Newsletter June 2016
June 3, 2016
Last month saw the second quarter launch on a positive note, which fizzled as the month ended, and May saw the opposite effect. A subdued and gloomy first half was salvaged by a more resilient second half and the month was modestly positive in the end. The USD reversed course again to strengthen, particularly against the Yen and the Euro (which fell 3% and 4% against the USD, respectively), while commodity performance was mixed and EM again discarded in favor of government bonds, which had a very solid month. This lack of discernible trending, has proved to be particularly challenging for trend followers, particularly in the currency area. While they have benefited generally from the steady pace of fixed income firming this year, as well as some positive trends in commodities, equity indices and currencies have defied all attempts to fix a trend upon them.
It is interesting to probe what caused investor sentiment to swing mid-month. It seems that the steadily improving US domestic data finally changed the rhetoric on the timing of the next Fed interest rate move, and a June hike started to look increasingly certain. This shored up the USD, while higher oil prices (US WTI and Brent WTI rose by 7% and 4.5% over the month) that seemed to find support in the high $40s and even hit $50 per barrel, also provided some comfort. This had a rippled effect on the outlook for banks (in the US market the S&P 500 financials index outperformed the S&P 500 index (2% to 1.8%) while in Europe the DJ Stoxx 600 banks was up 1.4%, but still down close to 14% for the year.
Equities get an A for effort
Equity markets tried hard to end the month in positive territory, and largely succeeded, with only the FTSE MIB in negative territory for May (-1%), while the DJStoxx 600 added 2.7%, the S&P added 1.8%, and the Greek market a stunning 11.3% in local terms following constructive developments with respect to the bailout. Ireland was also in demand (+5.5%), reflecting the growing confidence among investors in EU peripherals, while the FTSE was slightly flat (+0.3%). So far this market has had only a very muted reaction to Brexit chatter, as much of that seems to be reflected in the currency (and Gilts) at this stage. This may also be partially due to the large percentage of the FTSE that is represented by companies with ex-UK earnings, who have actually benefited from a weaker GBP, and have less exposure to the economic ramifications of a Brexit. The picture within EM was less clear however, with the MSCI EM index shedding -3.7% and Brazil finally capitulating as political woes mounted (the market lost 10.1% in the month after the impeachment announcement). Chinese markets were softer (the Shanghai composite was down -0.6%) while still -17.4% for the year to date, the worst market within the EM complex.
Credit firms as energy woes become muted
The firming oil price provided a relief valve for the energy and resources sector which is widely expected to be the spark that kicks off the next default cycle. Credit investors reacted by continuing to provide support across the maturity spectrum and capital structure, at least in developed markets. High yield firmed slightly (in the US it is now up 7.5% for the year), while in Europe it is up 3.4% ytd. All government bonds were in demand in May too (particularly UK GILTS which strengthened by 1.8% as Brexit fears abated). EM remained the exception, as bonds sold off across all regions, although remain strongly positive for the year at this stage.
Private equity firms are estimated to have a tremendous amount of dry powder currently (up to $400 bn in the US and just over $200 bn in Europe) (data from Preqin), which creates a positive backdrop for leveraged lending as well as private credit in general. This has for some years been a hybrid private equity/hedge fund strategy, and we expect more and more absolute return focused hedge funds to migrate to this area, particularly as merger arbitrage remains a challenge.
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As we approach mid-year it has been a stubbornly successful year for risk-based investing despite some sizeable jolts to confidence along the way. While European equity markets remain negative on the year (-2.7%), and foreign flows and confidence have seeped out of Japan (the Nikkei is -8.7%), resilience in the UK, US and EM (with the exception of China) and a new floor under commodity prices create a more positive mood music for the second half of the year. The next few weeks will be extremely important with a potential US interest rate move and a Brexit referendum, but it is only the latter that has the potential for a sharply negative surprise in our view.