The global markets were characterized by heightened volatility and uncertainty with all major equity markets ending the quarter in negative territory. China’s slowdown and currency devaluation placed pressure on global economies and markets. As a result of the correction in China, commodity prices and emerging markets currencies in areas highly dependent on China also experienced a decline. In addition, the ambiguity created by the inaction of the U.S. Federal Reserve (the “Fed”) also increased the volatility of global markets.
The non-U.S. markets experienced a correction largely due to increased fear of global deflation as China’s growth prospects continue to deteriorate. The region’s growing recessionary pressures have also impacted global trade as many countries, specifically emerging markets countries, depend on exports to China as a main source of their Gross Domestic Product. This headline risk overshadowed any positive developments from other non-U.S. markets such as the Eurozone. There are signs that the European Central Bank’s stimulus program and supportive monetary policies have had a positive impact as the Eurozone’s recovery continues and economic sentiment in the area improves.
The U.S. markets also ended the quarter in negative territory with the S&P 500 posting the largest quarterly decline since 2011. All domestic equity asset classes returned negative performance, with small capitalization firms performing the worst. Energy and materials, which are highly correlated to Chinese demand for commodities, were the worst performing sectors. Healthcare also experienced a correction due to concerns on new drug price regulations and overvaluation, particularly in biotech. Utilities was the only sector with a positive return for the quarter as the Fed kept short-term interest rates near 0%.
The fixed income markets reflected the risk-off sentiment of investors as there was a flight to quality for the quarter. Treasury yields came down significantly as investors saw Treasuries as a safe haven. High yield experienced a sell-off, as the asset class is dominated by energy and materials firms, and was the worst performing fixed income sector for the quarter. Emerging markets debt, particularly the debt denominated in local currency, also underperformed due to collateral damage of emerging markets currencies from the devaluation of the Chinese yuan.
Despite global weakness, the U.S. economy continues to be boosted by consumer spending, especially in the service sector. Unemployment continues to decrease largely due to a slowdown in the growth of the labor force. Corporations have shown weak earnings caused by the decline in energy as well as the strength of the U.S. dollar. While the Fed had been signaling for some time that they may raise interest rates at the September meeting, they cited the recent global slowdown for postponing the hike in short-term rates. Some potential headwinds to consider are the potential continued volatility created by Fed policy ambiguity and the long-term impact of the devaluation of the Chinese yuan and falling commodity prices.