How markets have performed (to end June 2018)
Financial markets in June were somewhat volatile, but directionless, as the news flow was evenly balanced between supportive and negative headlines. US equity market returns were the strongest, outperforming all other market regions. European market returns were burdened by ongoing investor concerns following the Italian election. Emerging Market assets, both equities and bonds, were the clear laggards as currency weakness and fears of the impact of a strengthening US Dollar weighed on prices. The Chinese equity market suffered its worst monthly fall in 18 months. In the commodity sector, oil prices rose strongly on the month (from a low of c$65 to a high of nearly $75) as OPEC’s decision to only modestly increase production kept a tight balance between supply and demand.
What are we thinking
An experienced and successful manager we saw during the month encapsulated the environment when he commented that seldom can he remember a situation where investors can build equally convincing cases to be modestly bullish, or bearish, and for those to be based on recently released data.
On the bullish front, US economic data continues to be strong with little indication of inflationary pressures building. Corporate earnings are healthy and unemployment is at record low levels.
Bearishly, investors can justifiably fear the impact of the trade tariffs introduced during 2018, and potential for further escalation in their applications.
Adding to uncertainty is a significant divergence in monetary policy between the US Federal Reserve’s tightening cycle and other central banks globally which retain accommodative policies.
Following our Investment Committee in late June we remain modestly defensive, the only change we are making is within High Yield debt. We have previously written about our increasing concerns in this segment of the fixed income market. The asset class is witnessing an unattractive trend of higher valuations and worsening lender covenant protection. We fear that the current pricing, leverage and lack of covenants leaves scant margin of safety for investors and, should the market turn, the potential for negative returns and elevated volatility is significant. Where possible we will be looking to reduce significantly, and even eliminate, exposure to this asset class.
Insights from some of our managers
A theme we have seen emerge amongst Asian equity managers of late is a focus on ‘efficiency’ in Asia – one might expect this to refer to the efficiency of production capabilities (automation, robotics), however their focus has been on corporate balance sheet and management efficiency. Generational management changes are being implemented in a number of family-controlled conglomerates, and there is growing expectation for a shift to focus on capital returns and shareholder value creation rather than expansion of the business footprint. Value style managers, in particular, are enthused by the potential investment opportunities thrown up by both the concentration of resources on core business lines and the spin-off/sale of non-core divisions.
The dominance of the US technology sector on market returns has continued in 2018, with Amazon’s performance accounting for 36% of the S&P500’s return to the end of June, according to a Goldman Sachs research report. Add in Apple, Microsoft and Netflix and these 4 stocks explain 84% of the return this year, and the Top 10 names (technology dominated) represent 122% of the index’s total return for the year – i.e. holding the other 490 names has lost investors meaningful performance in aggregate.