Newsletter | June 2019

– 17%: THE PERFORMANCE OF THE PHILADELPHIA SEMI- CONDUCTOR INDEX IN MAY

2.06% – THE EARLY-JUNE YIELD ON 10-YEAR U.S. TREASURIES

Investment perspective

The four-month rally of global equity markets came to a screeching halt in May. The early-year optimism over a trade deal between China and the U.S. gave way to concerns over a major breakdown of trade talks and growing fears of an economic slowdown. The prices of risky assets depreciated across the board; the MSCI World Index in local currencies fell by 6%, the spreads of credit and emerging market debt widened and commodity prices weakened, with oil down by 16%. Significant flows into safe-haven assets contributed to strong returns for high-quality sovereign debt, gold and defensive currencies such as the yen and the Swiss franc. The yield of the 10-year U.S. Treasury note declined by 0.38% to 2.10%, its lowest level since September 2017, while the yield on 10-year Bunds reached an all-time low of – 0.21%.

Once again, the tweeting activity of Donald Trump has been a major driver of financial markets; the U.S. President blamed China for trying to renegotiate certain terms, placed restrictions on business between U.S. companies and Huawei, decided to delay tariffs on European automakers and finally added new tariffs on imports from Mexico. The latter decision came out of the blue, with tariffs gradually rising if Mexico did not help to limit the flow of migrants. The 2020 re-election has started in earnest, with Trump seeing a multi-front trade war as a good way to play to his political base. For market participants, the rise of uncertainty makes the outcome of investment decisions much less predictable, hence the shift towards more defensive assets.

Apart from trade headlines, global macroeconomic data did not provide much support to the markets as forward-looking indicators tended to disappoint, in the U.S. in particular. The outcome of the much-awaited European elections was taken in its stride by the markets as the worst-case scenario was avoided; gains made by populist and far-right parties failed to match projections and the new European parliament will reflect the fragmentation of politics which has already been observed in many European countries.

The month of May was dominated by headlines over trade talks and a U.S. ban on the Chinese tech giant Huawei, limiting the business U.S. companies could do with it. This ban had a ripple effect on the whole technology sector, with semiconductor companies being the most severely impacted. The chart above shows that the reference Philadelphia Semiconductor Index fell by 17% in May, its worst monthly performance since November 2008.

 

Investment strategy

We are sticking to our relatively defensive asset allocation in view of a rising level of uncertainty and concerns over weaker economic data. We will not pretend to have been expecting such a steep reversal of equity markets, but we had felt that they were pricing in an overly optimistic scenario. We observe that markets are once again looking for some help from the Federal Reserve and that the odds of a Sino-American trade deal in the short term have significantly lengthened. In this environment, it is difficult to justify adding more risk to the portfolios and we therefore maintain our underweight equity allocation.

The recent trend of bond markets has been quite dramatic, in view of the collapsing yields, as has been the significant shift in expectations on rate cuts by the Federal Reserve. Markets are now pricing in a 55% probability for 3 rate cuts of 0.25% this year, compared to a 2% probability only a month ago! The market’s divergence with the position of the central bank is becoming quite extreme and the Fed will need to tread carefully to manage the growing pressure from the markets.

 

WE MAINTAIN OUR UNDERWEIGHT ALLOCATION TOWARDS EQUITIES

Portfolio Activity/ News

In May the portfolios gave back some of their strong returns recorded during the first four months of 2019. This resulted mainly from weak equity markets and from a widening of credit spreads. The more defensive fixed-income positions ended in positive territory while the best contribution was provided by the trend-following strategy, thanks to its high exposure to rates. In relative terms, most equity funds fared better than their benchmarks, with only some exceptions. Our fund investing into U.S. value companies was the largest detractor as it lost all of its early-year outperformance. Despite this setback, we maintain our confidence in the manager and have topped up positions in some portfolios.

The latest addition to our list of funds is an “out-of-the-box”Swiss franc bond fund investing into investment grade quality. The distinctive feature of this fund is that it invests both into higher duration top quality bonds and into up to a maximum of 30% of global investment grade convertiblebonds; this “barbell” approach enables the fund to benefit from its higher duration and top quality in risk-off periods and from its equity sensitivity when equities are rising.

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