September was a remarkable month for price action in US stock and currency markets given how sparse the new economic data set was. The month exhibited the largest one month move for September in US stock prices since 1939 (S&P 500 up +8.8%) buoyed by the mid-month reiteration by the Federal Reserve of their commitment to pursue additional monetary measures (i.e. quantitative easing by means of additional long-term US Treasury purchases) if the economy does not show signs of rebounding. For the first time in recent history, the Federal Reserve noted their concerns with the inflation rate being too low for their comfort level. Despite significant intermonth volatility in bond yields, the 10 year US Treasury yield finished the month at 2.52%, roughly the same level where it started the month at 2.48%, and the Barclays Aggregate Bond Index (“BABI”) returned a paltry 0.11%, its worst one month return since March of this year. The Fed actions led to the largest one month depreciation of the US dollar vs. the euro (-7.5%) since December 2008. Dollar depreciation led to nearly all asset prices in US dollars inflating as commodities rose in tandem across the board (Gold up +4.7%; Oil up +11.2%; Copper up +8.4%; Silver up +12.3%; Soybeans up +9.8%).
Amidst this backdrop the Limited Risk Portfolio returned +2.82% for the month, bringing the year-to-date total to +7.47%, versus +3.65% year-to-date performance for the S&P 500. The Limited Risk Portfolio performance was driven by exposures to domestic equity markets in the start of the month, particularly in the financial sector (tickers: UYG, GS, MS), but those positions were taken off by mid-month as equity beta market risk was scaled back amidst the strong run up in prices. International equity market exposure was kept on throughout the month in the form of an Indian equity market fund (ticker: MINDX) and this position was up +12.4% for the month. The Limited Risk Portfolio carried a high cash balance (28%) for much of the month as equity price action did not seem to be substantiated by economic fundamentals, but as quantitative easing expectations by the Fed resulted in a decisive weakening of the US dollar versus currencies and commodities, exposures were added to foreign emerging market currency funds (ticker: PELBX) and to gold ETFs. Additional high yield credit exposure (ticker: PHIYX) was added in the month as the trend of investors stretching for yield has been pronounced, and defensive equity beta risk was added towards the end of the month in the form of high dividend ETFs (tickers: DVY and XLU). Large capitalization, high dividend paying stocks with access to the US bond markets should be able to take advantage of an opportune time for long dated debt financing with both interest rates and credit spreads at historic lows. With the absence of projects to invest in, these companies have amassed the highest level of cash balances since the 1960’s and these will be most likely put to work in share buybacks for some of the companies. By month end cash balances in the Limited Risk Portfolio had dropped to 12% of the portfolio.
The Bond Portfolio returned +0.37% for the month versus a +0.11% return for the month for the BABI, bringing the year-to-date total to +5.92%, versus +7.95% year-to-date performance for the BABI. The Bond Portfolio performance was driven by exposure to the intermediate term corporate bond sector (tickers: VFIDX and FCBFX) as these were the best performing investment grade bond sectors for the month of September as US Treasury yields remained relatively flat for the month while credit spreads remained tight. Heading into 4Q10, the key performance driver for the Bond Portfolio will be duration risk and the effects that quantitative easing by the Fed has on the intermediate and longer-term sectors of the yield curve. Look for sharp moves either downward or upward in yields based on the perception of the extent of further announcements of quantitative easing after the Fed’s November 3rd FOMC meeting. This manager is currently positioned slightly long duration relative to the benchmark, but will be monitoring this closely.
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