January 2019 – The calm after the panic…

In January equity markets recouped most of December’s losses; at Altex we have gone a bit further with almost all our portfolios beating the end of November NAV: Sigma Fund Real Return (SFRR) reports a rise of +4.76% vs. a -4.42% loss in December, Sigma Fund Prudent Growth (SGPG) was up +4.11% vs. -4.99% in December, and Sigma Fund Quality Stocks (SFQS) increased +12.53% vs. -10.01% reported in December. On the other hand, the Eurostoxx 50 ends January at +5.26%, the S&P500 at 7.87%, and the Nasdaq 100 at 9.74%.

As already mentioned in our December commentary: the main causes for markets plummeting were the Fed’s policy and the US-China trade policy; and both policies are reversible. January’s rally is, in fact, the product of a relaxation in the tensions on these two fronts. While the remaining “tension factors” (Brexit, Mexico wall, partial close of the US administration, …) are still unresolved or are only making timid advances towards a solution, it turns out they are not so pressing as they seemed to be in December: although a final answer has not even been found to any of these issues it looks like markets are discounting a much different scenario to that of the end of 2018.

The behavior of stock markets in January (and previously in December) reminds us of two important facts:

1)   Listed assets’ valuations magnify market sentiments –upbeat and sluggish–, and

2)   In wholesale indiscriminate sale-offs it is crucial to always keep in mind the time horizon and strategy that will make us achieve our investment objectives.

When emotions overpower all other factors, valuations cannot be taken as a reliable indicator of the quality and long-term return potential of assets. Hence, when the price of a share falls in a bearish market it does not necessarily mean that the business itself is going to decline in the long-term. The best approach in these cases is to re-assess the quality of the companies and assets in your portfolio to ensure that they are sufficiently robust to survive a crisis of confidence.

Investment time horizon is equally important: maximizing short-term gains is often incompatible with maximizing long-term returns as both objectives require totally different strategies and analysis procedures. Most investors, such as us, have a time horizon that surpasses terms of office, economic cycles, and other temporary factors; it is therefore important to avoid –so long it is reasonably prudent– selling at a loss on the ephemeral whim that the asset is going to continue falling in the short-term. If, in spite of liking the asset, we do sell it, chances are that in the long run we will end up buying it again at a considerably higher price.

December’s plunge was the largest monthly fall since February 2009; January, on the other hand, has been the best performing month since October 2015, oddly enough, also in the aftermath of a China-related crisis. With such a high volatility, decision making has been very difficult. A factor explaining why volatility has increased so sharply is the changes in markets’ structure: agents are no longer the same, nor does their investment strategy resemble that of other periods. There is now a higher volume than ever of algorithmic trading and quantitative funds, as well as more passive investments (ETFs) following a momentum strategy. Bank prop desks have been whittled down to the bare minimum, thereby eliminating an agent that was capable of containing losses when an asset’s price was more attractive than what markets were willing to admit. Our strategy to curb volatility combines the use of different factors that allow us to increase our purchase power in a bearish market (liquidity, short positions on indices, US Government bonds, and safe haven currencies such as the Yen). We have also initiated a minor change in the Prospectus to allow us to include a small proportion of gold in the portfolios. This position will act as a safe haven in times of low of confidence in the system, although we do not foresee such a crisis in the short to medium term.

At a portfolio level, although we had increased the hedge of the SFRR in September, we suffered more than we had expected to up until December; however, our confidence in our portfolio assets remained unchallenged, allowing us to gradually decrease the hedges from 65% index short and 10% long Yen to 50% index short and no exposure to the Yen, after its price peaked on January 3.

Thanks to this discipline, we have been able to recover all of December’s losses. As of the date of writing this commentary, we have once again increased hedges to approximately 60% index short although we are still avoiding the Yen, as we feel there is still room for improvement. In order to keep the EURUSD risk neutral, after exiting the Yen position we opened a short one in USD for the same amount. After the hike in USD equity, the SFRR currently is 9.54% long in USD. In the case of the SFPG, hedges have been lowered from nearly 60% to around 54% as a consequence of higher equity price, while the exposure to the USD is at 5.74%.

As this last quarter’s volatility could very well be repeated further on, we will continue to actively manage hedges to diminish volatility using strategies compatible with our permanent objective of real term capital preservation.