Market Recap:
US markets continued to outperform in June, with the S&P 500 up 0.5% to be the only major country / region in positive territory on a year-to-date basis. Emerging markets remain in freefall, hampered by rising US rates, a stronger dollar and fears of a trade war between the US and China. American companies set a record for share buybacks in Q2 while mutual fund investors similarly set their own record for selling stock funds in June. According to market research firm TrimTabs, companies announced $433.6 billion in share repurchases during the last quarter, nearly doubling the previous record of 242.1 billion in Q1. At the same time, stock mutual funds saw $52.9 billion in outflows during the same period. While supportive of the US market, these buybacks could be an indication that firms are not reinvesting in their own companies and generally have nothing better to do with their cash.
Global credit was mixed over the month, as high yield bonds gained as investment grade and emerging market bonds plummeted. The JP Morgan Global Aggregate index fell –0.3% in May and is down –2.5% on a YTD basis. The US Federal reserve raised rates a quarter point in June as expected and announced its commitment to normalizing rates as long as economic data remains supportive. The European Central Bank (ECB) also announced that it will wind up its EUR2.4 trillion bond buying programme by the end of the year.
Oil prices soared in Q2 as geopolitics weighed on supply, helping to drain inventories and promising continued strength for the crude market in the months to come. Brent crude, the international benchmark, climbed by 13% during the quarter, temporarily topping $80 for the first time in over three years. Those gains came as an agreement between OPEC and other major producers capped their output while Venezuelan production dwindled. Moreover, bottlenecks in the U.S. kept some shale oil off the market while market participants anticipate Iranian production being hit by the re-imposition of U.S. sanctions.
Asset Allocation:
In March we moved Cash to Overweight at the further expense of government bonds. We wrote that the almost 40-year bond bull market had officially ended and that fixed income would be a driver of portfolio losses rather than a safe-haven. In other words, longer-dated government bonds, as the risk-free asset, posed the greatest risks to portfolio performance. The year-to-date returns in fixed income, a sea of red, is 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 a strong macro-economic backdrop means that company earnings can continue to rise. However, risk appetite appears to be waning, meaning that equity markets can still fall as P/E multiples contract. We continue to prefer emerging markets and Japanese stocks (in Yen) over US equities based on cheaper valuations and greater leverage to global growth. While we recognize that the recent strength in the US Dollar has proven to be a headwind for EM, we believe valuation will ultimately prevail.
Not surprisingly we maintain our long-held underweight recommendation in long dated fixed income which will suffer as both the real interest rate and inflation expectations move higher. As rates rise above inflation, providing a real positive yield, short-dated safe assets and cash equivalents are providing a credible alternative to higher-risk yield alternatives such as dividend paying stocks. Interestingly, 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.
Within Alternatives, we recommend overweight positions in Managed Futures/CTAs as a form of portfolio insurance, while staying generally positive on commodities (specifically: Oil). Private credit also remains an asset class of interest. We have downgraded Gold to underweight until its technical picture improves.