The month of July was going smoothly, with indices reaching new highs, until a tweet from Donald Trump rained on the parade. Equity-stretched valuations were counting on positive developments in the trade negotiations between the US and China to support the market during the summer. Jay Powell delivered the expected rate cut but, considering the macro economic data deterioration, the market felt it was too little, too late to avoid a recession.
Despite the month-end sharp market reversal, most world equity indices finished the period up-low-single-digits-to-flat. Mexico’s Mexbol Index declined -5.32% over the period due to a struggling economy, with a slump in industrial production and declining investment. The German Dax lagged most European equity indices, declining close to 2% due to its higher sensitivity to exports to troubled Asia and, more specifically, China. Sector-wise, energy, materials and healthcare lagged the rest of the market.
The sovereign rate rally in developed markets slowed down in July, with yields flat or slightly down during the period. Australia’s short-term yields declined by 30 bps due to the negative impact of the tense trade discussions in China. Higher-beta regions benefited from a softer growth outlook and weaker inflation prints. Brazil and Argentina had their short-term yields ease 40 bps and 100 bps respectively.
As for commodities, precious metals continue to benefit from economic uncertainty and an expected reboot of quantitative easing monetary policies. Over the month, gold took close to 1%, taking its year-to-date gains to over 11%. Soft commodities, natural gas, coal and the Brent all declined during the month low-to-high-single-digits per cent.
The HFRX Global Hedge Fund EUR was up +0.35% during the month.
July was, on average, a good month for long short equity funds, making the strategy – year-to-date – one of the best-performing. During the year, market direction has been the most important factor in driving performance among managers. Net long stock-pickers outperformed market-neutral strategies. Low net funds found it more difficult to be positive during the month due to strong sector rotations and heavy short stock-hedging. Average gross exposures have slightly increased recently but average net exposures remain significantly below the highs of recent years. The current environment is not easy, due to economic uncertainty and rapid sentiment changes. However, strong dislocations always create opportunities for either long or short investments. This strategy offers a wide range of levers than can be used to benefit from industry restructurings and sector dispersion from a long or short perspective.
July was a continuation of June, which was beneficial for both discretionary and systematic strategies. The latter made money from their long equity and bond positions, benefiting mainly from medium-to-long-term models. In this environment, we would tend to favour discretionary opportunistic managers that can take some risk off the table and stay on the sidelines when asset prices are heavily dislocated. Nevertheless, these managers can use their analytical skill and experience to generate profits from a few strong opportunities worldwide.
July was, overall, a positive month for quant strategies. CTAs had a good month, thanks to strong trends in both developed market bonds and equities. Results were more mixed in commodities: metals generated positive results, while the energy and agriculture sectors incurred losses.
The strategy is still benefiting from a much better opportunity set than last year in the US (the basis in the US is twice as wide as last year), as well as opportunities in Europe, e.g., France, Italy. The new LTRO programme and the Fed’s dovish tone are likely to sustain ongoing swap-spread widening and create dislocations. On the short part of the curve, the YTD tightening of the OIS libor basis has benefited some funds. It is important to highlight that funding and access to repos is one of the pillars of the strategy and that access to bank balance sheets has become more challenging. Since the beginning of the year, all managers in this space have delivered strong risk-adjusted returns, while being positively exposed to volatility.
In a world where G7 yield curves are less attractive than ever, Emerging market debt is benefiting from renewed interest, especially in Latin America. Despite a positive backdrop, volatility should remain high and evolve from month to month. Hence many of the managers we are tracking seem more focused on idiosyncratic investments that are more immune to the deglobalization rhetoric. Discretionary managers have again tended to outperform systematic strategies since the beginning of the year. Long Brazilian rates seem to be the only consensual and crowded trade among EM managers.
July was good for Event-Driven strategies, with positive performance contributions from both hard- and soft-catalyst strategies. Merger arbitrage performance reflected both the completion of a certain number of deals and also a general spread-tightening of pending deals. According to the managers we track, large-scale transactions continue to dominate the landscape – a characteristic of late-stage consolidation – and the continuous supply of investable deals continues to be unmatched by merger fund demand, helping spreads remain relatively wide. It is also interesting to note that the increase in shareholder activism challenging announced deals has increased the uncertainty of outcomes, keeping spreads wider. Managers are, on average, optimistic about the outlook for Risk Arbitrage due to a supportive business environment with benign financing conditions and the willingness of corporate management teams to fight for sources of business growth.
We still believe that we are in the late stages of the credit cycle. The 2019 risk-on environment reversed most of the spread-widenings seen in Q4 2018. Distressed and stressed strategies are currently tending to overweight their portfolios with hard-catalyst investment opportunities, whicht are diminishing the negative impact of beta. Managers are raising cash levels for dry powder with which to reload the portfolio with the new issues hitting the distressed market. We are closely monitoring distressed managers, due to the potential of high expected returns, but remain broadly on the sidelines.
Despite some more volatility, spreads – supported by the chase for yield – are still heading in the same direction. Hence we remain underweight, as there is limited-to-no-comfort in being short the credit market, where there is strong demand and the negative cost of carry is quite expensive.