-cap stocks up 14.2 percent. Growth stocks and the technology sector continue to lead the market. The iShares Russell 1000 Growth ETF returned 5.4 percent in August and is up 16.2 percent this year, compared to the iShares Russell 1000 Value ETF’s gain of 1.4 percent in August and 3.4 percent year-to-date return. Technology stocks are up 21 percent for the year.
The US fixed-income market was positive in August. US Treasury yields on the long-end of the curve fell modestly over the month. US core bonds (Vanguard Total Bond Market Index) gained 0.5 percent in August but remain in negative territory this year (down 1.2 percent). US high-yield bonds returned 0.7 percent last month, while floating-rate loans were up 0.4 percent (the ICE BofA ML US High Yield Cash Pay Index and the S&P/LSTA Leveraged Loan Index). The often-watched spread between short rates and long rates continued to compress during August. The yield differential between three-month and 10-year US Treasury rates finished the month at 75 basis points (it started the year at a greater than 100-basis-point spread). The three-month US Treasury rate has moved above 2 percent for the first time since the financial crisis started a decade ago.
International stocks did not fare as well as domestic stocks last month. Developed international stocks dropped 1.7 percent (Vanguard FTSE Developed Markets ETF), European stocks fell 2.8 percent (Vanguard FTSE Europe ETF), and emerging-market (EM) stocks tumbled 4.2 percent in August (Vanguard FTSE Emerging Markets ETF). The strengthening US dollar adversely affected EM stocks more than developed foreign markets.
The performance gap between US stocks and EM stocks has widened in recent months. After hitting a post–financial crisis high in late January, EM stocks have tumbled and have been flirting with a 20 percent drawdown (the industry’s bear market definition). The performance differential so far this year now stands at over 17 percentage points (a gain of 9.8 percent for US stocks and a loss of 7.7 percent for EM stocks in the first eight months of 2018). The magnitude of the underperformance has been a headwind for our overall portfolio performance, but it is not outside of the norm for EM stocks to lag by this amount over short-term periods. The chart to the right shows rolling 12-month return differentials between EM stocks and US stocks over the last 30 years. Underperforming by 20 percent is certainly painful in the short run; however, it is not out of the ordinary for a volatile asset class like EM stocks.