Bears behind the wheel

The debate between bulls and bears is hotter than ever. The US economy continues to display very strong fundamentals but ongoing discussions about tariffs and trade wars always put political risk on the table. As the risks are many, it is difficult to pinpoint what triggered the strong factor reversal at the beginning of September. The fact is that momentum and growth factors took a breather. Investors rotated into defensive sectors away from consumer discretionary. Technology darlings were also weak. One of the reasons behind this could be the congressional hearing in Washington that raised the prospect of tougher regulation for the sector. In the US, the telecom and healthcare sectors were the best performers. Energy stocks, supported by a strong oil price, also did well. Reversing recent trends, Argentina, Brazil and Turkey performed well, with some developments perceived as positive by investors. European equity indices, mainly driven by macro sentiment, were a mixed bag.

On fixed income markets, the attention was focused on Italy, whose hostile interactions with Brussels have pushed yields higher. The market seems to be micro-monitoring the situation since each meeting or government declaration is able to move yields up or down 0.50% in the short term. In the US, Treasury yields of medium-to-long-term maturities were up 0.20% on average, driven by the country’s overheating economy. And, in what is also a sign of the American late-cycle economy, the US junk-debt-spreads-to-Treasuries ratio has reached an all-time low.

As for commodities, oil continues to lead the pack, with Brent increasing close to 7% over the month, taking its price to $85. Some base metals, like copper and zinc, reversed a bearish trend, both increasing around 6%. Palladium, which is closely linked to electric batteries, continued its upward trend after reaching a bottom mid-August. It took close to 10% over the month.

The HFRX Global Hedge Fund EUR was down 0.95% for September.

Global macro managers with an Emerging Markets focus had, on average, a good month. Some developments were perceived by investors as positive, bringing relief to recently stressed markets like Argentina, Brazil and Turkey. As for strategies with a global focus, results were more heterogeneous where performance was driven by individual positioning. Currencies and oil were strong profit-drivers for the month. Finally, discretionary strategies tended to outperform systematic global macro programmes. These strategies tend to offer great opportunities in rising volatility environments, in periods of limited central bank intervention, and when rates rise.   

Emerging Markets remains a tough environment to be invested in. Investors remain concerned about the medium-to-long-term impacts of trade tensions between the US and its major commercial partners in the region. The rising costs of US-denominated debt issuance is also a reason for concern. While the timing of a resolution to most of these problems is unknown, the dislocations created by Donald Trump’s policies will, at some point, become opportunities.

Merger arbitrage, boosted by Comcast’s successful Sky auction in September, had a good month. The completion of this operation had a positive impact on deal spreads. Looking to the last quarter of the year, the outlook for merger arbitrage remains favourable. Pending transactions generally have strong strategic rationales and highly committed buyers.

We believe that we are in the late stages of the credit cycle, with default rates and spreads near historical lows. During September, the US junk-debt-spread-to-Treasuries ratio reached an all-time low. Nevertheless, although we are closely monitoring distressed managers, due to the potential of high expected returns, we remain broadly on the sidelines. We are seeing a growing number of US hedge funds specializing in distressed assets starting to raise money in anticipation of the next economic downturn.

After several months of outflows and marginal spread-widening, US high spread went back to its tightest spread level, supporting our negative view on the strategy.