Newsletter April 2016

Spring in the air

March saw a welcome continuation of February’s positive momentum, and Emerging Markets were the most obvious beneficiaries.  We enter the second quarter with significantly modified rate rise expectations, particularly in the US, a USD currency whose ascent may have run out of steam, a stabilizing oil price and the first green shoots of inflation expectations, notably in China.

Oil prices rebounded in March driving EM equity markets notably stronger (the MSCI EM added +13%, with Brazil the outlier, rising 17% in local currency terms), as well as bonds (+8%). This heady optimism spread to Developed Markets equities too, with markets strong both in the US (the S&P 500 added 7% over the month) and to a lesser degree in Europe – the Stoxx 600 rose 2% and the DAX +5%. The commodity rally also carried over to commodity-linked currencies, particularly the BRL and the NOK, while GBP recovered somewhat against the USD as BREXIT fears seemed to cool.

Financials – mired in misery

Last month we mentioned the trouble in the financials sector, and bank stocks have to date failed to recover from their early year rout. As of the end of the first quarter the DJ Stoxx 600 Banks was down close to 20% year to date (the S&P 500 financials was still negative (-5.15%) but had managed to recover some of its earlier losses in March (when it delivered +7.3%).  This persistent weakness seems to be driven by ongoing low net interest margins, compounded by a drop in trading revenues, while in Europe concerns over NPLs have ticked upwards.  This, together with the still lack lustre showing of European peripherals this year may be indicative of a burning sense of discomfort with the current outlook for Europe.

But maybe there is something more to it too. Recent DB commentary suggests that numerous indicators point to the imminent beginning of a new default cycle – there has been an accumulation of US corporate debt, which currently compares with that seen prior to previous default cycles, spikes in equity volatility have become more commonplace (there were two recently – both in August 2015 and at the beginning of 2016) and global yield curves continue to flatten against a backdrop of tighter monetary policy.  Another early warning sign was the announcement by Business Development Corporation of America that it was halting redemptions on its $2.5 bn non-traded fund as its pre-established limit was hit, following a rough period in the US junk-bond market, in particular within the energy sector. In 2008 it was little signals like this that were early warning indicators of greater distress and it is something to be noted and monitored closely.

When the trend is not a friend

Trend following funds struggled in March as the rise in the Euro generated losses in currency trading and long bonds and short energy stocks led declines across other sectors. The reversal of a downturn in coffee, cotton, corn and wheat drove losses within commodities while a drop in metals including gold caused drawdowns in long positions in these stocks. FX and macro managers have been particularly challenged this year as currency volatility has remained high and the swings unpredictable.

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With banks suffering and earnings season projected to be weak overall, it is hard to be optimistic for the months ahead. However, it is at this juncture that much care must be taken, and investors should be afraid (very afraid) of complexity, leverage and reaching for too much yield.