Global Market Review - July 2018
Investor’s reaction to the earnings disappointment of a handful of very large companies should be viewed as a signal that wider investment diversification is needed within the Tech space and that just maybe it’s time to give value stocks another look.
Risk appetite returned in July, powered by the highest US GDP growth in Q2 in nearly 4 years. Gross domestic product rose at a seasonally-adjusted annual rate of 4.1% from April through June, last surpassed by the 4.9% rate reported in Q3 2014. Strong consumer spending helped boost growth as well as an export rally that was partly related to accelerated soybean exports before China’s retaliatory tariffs on US production hit in July. Personal spending expenditures rose by 4% as a low unemployment rate, steady job growth and the 2017 tax overhaul all encouraged spending by businesses and consumers alike.
Other events that had been weighing on the markets also improved over the month, including trade war fears, political instability in Europe and Chinese growth concerns. US equity markets continued to outperform, with the S&P 500 up 3.6%. However, Chinese stocks fell as official data showed that China’s business activity was beginning to falter, a result of trade tensions denting economic growth. The purchasing managers’ index fell to a 5-month low of 51.2, although it is still in an expansionary mode.
A fresh round of selling hit US Treasuries and global developed market bonds in July, with the US 10-year note crossing 3% by the end of the month. In contrast, credit and emerging markets bonds rebounded sharply with the renewed ‘risk-on’ environment. The JP Morgan Global Aggregate index fell –0.1% and remains down –1.7% on a YTD basis.
At the beginning of Q2 we moved Cash to Overweight at the further expense of government bonds. 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 year-to-date returns in fixed income provide a stark reminder that bonds can also lose money. 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.
Global financial conditions remain fairly loose and despite recent disappointing Eurozone growth, corporate profits remain healthy. For the latest quarter, US profits are on track to register a rise of 25% from a year earlier, one of the fastest rates of earnings growth since 2010, according to FactSet. However, equity markets can still fall due to contracting P/E multiples — one need only look at the current risk-off episode being triggered by Turkey. We still have a tilt towards emerging markets and Japanese stocks (in Yen) over US equities based on cheaper valuations.
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. As we wrote last month, with its shorter duration and higher coupon, high yield bonds are poised to outperform other fixed income sectors in this rising rate environment as long as defaults remain low. With 2-year Treasury notes now yielding 2.6%, we view cash and cash equivalents as an attractive alternative to longer-dated 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.