Newsletter | November 2023
U.S. 10-year yield flirted with 5.0 percent, finishing at 4.93%, down from the high of 5.02%
- 6.8% THE PERFORMANCE OF RUSSELL 2000 INDEX
Investment perspective
All inflation metrics have slowed considerably since their peak, but all remain still above central bank targets. Despite this, developed central banks in major developed markets have reiterated their decision to pause monetary tightening cycle, which could mean that we have indeed reached the end of the cycle. Despite central banks pause, the US 10Y yields rose just over the 5% mark and has conditioned market behavior and returns. At 4.93% at the end of October, yields have not been this high since mid-2007. The 2Y/10Y spread finished the month at 16 bps after peaking at over 110 bps in July.
October was a terrible month for financial markets. It was an awful one for eq-uity markets, but also for bondholders across all sectors especially for those with long maturities. The Global Aggregate index hedged in U.S. dollar was down 0.7%, the Global Aggregate Corporate and Global High yield were down 1.0% and 0.9%, respectively, while EMD USD Aggregate dropped 1.5%. As in September, the worst performance was recorded on the US Long Treasury seg-ment with a decline of 4.9% after an 11.8% drop in the 3rd quarter.
The All-Country World index recorded a decline of 2.7% in local currency and more than 3% in U.S. dollar. In the US, the Equal Weight Index fell by 4.1%, while the main index was down 2.1%. In addition to the sharp decline in small-cap indices (-6.3%), we also note the significant and consequential fall in value-style indices (-3.5%) compared to growth indices such as the Nasdaq 100 (-2.1%). European indices started the 4th quarter on the back foot as well, slipping 3.6% in October. Mid- and Small caps materially underperformed large caps with declines of 4.8% and 5.9%, respectively. In U.S. dollar, emerging markets declined by 3.9%, China A by 3.0% and Frontier markets by 5.8%.
The U.S. dollar index (DXY) strengthened marginally (+0.5%) while the Japanese yen continues to plummet to new lows against the U.S. dollar. As is often the case in these risk-off phases linked to geopolitical tensions, the price of gold benefited greatly, rising by 7.3%. More surprising was the 10.8% fall in the price of the West Texas crude oil.
Investment strategy
At the beginning of the year, the consensus view was that a recession was inevitable, due to the rise of oil prices and, above all, due to a restrictive monetary policy that saw key interest rates raised at an unprecedented speed and level.
Some nine months later, the latest release of the real GDP growth for the US economy in the third quarter was surprisingly strong, with an annualized growth of 4.9% q/q. The situation is quite different in Europe, where the latest publication confirmed an anaemic growth that is flirting with the levels generally associated with a contraction phase.
After a spike in inflationary pressures in the wake of rising oil prices, the figures published in October showed a decline, which should reassure central banks. As a result, we do not expect any further rate hikes and believe that we have reached the peak of the cycle.
In the US, the long-term interest rates have risen on the back of continued economic strength, particularly in the labour market, which has further postponed a rate cut and the growing need for issuance to finance the budget deficit.
As bond yields have risen in recent month, the asset class should come back in favor with investors. What’s more, reduced uncertainty over the path of key interest rates and falling inflation rates should support both sovereign and investment-grade bonds, which are generally more interest-rate-sensitive than high-yield bonds.
2Y/10Y SPREAD FINISHED THE MONTH AT 16BPS AFTER PEAKING AT OVER 110BPS IN JULY
Portfolio Activity/ News
Market developments in October will undoubtedly have tested investors’ nerves, but also important technical supports. The next few weeks will be decisive, as we could either see an acceleration of the downtrend or a major rebound to correct the oversold situation observed on many markets. In the event of a rebound, this could be violent, as such a reversal in the trend for interest rates and/or equity indices would force trend strategies to close their short position in both interest rates and equity markets.
We are maintaining our favorable view on equities, an over-weight stance that we have gradually increased in October, and are continuing to rebalance our bond holdings towards a better balance between interest rate and credit risk.
Within fixed income, we are maintaining our exposure to emerging market high-yield corporate debt, where we believe the carry is sufficient to mitigate country and specific risk of the market segment. In emerging market equities, and more specifically China, we have replaced our greater China exposure with domestic Chinese A shares.
Within our liquid alternatives allocation, we have taken some profits on our trend strategies and now remain neutral on that group of strategies. The proceeds were reinvested in our dedicated risk parity strategy bucket, a strategy that aims to provide an effective and efficient access to a broad set of asset classes including commodities such as gold.
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Newsletter | October 2023
U.S. 10-year yields hit 16-year peak as Fed seen higher for longer
- 7.29% THE PERFORMANCE OF US LONG TREASURY INDEX
Investment perspective
As widely anticipated, the US Federal Reserve decided to hold its target rate range steady at 5.25-5.50%, the highest level in 22 years. In their newly released “dot plot”, at least one more hike is in the card this year and that cuts would begin later than previously signaled. The ECB raised rates 25bps to 4% and signaled that it was likely be the last increase. The BoE and SNB surprised investors with their decision to take a break from their rate hiking cycle. As Investors are internalizing the likelihood that rates will stay higher for longer, U.S. treasuries were notably weaker with the curve bear steepening. The U.S. 10-year yield rose nearly 90bps, touching its highest level since 2007. The 2-year/10-year spread, inverted by more than 100 basis points on June 30, before narrowing to 50 basis points by the end of September. In that context, bond markets posted a second consecutive month of declines across all sectors. The Global Aggregate hedged in U.S. Dollar was down 1.7%, the Global Aggregate Corporate -1.9% and the Global High Yield -1.1% while EM USD Aggregate was down 2.3% The worst performer was the US Long Treasury segment with -7.3%. Global equities continued their downward trend, with the All Country World index recording a decline of 4.1% in U.S. Dollar. Contrary to August, developed markets suffered more than emerging markets, with a decline of 4.3% and 2.6% respectively. Major US equity indices were down in September, a month that lived up to its reputation as the worst month of the year in terms of returns. The U.S. large cap declined by 4.8% while the heavy information technology index was down 5.8%. European equities held up better, with a decline of 1.6%, as did Japanese equities, up 0.3% in local currency. Chinese equities were down 2.6% in U.S. dollar while Indian equities were up 1.7% expressed in U.S. dollar. With oil prices recently reaching record highs for the year in 2023, energy prices continue to pose a significant risk to the disinflation narrative. The U.S. Dollar index was up 2.5% while gold was down 4.7%, logging a decline for the second straight quarter.
Investment strategy
Several equity indices hit their highs during the third quarter, before declining significantly, reducing year-to-date returns. The road to a soft-landing may be winding and full of diverging signals but hopes for such a scenario remain intact despite a very aggressive monetary policy. Several Western central banks have not raised interest rates further in September even if inflation remains above the 2% target. These announcements would seem to signal the end of the monetary tightening cycle and the opening of a stabilization phase for short-term interest rates. This phase of rates plateauing around current levels is likely to last several quarters before possible rate cuts in the second half of 2024. The main risks of the current soft-landing scenario are either a more severe slowdown in economic activity or continued strong growth leading to a resurgence in inflation. Even if inflation will only fall gradually, we passed the peak a few months ago, and the theme of disinflation is still relevant. Against this backdrop of moderate growth and disinflation, we find corporate bonds attractive, even in the event of rising defaults, as they offer carry with limited interest-rate risk. Like economies, markets are at a crossroads following recent price action that pushed them close to critical technical levels and into an oversold situation that are generally rare opportunities to increase market exposures.
U.S. SMALL CAP INDEX NOW IN NEGATIVE TERRITORY YEAR-TO-DATE
Portfolio Activity/ News
Considering that we had reached terminal rates, we tactically increased our equity weighting in September and are maintaining this position.
Our rather cautious stance on long-dates bonds has proved judicious, and we are maintaining this positioning, while recognizing that we could selectively take advantage of any price exaggeration. We remain confident about our short-dated corporate bonds exposure. However, we recognize that even a moderate deterioration in economic conditions because of tighter financial conditions will create some challenges for highly indebted companies, causing default rates to rise. After a phenomenal rally in the first part of 2023, technology companies and, more generally, so-called growth stocks fell sharply in August and September due to an increase in the likelihood of interest rates remaining higher for longer. We took advantage of this selloff to initiate a position in a strategy focused on investing in exceptional growth companies. As a provider of diversification and return in adverse markets, it is interesting to note the very good performance of our alternative strategy bucket. Indeed, our trend-following exposure recorded a positive return of more than 5% in a complicated market for both bonds and equities.
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Newsletter | September 2023
U.S. 10-year yield jumped to 4.34% on growing concerns of supply
- 12.7% THE PERFORMANCE OF WHEAT INDEX IN AUGUST
Investment perspective
The resilience of the U.S. economy and falling inflation led to a wider adoption of the soft landing scenario. However, the release of stronger-than-expected figures and a hawkish Fed put pressure on U.S. long rates leading to a number of setbacks in terms of return for risk assets after several favorable months. The U.S. treasuries were mostly weaker with the curve bear steepening, though yields finished the month well off their highs. In that context, bond markets delivered negative returns with the Global Aggregate hedged in U.S. dollar down 0.13% and the Global Aggregate Corporate down 0.4%. The most affected segment was the EMD complex with -1.4% for the hard currency sovereign index and -2.0% for the local currency index. One of the most prominent headwinds facing equities was the backup in interest rates. Global equities sold off 2.8% in U.S. Dollar terms. Developed markets outperformed emerging markets, with a loss of 2.3% versus 6.2%. The U.S. large cap index was down 1.6% while the equal-weight index was down 3.2%, posting their first monthly decline since February. As is often the case, last month’s risk-off environment was felt more keenly by European and emerging market equities, with declines of 2.5% and 6.2% respectively. Among emerging markets, Chinese equities were down almost 9% in U.S. Dollar. The Dollar index gained 1.7%, reversing most of prior two months’ losses. Gold fell more than 2% while oil prices continued their upward trend (WTI up 2.2%). In Europe, the gas prices jumped by 23% due to fear of LNG supply disruptions at plants in Australia. Other commodities posted negative returns. The equity volatility was unchanged at 13.6% while the interest rate volatility (MOVE index) came down sharply and is likely to get a reprieve as we approach the end of the rate hike cycle. According to the State Street Risk Appetite Index, investors’ cash allocation showed the biggest jump over a year mostly at the expense of investors’ allocation to equities.
Investment strategy
The U.S. economy proved resilient despite tighting financial conditions. Helped by encouraging signs of easing in the job market, the risk of additional Fed tightening is limited and current yield should be close to terminal rate. U.S. real yield are approaching 2%, the highest since 2009, suggesting that financing conditions are indeed more restrictive and should cool down the US economy. Credit spreads are well behaved and sit at their long-term averages. They could potentially widen if economic slowdown is more pronouned that currently anticipated. However, we do not expect them to widen massively, and even in that case falling sovereign yields would partially compensate for the negative impact of spread widening. Having more S&P 500 equal-weight exposure has been painful
year-to-date. However, the combination of cheaper valuations and some reversion to the mean does give us confidence. We remain positive on Japanese equities due to strong fundamentals, cheap valuations and loose monetary policy. While aware of the risks and challenges ahead, we recognize that the recent market downturn could provide us with an opportunity to temporarily increase our equity to slightly overweighted the asset class, to the detriment of gold.
U.S. 10-YEAR REAL YIELD ARE AT 1.89% - HIGHEST LEVEL SINCE 2009
Portfolio Activity/ News
Our asset allocation and portfolio composition remained cautiously positioned during the month, which contributed positively to our relative performance. Within fixed income, we reduced our emerging market debt sovereign and hence duration exposure. We reinvested part of the proceeds in emerging market debt corporate strategy, which offered an attractive risk-reward profile. The recent sell-off in developed market bonds has given us and our managers the opportunity to gradually increase our interest rate sensitivity as measured by duration. We pared back our credit long/short exposure but remained invested in this type of strategy to reflect our cautious stance. In Europe, we initiated a position in a dedicated flexible credit opportunity strategy that provides an exposure to credit with an active duration management expertise. Our U.S. equity portfolio has remained unchanged during the period. It’s important to highlight that our exposure comprises of a significant long/short exposure particularly suitable in the current environment. We pared back our frontier markets position for our European reference currencies and reinvested the proceeds in European or Swiss equities.
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