This update is an excellent companion to the comprehensive themes overview we recently published. *Note that this Private Pool is currently available through IIROC Dealer Firms and their registered/approved individuals.
Market volatility remained elevated, most sovereign yields rose, and credit spreads have tightened against the backdrop of severe COVID-19 resurgence in Europe and the U.S., and political uncertainty stemming from the U.S. elections and Brexit deal.
U.S. economic data was positive:
- Annualized GDP rebounded in the third quarter, with personal income and spending boosted by a stronger labour market and pandemic aid. Nevertheless, a surge in virus cases cast anxiety and dragged down consumer sentiment.
- The job market held steady as weekly claims reached the lowest level since the start of the pandemic.
- The manufacturing Purchasing Managers' Index (PMI) slowed slightly while the services PMI climbed ahead of forecasts. Housing data remained resilient.
- The National Association of Home Builders housing market index broke a record high, shifting demand for suburban living boosted housing starts and building permits, and existing home sales advanced. However, new home sales declined, led by a sharp drop in the Northeast, and lower supply hurt pending sales.
Eurozone’s GDP expanded in the third quarter as restrictions relaxed, manufacturing PMI improved, while services PMI declined further into contractionary territory. Chinese annualized GDP advanced in the third quarter. Manufacturing and services continued to recover aided by resilient exports, robust demand, and strong hiring. Japan’s industrial production grew amid recovering factory output and rising external demand. Australia’s annual inflation ticked up; however, high unemployment and poor demand have kept a lid on inflation.
Most global sovereign yields moved higher despite the worsening pandemic, the U.S. election uncertainty, and a sell-off in global equity markets. The U.S. Treasury yields rose on prospects of a Democratic party election sweep and additional fiscal stimulus. In Europe, German bond yields declined as economic data continued to disappoint and new lockdown measures were imposed.
Global credit bonds outperformed duration-equivalent government bonds as credit spreads tightened. Within securitized credit, agency Mortgage Backed securities, Commercial Mortgage-Backed Securities and asset-backed securities all outperformed duration-equivalent Treasuries. Emerging markets external debt modestly detracted, as the impact of spread narrowing was offset by U.S. rates. Emerging markets local debt outperformed external debt, driven by EM rates and EM currencies to a lesser extent.
Performance and attribution
Strategic sector positions generated positive results overall, as the emerging market opportunities exposure, which featured long positions to Mexican and Indonesia government bonds benefitted from a rally in rates. Credit Dislocation Strategies, which featured exposures to investment grade and high yield corporates, performed well as spreads continued to grind modestly tighter. Negative contributors included exposures to South Korea and Australia government bonds within Core Challenges, which seeks exposure to global sovereigns that have more sustainable fiscal trajectories.
Market neutral strategies were the largest detractor in October as currency positions underperformed. As the U.S. dollar gained 0.16% in October, the account’s 6.5% short U.S. dollar position detracted. In addition, long Euro positions detracted as the Euro fell relative to the U.S. dollar.
Sector rotation strategies, which featured short CMBX (a group of financial indexes that track the commercial mortgage-backed securities market) positions underperformed slightly. While we continue to see potential opportunities between property and collateral quality, in recent months, we have trimmed our short CMBX position in half. This is due to much of the deteriorating retail and lodging developments being now largely priced in.
Positioning and outlook
During the month, overall duration remained relatively flat around 5.5 years, primarily via North American and Asian (excluding Japanese) countries.
We maintain positions in Credit Dislocation Strategies, which feature exposures to below investment grade credits. While overall credit spreads have tightened since the March wides, we still see considerable dispersion in select Credit sectors.
Over the month, we moved from roughly neutral to long Investment Grade (IG) corporate bonds. As IG credit spreads remain above historical averages (60th percentile), we believe that over the near term, spreads could tighten as we get a resolution from the U.S. election and potentially move closer to an economic package focused on small businesses, which could renew help to the unemployed and perhaps provide some relief to the airline industry.
The account retains a moderate pro cyclical lean relative to history as we continue to maintain exposures to emerging markets local debt, bank loans and structured credit. However, in recent weeks we have reduced exposure to global inflation linked bonds, high yield and resized our U.S. dollar underweight in anticipation of softening of economic activity and uncertainty on the path of the pandemic. We still maintain approximately 5.5 years of total duration, but are currently holding our lowest exposure to U.S. Treasury duration in recent years.
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