Quarterly Market Report – Q2, 2018

An old market adage often referred to as ‘The Halloween Indicator’ urges investors to “Sell in May and go away”. Many academic studies have successfully demonstrated that, while in the past, lower trading volumes over the summer months may have led to stagnant markets, in today’s multi-asset, globally connected investment universe, this seasonal strategy is unlikely to be the best course of action.

That said, as we enter the second half of 2018 the investment landscape seems littered with potential stumbling blocks that will need to be carefully navigated in order to end the year in positive territory.

On 12th June, the world’s media gathered in Singapore to witness a historic meeting between Donald Trump and the North Korean dictator, Kim Jong Un.

The SGD$16 million, taxpayer-funded media circus had little to no impact on global markets, most likely due to the lack of details published after the event. We did learn that the controversial leaders had pledged to continue to work towards de-nuclearisation of the Korean Peninsula. More worryingly, we also learned that the US Secretary of State, Mike Pompeo believes that Singapore is still part of Malaysia and that after openly crying live on CNN, former NBA professional basketball player, Dennis Rodman may be very close to some form of a breakdown.

While the summit appears to have delivered very little in the form of tangible progress, it did serve to divert media attention from the ill feeling Donald Trump had garnered just hours earlier at the G7 Summit in Quebec. Expressing his support for the readmission of Russia, a very public Twitter spat in which he referred to the Canadian leader Justin Trudeau as “dishonest and weak” and his refusal to endorse a post-summit joint communique are all indicators that we may now see stronger retaliations for increased tariffs on steel and aluminium imports to the US. Whilst a full-blown trade war may not lead to a recession in the US, a reduction in consumer and business confidence could lead to a slowdown in current US momentum.

On a brighter note, unless you are lucky enough to live on a deserted island, you will likely be aware that in June and July, Russia is playing host to the 21st FIFA World Cup. With over three billion people – almost half of the world’s population – expected to follow the event, it’s no surprise that the World Cup has the ability to impact market performance.

A 2010 Study by the European Central Bank of 15 global stock exchanges found that trading volumes fell by an average of 45% when the national team were playing, and by a further 5% each time a goal was scored. Another study by Goldman Sachs found that since 1974, on all but one occasion, the national stock index of winning countries has outperformed by an average of 3.5%. Likewise, losing countries often suffer from ‘post-final blues’, underperforming by as much as 5.6% in the following three months.

Equities

Despite a strong start to the year, the S&P 500 gave up all gains in February, and we began Q2 only just inside positive territory. Trade tensions continue to weigh heavily, and we ended the quarter at 2718.37, a year to date price gain of just 1.67%.

Despite the relatively weak performance of the S&P, tech stocks have enabled the Nasdaq to show greater resilience, and the index is currently at 7510.31, a year to date gain of 8.79%.

After recording the largest ever daily spike (+20.01 to a peak of 37.32 points on 6th February), the VIX index started the quarter at 23.62, peaked intraday at 25.72 and ended the quarter at a level of 16.09: an increase from the quarter’s closing low of 11.64 in early June, but still low enough to signal some confidence in continued growth and stability.

In Early June, Donald Trump celebrated his 500th day in office with a series of boasts relating to economic growth, job creation and crime reduction, all of which are claimed to have improved during his tenure. Despite these being easily manipulated statistics, the global economy does continue to grow, and thanks to investment in American shale production, tax cuts and increased spending, the rate of US economic growth may, in fact, be improving. The trade war could, however, pose a significant threat to both US and global growth as we enter the second half of the year.

May and early June saw significant political uncertainty in Europe weigh on markets. In Spain, The People’s Party leader and Prime Minister Mariano Rajoy was ousted in a vote of no confidence following the conviction of 29 party affiliates on various charges including corruption and money laundering. After several tense days, Mr Rajoy was eventually replaced by Pedro Sanchez, the leader of the Socialist Workers Party, who now faces the daunting task of uniting a divided parliament and rebuilding the political capital the party lost when they implemented severe austerity measures after the European debt crisis.

Italy finally managed to elect a new Prime Minister, a former law professor with no political experience who may or may not have lied about his academic credentials on his CV. In any event, Giuseppe Conte will have his work cut out for him as he takes office. The real driving forces in the current coalition government will be the party leaders from the right-wing League Party and the vocally anti-establishment Five Star Movement. While it seems that fears of a European exit and ditching of the Euro may have been calmed, promises of a spending and tax cutting binge to reduce current public debt levels have led to concerns of a new European crisis, unsettling European markets further. The Euro Stoxx 50 closed the quarter at 3395.60, losing 3.09% year to date, though, only marginally down 0.47% of a total return basis.

Market-wise, there was better news from the UK, where, despite warnings on the speed of progress and uncertainty over the finer points of October’s Brexit arrangements, the FTSE 100 saw the largest quarterly gain in five years of +8.2%. On a price basis, the FTSE remains in negative territory year to date (-0.66%), though, is up 1.63% with dividends being reinvested.

In China, a falling Yuan and continued trade fears have weighed heavily on the Shanghai Composite making it the worst performing global index thus far in 2018 with a year to date negative return of 13.90%, 10.14% of this fall coming in the quarter under review.

The Hang Seng returned -2.53% over the quarter under review and closed the quarter with an index value of 28,955, whilst the Nikkei 225 ended the quarter on 22,304, a quarterly total return of 4.08% in Yen terms.

 

Bonds

Earlier this quarter we saw 10-year US Treasury yields rise to over 3% (3.11% on the 17th of May) – the highest in over seven years. This was felt to be partly due to an expected increase in Treasury supply to fund the budget gap resulting from aggressive tax cuts passed by Congress in late 2017.

Since then, yields have fallen significantly, by 28 basis points to a new four week low of 2.83%, though, have since closed the quarter down 25bps – yielding 2.86%. The divergent view on long-term growth and short-term interest rates has pushed the yield differential between two and ten-year notes to just 33 basis points and the narrowest gap since 2007, which coincided with the start of the worst recession for over 80 years.

A recent poll of 80 bond strategists by Reuters suggested a yield curve inversion, when long-term interest rates fall below short-term was, at most, only two years away and, some predicted, potentially much closer.

Two-year rates are expected to rise to as much as 3.05% within the next 12 months and 10-year yields to 3.30%, however, the yield curve could be only two rate hikes away from inversion. Given that an inverted yield curve has preceded every recession in the past 60 years, this is clearly a cause for concern, but one we are certain the US Federal Reserve (Fed) is keeping a close eye on.

Currencies

Despite the prevailing trade war fears and a weak start to Q2, The US Dollar rallied across the board over the quarter to record its strongest quarter since 2016, up 5.00%, as measured by the DXY index.

Q2 has seen the USD steadily rise versus the Japanese Yen with a gain over the quarter of 4.32% as referenced by Bloomberg, though, the greenback remains down 1.71% year to date, but despite some losses in mid-June, recovered last week after reports that the White House has walked back some of the harshest measures to curb Chinese investment in US Technology companies.

Likewise, the traditional safe haven Swiss Franc saw the USD lose ground during the early part of the first quarter but gain steadily from mid-February to early June. Initial trade fears saw the Dollar weaken but last week saw a recovery as risk appetite appeared to return, and the “Swissie” ended the quarter just below parity.

The return of risk appetite also saw ‘Cable’ reach 1.3078, the high point from a USD perspective of 2018 following a steady climb from the lowest level, 1.4339 in Mid-April.

The Canadian Dollar posted a YTD low versus the greenback with the USD/CAD ending the quarter at 1.3133 and versus the Euro, the Dollar also saw a similar steady climb from 1.2324 at the beginning of the quarter under review, touching a YTD high of 1.154 mid-period, before settling back at 1.1684 by quarter’s end.

It is generally felt that the US Central Bank’s monetary policy remains accommodative and that at least two more interest rate increases seem possible in the coming months. Clearly the Dollar is benefiting from a Fed that is steadily tightening monetary policy but many market participants now consider the US economy to be in the late stages of the cycle and with growth being propped up by fiscal stimulus, we cannot be sure how much longer it will be before the US Dollar’s current strength will begin to slow.

Commodities

Despite the talk of trade wars and subsequent jittery markets, gold, traditionally a ‘haven’ asset has continued to decline and ends the quarter at US$1,253.17 per troy ounce, marginally above the quarter and YTD low of US$1,248.25 per troy ounce on the quarter’s penultimate days trading. This has led to some confusion – sentiment for gold remains bearish and the traditional safe-haven demand currently seems absent. There are several reasons why this may be the case. Gold and the US Dollar generally display an inverse relationship and the current strong USD will make all Dollar-priced commodities appear more expensive.

Also generating significant column inches in the financial press this quarter is the oil price, like gold, leading to a mixture of speculation and uncertainty. Donald Trump took to Twitter (where else?) to express hope that OPEC would increase output leading to a fall in global oil prices. Following their meeting in late June, OPEC did, in fact, agree to increase output…prompting an unanticipated immediate increase in the price of oil.

Despite releasing a vague statement, markets noted that many countries would in fact not be able to achieve the maximum increases stated, which, at approximately one million barrels per day, was viewed as only a moderate increase of less than 1% of total supply. The increase in production, even if met, is not considered sufficient to offset growing global demand or to compensate for falls in output resulting from new sanctions in Iran, the economic collapse in Venezuela and further issues in both Nigeria and Libya.

So should investors sell in May and sit out until November? As I mentioned earlier, this adage relates to a time where traders invested in single markets. Volumes were low, and cycles were slow. Today we are able to access global portfolios across multiple asset classes seeking alpha from managers who are often able to find gains across all market conditions.

Whilst the environment currently seems volatile we can expect to see high levels of uncertainty remain for the rest of 2018, we remain confident that the best course of action to generate long-term returns is to avoid the dealing costs and timing issues associated with short-term seasonal strategies and continue to hold a well-diversified, multi-asset portfolio providing both growth and defensive capabilities.

[Source: All chart data sourced from Bloomberg – July 4th, 2018]

Download:  MitonOptimal Quarterly Market Report Q2-2018