Positive returns for global equities masked stark divergences between the US and the rest of the world.
The S&P 500 gained 3.0% in August, while stocks in Europe (-3.5%), UK (-4.1%) and EM (-2.9) were down on the month. Some EM assets saw a particularly sharp decline, with Turkish equities down almost -29% in USD and the Brazilian Bovespa down over -11%. Recent US equity strength is unusually extended versus ex-US equities. Admittedly, reducing US stocks simply because they are "expensive and outperforming" has been a terrible trading rule to live by lately. However, I remain firmly in the camp that still believes that “global diversification is not dead”.
Global fixed income performance was mixed, with US government bonds outperforming their European counterparts while emerging markets suffered from contagion from the turmoil in Turkey and Argentina. The JP Morgan Global Aggregate index rose 0.1%, driven by 0.8% gain in US Treasuries. Local emerging market bonds plunged –7.1% in a combination of plummeting currencies and soaring bond yields.
The Dollar gained 0.8% against the Euro and 1.3% against the British Pound in August. Copper prices dropped on investor concern over the months-long trade fight between the U.S. and China. With China accounting for about half the world’s copper demand, traders are anxious that tariffs will slow the Chinese economy and lower consumption of materials used heavily in construction and manufacturing. Gold continued to struggle in August and remains in a very negative trend, although this is reversing somewhat at the time of writing as the dollar weakens into September.
At the beginning of Q2 we moved Cash to Overweight at the further expense of fixed income. We believed then, as we do now, that the 40-year bond bull market had officially ended and that rather than provide a safe-haven, fixed income would be a driver of portfolio losses. The end of bond purchases by the Fed and ECB may produce further losses as liquidity dries up at the same time inflation finally rears its head. This slowing of liquidity is possibly a reason behind the rout we are now seeing in emerging market securities.
We maintain a neutral weighting in Equities. US stocks maintained their risk-on sentiment supported by generally solid corporate earnings and limited spillover from EM volatility. We have removed our tilt towards emerging market stocks in the face of such negative momentum, recognizing that although valuations are at a relative extreme, they may overshoot even further before reverting to the mean.
As we wrote over the summer, with its shorter duration and higher coupon, US high yield bonds are poised to outperform other fixed income sectors in this rising rate environment as long as defaults remain low. We maintain our long-held underweight recommendation in long-dated fixed income which continues to suffer as both real interest rate and inflation expectations move higher. With 2-year Treasury notes continuing to rise, now yielding 2.8%, we view cash and cash equivalents as an attractive alternative to longer-dated government and corporate bonds.
Within Alternatives, we recommend overweight positions in Managed Futures/CTAs and Market Neutral strategies as a form of portfolio insurance. Private Credit also remains an asset class of interest. In June we downgraded Gold to underweight until its technical picture improves.