Sharp market falls continued in June, although with a relatively contained impact for our Funds.
- Inflation continues building up and the FED’s quantitative tightening plans remain unchanged
- Rotation from Value to Growth since mid-June
- Asia improves vs Latin America
- Commodities and raw materials correct from maximums
- Overexposure to defensive assets continues
- Floor formation phase begins, risk of rupture remains, but we will closely monitor markets for trend changes
- Quarterly falls of 15% in the S&P 500; history shows there have been gains of over 25% in the following 12 months
SFRR ends June at -3.53% (-25.34% YTD), SFPG at -3.13% (-30.95% YTD), and SFQS at -6.60% (-25.57% YTD) while the MSCI World posts returns of -6.60% in EUR, (-14.43% YTD in EUR).
S&P 500 and Nasdaq 100 were down -8.39% and -9.01%, respectively. The bear trend continued after the rally of late May, triggered by inflation data that shows no sign of improving. However, unlike in previous corrections, falls were headed by commodities and cyclicals. A soaring inflation has forced the FED to raise rates 75bps in June, and an additional raise of 75bps is expected in July (which could eventually be 100bps after the inflation rate accelerated to 9.1%).
We are now entering a different phase of the crisis: the rotation from Growth to Value seems exhausted and began to reverse in June. The assets that had suffered most since early 2022, were the best performing ones this month: from the 8th-10th of June indices such as Nasdaq, Russell 1000 Growth and the Asian portion of the Emerging Markets slightly outperformed vs. the S&P500, while energy, raw materials, the Russell 1000 Value Index and the Latin American portion of Emerging Markets underperformed. Although the rotation is still incipient it may be a sign of a phase change.
Because of rate increases, increasing mortgage costs, and contained business spending, it is likely that real economy and macro indicators will weaken. Nevertheless, both savings and the demand for services remain high: the product consumption during the pandemic has shifted to service consumption, which is much more labour intensive. This creates inflation, but it also increases families’ capacity to assimilate higher prices, softening the impact of a crisis.
Markets always anticipate economic estimations months in advance. As long as demand doesn’t take a nose-dive –and it is showing no symptoms– it is reasonable to believe that we are entering a floor formation stage, with some months of significant rises and falls –contained within a lateral range– allowing for the accumulation/purchase of oversold Growth assets and the distribution/sale of overbought cyclicals.
Bank consensus, mostly US, is that there may be further falls –ranging from 8% to 10%– in the S&P500 until it reaches the 3400-3500 level, when purchases are likely to start, unless markets anticipate the floor and recover before then.
Against this background, we continue to hold high levels of cash in our funds and managed portfolios. We have re-entered Growth holdings we had exited and watch markets closely for signals pointing to a trend change in inflation. The FED’s policy will inevitably lower inflation, the question is how far it will slow down economy as well, and how much is already discounted by markets.
We are in an extreme positioning situation; at the time this commentary is written, the Euro has dropped to parity with the USD, dragged by the wide divergence between EUR and USD interest rates. The more extreme segments of the Growth universe have started to recover after reaching the Covid minimums, and more volatile cyclical assets are falling after reaching 10-year maximums (on June 13, Bloomberg Commodity was on the verge of beating its previous maximum of 2014). In this scenario of extreme valuations –both bull and bear– we must consider two facts: first, extremes can always be stretched a bit more and we should be cautious when taking positions; and second, oversold, overbought and extreme fear are not sustainable in time and there should be a mean reversion and normalized prices in the near future.
In July, our thermometer reached buy-on readings for the first time since January. Although this does not point to the end of the bear market, it is additional evidence of the divergence between the direction of the market and the appetite for protection in the derivatives markets. Such divergences are the first indicators of a market trend change. Investors with a higher risk profile should start to build up their Growth portfolios, while keeping an adequate level of cash. Investors with a lower risk appetite might wait until the floor formation phase is more consolidated since there may be further corrections in the pipeline. US bonds are staring to offer value in both the defensive (10Y) and the high yield versions, so long as the moderate to low recession scenario does not worsen dramatically.
At the current levels, over the next 12 months, potential gains compensate the volatility that we will need to undertake over the summer. Since 1945, whenever the S&P500 has posted quarterly falls above 15%, there have been substantial gains after 6 months and the 12-month average has been of 26.07%.