December 2014 Commentary
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Transcript of December 2014 Commentary
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8/18/2019 December 2014 Commentary
1/19333 S. Grand Ave., 18th Floor || Los Angeles, CA 90071 || (213) 633-82
Quarterly Commentary
December 2014
333 S. Grand Ave., 18th Floor || Los Angeles, CA 90071 || (213) 633-82
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Overview
During the rst two weeks of December, weakness in
the Energy sector spread through global markets as
market parcipants were trying to nd an answer forthe precipitous decline in oil prices. As energy prices
connued to fall, the strength of global economic
growth came into queson. This uncertainty, coupled
with accelerated elecons in Greece and the extreme
volality in Russian nancial markets led to a decline
in most risk assets. On December 17, investor
condence received a boost following a benign
outcome from the Federal Open Market Commiee
(FOMC) which centered on new language stang thatthe FOMC will be “paent in beginning to normalize
the stance of monetary policy.” With everything
seemingly back to normal, risk assets moved higher as
if nothing ever happened.
During the second half of the month, a strong third
Gross Domesc Product (GDP) print calmed any
lingering concerns. According to the nal release of
third quarter GDP, the economy grew 5.0% quarter-
over-quarter (QoQ) marking the strongest growth in
11 years. As a result, the American consumer
appeared to be more comfortable spending as
personal consumpon contributed 2.2% to GDP.
Despite the strong gure, GDP is up 2.7% year-over-
year (YoY) outperforming most developed countries.
By comparison, 2014 GDP growth is projected to
come in below 1.0% in both the eurozone and Japan.
Quarterly Commentary
The European Central Bank (ECB) and the Bank of
Japan (BoJ) connued to reiterate accommodave
monetary policy in support of weaker than expectedgrowth.
Domescally, the U.S. economy appears to be on
beer foong as employment gures connued to
improve. Total nonfarm payrolls increased by 252,000
during the nal month of the year as job addions
rose unexpectedly in the construcon industry. The
increase in hiring combined with a contracon in the
civilian labor force led to the drop in the
unemployment rate which fell to a mul-year low of
5.6%.
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Although the data appears strong on the surface, a
majority of job gains have gone to older cohorts. The
Energy sector has been another bright spot for
employment which may face a headwind if energy
producers connue to cut back on capital
expenditures.
Global commodity prices were the loser during
December as the energy sector led the decline.
Commodity prices as measured by the S&P GSCI Index
fell 13.63% to the lowest index level since 2009.
Lower energy prices impacted inaon data points in
the U.S. as the Consumer Price Index (CPI) and the
Producer Price Index (PPI) for nal demand fell to1.3% YoY and 1.4% YoY, respecvely. Transportaon
and raw material costs connue to decline.
Tradional markets such as U.S. equies were rather
unchanged for the month, down just 0.26%. The xed
income market as measured by the Barclays
Aggregate Bond Index rose just 0.09%. The U.S. Dollar
(USD) remained strong with the consensus viewpoint
pushing the U.S. Dollar Index (DXY) to a new 8-year
high of 90.27.
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Modi has not only adjusted fuel subsidies, but lied
foreign direct investment limits, implemented small-
business labor reform, and eased investment
regulaons inland. In Indonesia, aer raising the price
of fuel, President Jokowi appointed a “working”
cabinet for his government who were relavely well-
received as market-friendly by investors. Finally in
Brazil, where third quarter GDP had a slight 10 bps
increase, investors looked favorably upon the newly
re-elected President Rousse’s appointment of the
market-friendly Joaquim Levy to the post of Finance
Minister. He has commied to targeng a 1.2%
primary scal surplus for 2015. The Brazilian
government also engaged in a number of needed
acons, including hiking the overnight lending rate
11.75% to combat inaon and changing rules to
access social benets to help reduce the scal
expenditures.
In contrast, net-exporters of energy whose budgets
were built around high oil prices have struggled in this
new environment and assets linked to them have
underperformed accordingly. Russia, Venezuela, and
Nigeria are among naons where assets have
performed poorly in the face of declining energy
prices in the fourth quarter. Russia has seen the ruble
probe lows versus the USD not seen since the global
nancial crisis in 2009, as in addion to sinking crude
oil and natural gas prices, it has had to deal with rapid
capital ight ed to sancons from the U.S. and
European Union (EU) due to its support for rebels in
Ukraine’s eastern provinces. The Russian central bank
hiked the benchmark rate to 17% in an emergency
meeng and allowed discreonary FX intervenons to
combat the tumble of the ruble in mid-December.
Though the move did appear to somewhat stabilize
the currency, the central bank’s repeated
intervenons to defend the currency have dropped
USD reserves to under $400 billion. Venezuela, which
has labored under the command of “Chavista”
economic policies of President Maduro, has seen its
sovereign debt sink to decade-lows as oil ha
retreated. The black market rate per USD reache
approximately 200 bolivares as of December 3
versus the ocial rate for 6.3 bolivares per dolla
Maduro’s government has proven unwilling t
implement any serious reforms, such as unifying o
devaluing the FX rate or reducing social transfer
Inaon stood at 63.6% as of November, while 5-yea
credit-default swaps touched all-me highs
December.
December saw a sharp reversal to the prior eigh
straight months of net inows from investors int
EMFI funds: $3.0 billion le the asset class, which waabout evenly split between hard currenc
denominated funds and local currency denominate
funds. The month’s oulows brought net fourt
quarter inows into the space down to $380 millio
For the year, EMFI funds saw $13.4 billion in inow
the bulk of which occurred in the second quarter 201
Investors’ 2014 allocaons were driven by har
currency EMFI funds which had $16.3 billion ente
versus $2.8 billion exing local currency funds in 2014
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Agency Mortgage-Backed Securies
For the fourth quarter, the Barclays U.S. MBS Index
returned 1.79% while the Barclays U.S. Treasury Index
returned 1.93%. The yield curve aened further
from the previous quarter with the longer end of the
curve decreasing and the shorter end increasing. The
10-year U.S. Treasury (UST) yields declined by about
32 bps while 2-year yields increased by about 12 bps.
The underperformance is largely aributed to the
lower duraon prole of the MBS sector relave to
the UST space. The duraon of the Barclays U.S. MBS
Index shortened from 5.01 to 4.34, whereas the
Barclays U.S. Treasury Index ended the quarter at
5.58. Lower coupon MBS outperformed their higher
coupon counterparts as the lower poron of the
coupon stack usually exhibit higher duraon proles.
Not surprisingly, 30-year collateral outperformed 15-
year collateral as U.S. interest rates declined more a
the far end of the yield curve.
Prepayment speeds across all agencies (Fannie Ma
Freddie Mac, and Ginnie Mae) increased quarter-ove
-quarter (QoQ). The increases were mainly aribute
to declining rates as mortgage rates declined b
approximately 36 bps (based on Freddie Ma
Commitment Rates), allowing for more borrowers t
be incenvized to renance their mortgages. Durin
the month of October, rates were fairly volal
propagang a spike in renancing acvity (a
measured by the Mortgage Bankers Associao
(MBA) Renancing Acvity Index). Prepaymen
speeds declined MoM for the month of Novembe
but this was largely caused by the low day count o
only 18 days. Although aggregate speeds did increas
for the quarter, prepayment speeds as a whole wer
relavely stable for the most of the year. Despite 10
year UST rates declining by 86 bps for the yea
Fannie Mae prepayment speeds were fairly rang
bound between 9 and 12 CPR (Condion
Prepayment Rate). This is largely due to prepaymen
burnout having occurred for the higher porons o
the coupon stack. Much of the prepayment spee
acvity occurred within the lower 3.5s-4.5s coupon
where many of the newer originaons of loans hav
occurred (thus, having less burnout eect).
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Total gross issuance of Agency MBS during the
quarter was $98 billion, $84 billion, and $59 billion for
the months of October, November, and December,
respecvely. Issuance declined QoQ caused mostly by
housing seasonality with weaker housing sales
numbers during the winter months. Issuance for the
year ended just shy of one trillion, which is about 60%
of prior year’s issuance numbers. This is consistent
with prepayment acvity being relavely stable for
the most of the year as a lack of higher prepayment
acvity normally results in lower gross issuance.
On the Government Sponsored Enterprise (GSE)
front, the recent passing of the spending bill includeda provision that prevents the Federal government
from supporng state and local eorts to use Eminent
Domain to acquire mortgages. This has helped
provide more clarity on the future of Eminent Domain
and its impact on the mortgage space going forward.
It doesn’t seem likely that further new legislaon will
made on the mortgage front with the street largely
speculang that some further extension/reform may
occur on already exisng renancing legislaon suchas HAMP (Home Aordable Modicaon Program)
and HARP 2.0 (Home Aordability Renancing
Program). While it’s sll too early to determine the
likelihood or any details of such reform, it is
important to note that programs such as HARP will be
ending by the end of 2015.
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Non-Agency Mortgage-Backed Securies
The non-Agency mortgage market quietly cruised into
the end of the year on lower volume and rm pricing.
Total bid list volume accounted for $32.9 billion of
current face during the quarter with much of the
supply coming in October and November. December,
tradionally a quiet month, saw $8.9 billion of list
volume with much of the supply being evenly
distributed across collateral types. Despite weakness
on the periphery, with oil and internaonal equity
markets selling o sharply, the non-Agency market
held rm and investor appete in this sector
remained strong. There were instances of larger
block trades not trading because sellers did not
realize the prices they were hoping for, but rather
than aribute this to market weakness, this was
largely due to the fact that credit has been very
strong at the start of the new year over the past
several years and sellers are hopeful for even higher
levels in 2015.
Fundamentals have remained stable for much of the
quarter and December remiance reports have
connued this trend of stability. Credit risk transfer
trades have shown a bifurcaon on prepayment
speeds with seasoned STACR deals seeing slightly
slower prepayment speeds whereas more recent
transacons have seen increases in prepays up to 1
CPR. On the legacy bond front, the theme of stabilit
has remained. Prime collateral saw an approximat
prepay increase of 0.3 CPR while Alt-A and subprim
collateral speeds declined by 0.7 and 1.1 CP
respecvely. Liquidaon rates on prime and subprim
collateral increased by 0.8 CDR (Condional Defau
Rate) and 0.2 CDR while Alt-A liquidaons fell by 0
CDR. Modicaon rates declined on the month wit
only 0.4% of the loan populaon being modied.
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Investment Grade Credit
The Investment Grade (IG) sector as measured by the
Barclays U.S. Credit Index ended the month 7 bps
wider generang a monthly total return of 0.01%. Thesector underperformed duraon-matched UST by 41
bps marking the h consecuve month of negave
excess returns. For the fourth quarter, the Index
returned 1.76% pung the sector up 7.53% for 2014.
The duraon of the Investment Grade asset class was
a big contributor during the fourth quarter as UST
rates fell.
Taking a look at December performance by sector, it
came as no surprise that commodity-related
companies underperformed. The worst-performing
sectors were Oil Field Services (-490 bps),
Independent Energy (-263 bps), Rening (-230 bps),
Metals (-164 bps) and Gaming (-160 bps). On the
opposite end of the spectrum the best performing
sectors were Health Insurance (+51 bps), Electrics
(+47 bps), Lodging (+32 bps), Airlines (+28 bps) and
Pharmaceucals (+15 bps). Performance also
diverged by credit quality as the energy and
commodity-related sell-o during resulted in a
steeper credit curve. Triple-B rated credits
underperformed on both a relave and absolute
basis, widening by 13 bps. Single-A rated credits
widened just 2 bps.
Fixed-rate gross investment grade supply fo
December was rather light at approximately $52
billion. This gure brought 2014 issuance to $1.1
trillion, a new all-me high as mergers an
acquisions (M&A) acvity remained strong. So calle
“tax-inversion” deals were the hot topic during 201
with several transacons taking place.
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default rates to four-and-a-half year highs. The tw
defaults totaled $13.2 billion in bonds. The pa
weighted U.S. high-yield default rate increased t
2.96% from 1.92% in November.
High-yield new-issue acvity was light in December a
deals aimed at closing before the holidays. $7.4 billio
of USD-denominated bonds priced during the mont
making it only the second sub-$10 billion month ove
the last three years. $61.3 billion priced during th
fourth quarter.
High Yield
The High Yield sector as measured by the Ci High-Yield
Cash-Pay Capped Index lost 1.67% during the
December and 1.32% for the quarter. The Index’s yield-
to-worst was 6.67% at December 31, widening 45 bps
for the month, 56 bps for the quarter and 107 bps for
the year-to-date period. Weakness in the Energy sector
was the major concern during the rst few week of the
month as oil connued its decline. The market then
turned around by the third week as buyers stepped in
and drove some posive price momentum in the
Energy sector and high-yield overall. While yields were
higher across the rangs spectrum, investors reduced
risk in CCC-rated securies, which returned -3.16%, at a
faster pace than Bs and BBs, which returned -1.91%
and -1.06%, respecvely. Most sectors posted negave
total returns in December, with Energy-related
industries, Environmental Services and Metals/Mining
posng the weakest performance.
Technicals in High Yield deteriorated slightly during the
month as the sector experienced two defaults. The
second largest default of the year and fourth largest on
record (Caesars Entertainment Operang Co.) pushed
Quarterly Commentary
Source: S&P Capital IQ Leveraged Commentary and Data (LCD)
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appeared to reiterate a cauous tone about raisin
rates. As such retail loan mutual funds reported the
ninth consecuve monthly oulow, which was $7billion during December and represents the large
monthly oulow for all of 2014. Net loan supp
increased by $7.9 billion during December, which wa
the second smallest monthly increase in 2014. Ne
loan supply has increased by $149.5 billion YTD
Record CLO issuance was very supporve of bank loa
issuance.
Despite the pull back during December, loan
connue to look cheaper as the fundamenta
remained relavely unchanged. There were no ne
defaults in the Index for the month of Decembe
which has resulted in the trailing 12 month defau
rate to decrease 9 bps to 3.24% (0.34% excludin
TXU).
Bank Loans
The S&P/LSTA Leveraged Loan Index lost 1.25%
during December dragging the index down 0.51%
during the fourth quarter. The index yield-to
-maturity
(YTM) increased 40 bps to 5.42% during the month of
December. The discounted spread to a 3-year life is
now LIBOR +561 bps, up 60 bps from the beginning of
the quarter.
The worst performing industry for the month was Oil
and Gas, which had a total return of –9.11% during
December. The Oil and Gas sector was also the
biggest underperformer for the quarter down 11.86%
due to the decline in the price of oil. The top
performing industry for the month of December was
Clothing-Texles, which returned -0.14%. As such, all
S&P/LSTA industries in the Index experienced a
negave total return for the month of December.
With the broader loan market on a weaker foong
during December, the average bid price decreased
1.59 points to 95.92. Demand for bank loans seemed
to wane as investors reassessed the likelihood of the
Fed raising rates. The FOMC announcement pushed
most of this fear out into the future as Janet Yellen
Quarterly Commentary
Source: S&P Capital IQ Leveraged Commentary and Data (LCD)
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reported in December.
Industrial metals lost 5.92% as global growth slowe
considerably. Copper was down 4.64% as Chines
consumpon waned due to their economic slowdow
and inated real estate market. Aluminum fell 6.19
as demand from the aerospace and automov
sectors decreased as global growth has slowed down
Inaon connued to remain contained in the U.
while deaon is a real concern in the eurozone an
Japan leading to a drop in precious metals prices. Th
sector lost 3.07% with gold down 2.34%. Silvedisplayed its characteriscally high beta and lo
8.85%.
Commodies
In the fourth quarter, the global commodies markets
sold o 27.67% as measured by the S&P GSCI Index.
This puts the Index squarely in the red for the year,
down 33.08%. The weak fourth quarter was driven by
losses across most of the S&P GSCI sectors with only
agriculture ending up over the period. The most
acutely felt pain was in the energy sector which lost
38.90% in the fourth quarter. The best performer was
the agriculture sector; it bounced back from a weak
third quarter, ending up 8.71% for the fourth quarter.
This bear market was caused by several factors,
including an economic slowdown in China, emerging
markets and Europe, more ecient consumpon of
resources, and persistently low inaon in G7
countries.
The energy sector saw declines across the board in
the third quarter. Both Brent (-40.35%) and WTI (-
41.19%) prices collapsed as global demand waned.
The crude markets are sll tesng technical support
levels with higher volality expected over the short
term. WTI is under further pressure from increased
energy eciency in the U.S. coupled with increased
U.S. producon. Energy prices suered across the
disllate complex as well, with gas oil, heang oil and
unleaded gas all falling more than 29%. The negave
demand shock for energy products also hit natural
gas driving it down 33.60% in the fourth quarter.
Agriculture saw the greatest gain of the S&P GSCI
sectors in the fourth quarter as unfavorable weatherimpacted future yield forecasts. Wheat was the best
performer, gaining 21.82% while corn also rallied
19.70%. Sugar (-11.73%), coee (-15.81%), and cocoa
(-12.01%) were the only losers in the fourth quarter.
Livestock saw a loss of 5.00% as lean hogs (-13.94%),
live cale (-0.82%) and feeder cale (-3.21%) all lost
value. The drop in lean hogs occurred as the US pork
breeding herd recovered with larger lier sizes
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and 2.0 BBs widened out 20 bps. This slight widenin
experienced this month can be largely aributed t
the glut of supply and concerns about Risk Retenon
Collateralized Loan Obligaons (CLOs)
CLO total issuance in December was roughly $7.75
billion across 16 deals, the third lightest month in
2014 following January and September. The decrease
in issuance for December can be aributed to most
market parcipants out of the oce because of the
Opal CLO conference during the rst week of
December and the holiday season at the end of the
month. December’s issuance brings the total issuance
for 2014 up to $124 billion across 234 U.S. CLO deals.
This issuance wildly outpaced market expected
issuance for 2014. Market parcipants believed
issuance for the year would be around $70-80 billion
due to the road blocks created by the Volcker Rule
and Risk Retenon. Managers increased the number
of deals they issued this year in order to print as
many deals before the implementaon of Risk
Retenon.
Regulators released the nal ruling on Risk Retenon
in December. The nal ruling pushed back the
eecve date for Risk Retenon to December 2016
back from October 2016. Manager will sll be
required to take down 5% of the CLO via a vercal or
horizontal slice. At the Opal CLO Conference this
month, Risk Retenon was the main topic of
conversaon. Managers have begun to explore the
most viable opon for taking down risk for their
respecve rms. It remains to be seen if smaller rms
will merge together or larger cash intensive rms will
buy out less cash intensive management companies.
With regards to future issuance, the general
consensus at Opal was that 2015 issuance will be in
the $60-90 billion range.
Over the month of December, spreads for 1.0 and 2.0
securies widened. 1.0 securies, CLOs created
before 2009, only widened by 5 to 10 bps for AA
through BB rated securies. AAA 1.0 spreads were
unchanged for the month. 2.0 securies also widened
with the AAA through BBB widening out by 10 bps
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decreases in delinquency rates while mulfami
delinquency increased by 2 bps to 8.85% an
industrial delinquency inched up 6 bps to 7.55%
Lodging, the top performing major property type, sa
its delinquency rate fall by 20 bps to 4.77% whi
oce sector delinquency fell by 13 bps to 6.08% an
retail delinquency shrank by 1 bp to 5.66%. Th
Moody’s/RCA Commercial Property Price Indice
(CPPI) naonal major markets composite inde
increased .63% in November 2014 while non-majo
markets improved by 1.46%. Major market CPPI is u
15.4% YoY while non-major markets have improve
by 12.6%. December loan loss severies average
50% on $670 million of outstanding loans liquidated.
Commercial Mortgage-Backed Securies
CMBS markets soened in December aer an inux
of deals ooded the market in conjuncon with
broader macro market volality. Following inial
turbulence to start the month, the market took a
breather during the last two weeks as the holiday
schedule lead to limited market trading towards the
end of the year. The Barclays U.S. CMBS Index
returned -0.14% for the month and 3.86% for the
year, underperforming the broader aggregate by
35bp and 210bp respecvely. Legacy paper was at to
wider while new issue was wider throughout. For the
month, legacy AAA spreads widened by 1 bp to 88
bps over swaps. The most recently priced new issue
deal 10-year last cash ow (LCF) AAAs priced at 95
bps over swaps, a 3 bps widening over the last deal
priced in November while BBBs priced at 390 bps, a
15 bps widening.
Investors began looking towards 2015 as the holidays
approached with many pares projecng connued
growth in originaons and issuance as the CRE
markets connue to recover and more originators
enter the market. The December new issuance
calendar consisted of nine deals totaling $8 billion
brought to market. Of the nine deals, four were xed-
rate conduit transacons, totaling $5 billion of
issuance. 2014 private label CMBS issuance nished
the year at $91 billion, a 5% increase over 2013 while
2014 conduit and Single-Asset-Single-Borrower
issuance nished the year at 99 deals totaling $86
billion. Of the 99 deals, 49 were conduits totaling $57
billion in issuance, a 7% increase over 2013; and 50
were Single-Asset-Single-Borrower deals equang to
$29 billion of issuance, a 12% increase over 2013.
The overall U.S. CMBS delinquency rate decreased to
5.75% in December, down 5 bps month-over-month
and down 168 bps from December 2013, according to
Trepp Analycs. For the month, three of the ve
major property sectors (lodging, oce and retail) saw
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The fourth quarter reected trends in place throug
much of 2014 and evident in December. That
falling yields on longer securies driven by lo
inaon, a strong dollar and falling foreign sovereig
debt, and rising yields on shorter maturity deb
largely driven by ancipaon of the approaching sta
of a Fed ghtening cycle. The 5-year UST yields 12 bp
in the fourth quarter, while the 10-year and 30-yea
yields fell 33 and 46 bps, respecvely. The two-ye
yield, by contrast, rose 8 bps and the one-year B
yield rose 12 bps. The Barclays U.S. Governmen
Index returned 1.86% for the quarter.
U.S. Government Securies
Market tone in December was set by a connuaon of
recent trends; weak growth and falling sovereign
yields in Europe and Japan, a strong dollar, low
inaon associated with falling commodity prices –
especially in the energy sector, and widely held view
that the Fed will begin raising yields on overnight rates
someme around mid-2015 as the domesc economy
extends its gradual recovery. The result was a mixed
performance for UST securies. Yields on balance were
slightly higher, but the year-long curve aening trend
connued unabated. The 10-year UST note yield was
virtually unchanged on the month while the 30-year
bond yield fell by 14 bps and the 5-year note yield was
up 17 bps.
The market as measured by the Barclays U.S.
Government Index returned 0.13% for the month, with
lile net capital appreciaon augmented by
Government market’s modest income, bringing theyear-to-date return to 4.92%. Treasury Inaon-
Protected Securies (TIPS) returned a dismal -1.13%,
reecng modest realized inaon and the connuing
drop in inaon expectaons. TIPS full year 2014
return fell to 3.64%. The tax-exempt market fared
beer, beneng from a comparavely long duraon,
modest supply and stable to improving credit quality.
The Barclays U.S. Municipal Bond Index returned
0.50% in December, for a stellar 2014 return of 9.05%
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low oil prices and a strong dollar, but more crucial
connued weak household income growth. We ar
not convinced that lower gas prices alone ar
sucient to meaningfully improve consume
spending. Furthermore, we believe a recovery
household income is necessary before we can see
durable recovery in home construcon.
Against this backdrop, we prefer companies wit
strong revenue growth potenal, which we view a
those companies that can grow revenue despite
connued slow-growth economy. Generally speakin
these are companies that either possess the produc
service dierenaon to take market share despite
slow economy, or are compeng in secular growt
industries that are not dependent upon the aggregat
level of GDP growth. The porolio is most leverage
to secular growth companies in Technology an
Healthcare, and is underweight Energy and Ulies.
Looking back, there were some strong headwinds
2014 for acve equity management. First, 2014 wasgood year for the large-cap benchmarks and a wea
year for smaller stocks and acve equity manager
Of the 12 years Merrill Lynch has tracked the dat
2014 was the worst year for relave performance b
acve managers, with only 14% of Funds beang th
S&P 500 Index and only 6% of Growth Fund
outperforming. 2014 was a good year fo
“benchmark hugging” managers. Long term (se
research from Petajisto) high acve share has beeassociated with manager outperformance – basical
those managers who look most unlike the benchmar
are where investors found outperformance. 2014 wa
the opposite – low acve share managers signicant
outperformed high acve share managers.
Second, 2014 was most notable for the signican
outperformance by large-caps relave to small-cap
U.S. Equies
The key forces inuencing equies in the fourth
quarter were to be found outside of equies: falling
UST yields (despite impending Fed rate hikes in 2015);
a strong dollar; and the complete collapse in the price
of oil. The 10-Year UST, which started the quarter at
almost 2.5% ended December at 2.17%. Against this
backdrop, it is hardly surprising that the standout
performer in the S&P 500 Index was the Ulies
sector. For the quarter, Ulies within the S&P 500
Index were up a whopping 13%, to end up almost 29%
for the year.
The strong dollar led to the outperformance of more
domescally-focused sectors, specically Consumer
Discreonary and Staples and Healthcare. As we enter
2015, we are watching the strong dollar as one of
several challenges to revenue growth for corporate
America. Not only does the strong dollar reduce the
value of overseas earnings, but will likely depress
export-driven revenues.
Finally, the price of oil (WTI) fell 40% in the quarter,20% in December, and ended the year 47% o its highs
of the summer. Not surprisingly, the Energy sector was
the worst performing sector in the S&P 500 Index,
losing almost 11% in the fourth quarter. As we look to
2015, we see lower oil as another drag on revenue
growth. Energy exploraon and development has
represented a signicant source of capital spending in
the U.S. in recent years; with oil now trading below the
marginal cost of producon for many U.S. oil basins, itis reasonable to expect that capital spending to grind
to a halt. We were already seeing this in December
with energy companies announcing capital spending
cuts for 2015.
We believe top line growth for corporate America will
remain tough to nd in 2015, with the S&P 500 Index
struggling to deliver revenue growth above mid-single-
digits. This is due not only to the double headwind of
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A reversal of this trend would most likely benet us
given our lt away from mega-caps towards midcaps.
In 2014, there was an unusually large outperformance
by defensive stocks versus cyclical stocks – the
whopping 29% return of Ulies in the S&P 500 Index
helps to show this. Even within tech stocks, we saw a
striking defensive lt in 2014 and established
technology companies generally outperformed.
As we have noted previously, the lack of
dierenaon in the market between growth and
value stocks in 2014 is notable. For the year, the
Russell 1000 Growth and Value Index returned 13.1%
and 13.5%, respecvely. This unusually strongcorrelaon was seen in the fourth quarter as well
(despite the sector-level volality), with the
benchmarks returning almost exactly the same
performance (4.8% and 5.0%, respecvely). One of the
best explanaon for this is asset ows: specically, to
the extent there were posive net ows into equies
in 2014 they went almost enrely into ETFs.
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signicantly higher +36.84%, as measured by th
Shanghai Composite. The Nikkei was +7.89%, Han
Seng +2.93%, and Kospi-5.17%. Chinese equie
beneted from targeted People’s Bank of Chin
(PBoC) easing.
Emerging markets sold o in the month of Decembe
with MSCI Emerging Markets Index -4.82%, down
4.88% in the fourth quarter. Russian equies cam
under pressure with MSCI Russia Index -23.95%
December and -33.74% during the quarter. Th
Russian economy faces headwinds from the stee
decline in oil prices and sancons imposed by th
West. Brazilian equies, as measured by the Bovesp
declined -8.62%, -7.59% for the quarter as th
country suers from lower commodity prices, hig
inaon, and twin budget and current accoun
decits.
Global Equies
Global equies as measured by the Morgan Stanley
Capital Internaonal (MSCI) All Country World Index
(ACWI) declined-2.04% in December, with fourth
quarter performance of +0.06%. U.S. equies were
generally lower during the month with the S&P 500
Index and Dow Jones Industrial Average returning -
0.42% and -0.03%, respecvely. The Nasdaq and
Russell 2000 Index were mixed returning -1.16% and
+2.68%, respecvely. Despite the weak December, U.S.
equies managed posive returns for the quarter of
with S&P 500 +4.39%, Dow Jones +4.58%, Nasdaq
+5.40%, and Russell 2000 +9.35% The macro data outof the U.S. was generally posive in December with
beer than expected jobs data, industrial producon,
consumer condence, and upward revisions to third
quarter GDP.
In Europe, regional equies came under pressure
during December with the DAX -1.76%, CAC -2.67%,
and FTSE -2.33%. In the periphery, equies declined
with the FTSEMIB -5.01% and IBEX -4.56%.1 For the
quarter, European equies were mixed with DAX
+3.50%, CAC -3.25%, and FTSE -0.86%, while in the
periphery, equies declined with the FTSEMIB -5.01%
and IBEX -4.56%. The economic data across the
Eurozone was generally disappoinng while inaon
connued to run well below the ECB’s target inaon
rate. The ECB le rates unchanged at December’s
meeng but further monetary easing is being priced in
by the market.
Asian equies were mixed for the month with the
Nikkei -0.06%, Shanghai Composite +20.37%, Hang
Seng -1.59%, and Kospi -3.29%.2 For the quarter, Asian
equies were mostly higher, with Chinese equies
Quarterly Commentary
1. The DAX is the German stock index, represenng 30 of the largest and most liquid German Companies that trade on the Frankfurt Exchange. The CAC 40 Index is a
French stock market index, tracking 40 of the largest French stocks on the Paris Bourse. The FTSE MIB is a benchmark stock market index for the Borsa Italiana, the Italia
naonal stock exchange, which consists of the 40 most-traded stock classes on the exchange. The IBEX is the ocial index of the Spanish Connuous Market, comprised
of the 35 most liquid stocks traded on that market.
2. The Nikkei is a price-weighted index comprised of Japan’s top 225 blue-chip companies on the Tokyo Stock Exchange. The Hang Seng is a free-oat capitalizaon-
weighted index of a selecon of companies from the Stock Exchange of Hong Kong. The Kospi is a market capitalizaon weighted index of all common stocks traded on
the Stock market Division on the Korea Stock Exchange.
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