December 2018 – Bugle calls and retreat

December was the month of bugle calls and retreats. Pessimism overpowered rational data analyses and indices posted month-end falls unseen since the 2008-2009 crisis. The S&P 500 was down -9.18%, while the Nasdaq 100 and the Eurostoxx fell -8.91% and -5.41% each (the fall in Europe was lower this month after accumulating higher losses over the year: -14.44% in 2018). In this wholesale plunge our shares’ performance was in line with the indices’. In spite of our over exposure to the US markets, losses in Sigma Real Return and Sigma Prudent Growth were curbed to -4.42% and -4.99%, respectively, thanks to the excellent behaviour of the portfolio hedges (short in S&P 500 and Eurostoxx 50 futures, long in JPY vs. USD). Sigma Quality Stocks ended December down -10.01%, underperforming indices slightly as technology shares were severely punished, infected by the trade-war and poor data published by Apple (which, by the way, is not part of our portfolio).

The fall in December’s performance was unreasonably sharp, with large funds closing positions and a good part of the investor community giving up (a bad move in our opinion). Previous crises (2015-2016, 2011-2012, 2008-2009…) suggest that after such episodes of investor surrendering and price irrationality, markets usually reach a support level, and the time needed for this support level to be consolidated varies considerably: many days –in some cases months– may pass since the support level is reached until the trend change is confirmed.

The coup de grace that made investors capitulate was the Trump-Powell quarrel over what the FED should or should not do. Trump’s pressure on the FED to hold off rate hikes and to freeze its progressive balance sheet reduction plan placed Powell in a difficult position; he had to chose between bad and worse: he either stayed independent and sent a message of confidence in the US economy, or he cancelled the announced rate rises projecting an image of uncertainty, which would fuel fears of a recession. Powell chose the best of the worst, after which markets nosedived, bottoming on December 24.

The fact is that markets were misinterpreting the news which weren’t as bad as they made them out to be, and our November commentary’s previsions were coming true: The US and China stances were softening and the FED stressed it would be more flexible when considering eventual rate hikes. On the other hand, even if the Brexit discussions weren’t going exactly well, fears for a hard Brexit seemed to be dispelling (an extension of the deadline was considered), and tensions between Italy and the EU were relaxing.

However, while market realities were actually getting better stock prices kept plunging deeper and deeper, and this turmoil ended in the chaos lived in the days in which markets were most illiquid.

On our part, we braved the overwhelming bearish market sentiment and decided to neither sell nor increase hedges. In times of turbulence market prices can be far from their reasonable levels, and the risk of a rebound is enhanced (in fact, such a rebound has already begun in January).

Since the December 24 low, we’ve been on the lookout for a rebound and especially vigilant of possible double bottoms (quite common in correction phases). On January 3 we closed our long position in JPY with considerable profits and increased our short position in the USD vs. EUR to neutralize the currency exposure of Sigma Real Return. This has allowed us to surf the rebound without the burden of a weakened USD.  We continue to maintain our short position in German bunds as we feel its current returns are unnaturally low.

The last quarter of 2018 has left a bitter aftertaste, but 2019 looks more promising thanks to our management during the crisis. In September we had increased the hedges to 65% of the portfolio; we then gradually decreased them until the current level of 50%; we have also sold the long positions in US Treasuries and Japanese Yens we had at the beginning of the crisis. And most important of all, we have not been tempted to sell any of our portfolio holdings given their high quality, strong balance sheets and healthy growth perspectives. These holdings will ultimately account for the returns our investors obtain in the long term.

In 2019 we will go on tactically managing hedges in order to reduce the portfolio’s volatility and continue realizing gains on assets as they reach maximum valuations.