November 2018 – Disconnection between feelings and fundamentals

In November, markets were in a tense calm in anticipation of the two key meetings due to take place this month, namely the Fed meeting and the G-20 summit. Indices posted mixed month end returns: the Eurostoxx 50 fell -0.76%, while the S&P 500 and the Nasdaq were up +1.79% and +0.34%, respectively. Sigma Fund Real Return returned -0,1%, Sigma Fund Prudent Growth posts -0,51%, and Sigma Fund Quality Stocks was up +1,62%.

This dispersion of results is mainly the consequence of October’s sector rotation. While part of the riddle was still unsolved, investors continued to be cautious and the rally in more defensive industries kept up. Although over the last week of November some pieces of the puzzle fell into place, the most hurt sectors still exhibit a very volatile behavior –upwards and downwards – upon the publication of any news. An example of this overreaction is the rally prompted by the Trump-Xi Jinping trade truce, that was closely followed by the correction triggered when Huawei’s CFO was arrested.

The valuation of the main stock indices isn’t high, but adjusted by gains and growth outlook. We believe markets are discounting an excessively negative scenario, influenced by the ubiquitous Trump and his trade policies, present not only in all fund managers’ commentaries but also in many corporate earnings revision and 2019 estimates announcements. The valuation of defensive sectors is sky-high, while the growth and value industries trade at considerable discounts. While this pessimistic outlook decreases the risk of a wholesale overpricing in markets, it also increases the risk of a rebound for short positions.

In times of sharp volatility, the best policy is to step back and gain some perspective in order to assess the current situation as compared to previous crises. In the current scenario, the fiscal and monetary policies lagging markets are still reversible, and the actors setting off such policies will be the main beneficiaries once the situation goes back to normal. Thus, the FED will temper its tone on rate hikes so it cannot be held responsible for an un-wished recession in the US, while Trump needs to make deals that have a positive impact on stock exchanges to avoid squandering his re-election possibilities in two years’ time having destroyed a large part of American families’ savings, who place much more trust on US corporate growth than Europe does. Finally, Xi Jinping is the last one to want to wage a full-fledged trade war: as head of a planned economy, he needs to uphold stable growth to be able stay in the world’s limelight while maintaining social order in a country immerse in its transformation from an agricultural and industrial economy into a market economy.

In 2016, concerns for Chinese growth triggered a similar correction to the present one, and the current situation is not only not worse, but even slightly better if we take into consideration corporate profits. Another factor that makes us feel optimistic for the future is that the actual heightened political imprudence is offset by the prudence of corporate decisions, which are more cautious both in their forecasts and in their investment decisions. Some analysts see this as a threat not only to investments but also to growth; however, from a longer-term perspective the possibility of finding positive surprises the future bringing increases. In Europe, despite the Brexit commotion and the Italian pulse, the situation nowadays is notably better than that of the 2011-12 European peripheral countries crisis; indeed the Euro Stoxx 50 only trades 13% above its year-end 2012 levels. Certainly, the Brexit can cause further turbulences and it is difficult to gauge its impact on economy on the short-term, but we’ll come through this rough patch, and prices will find a solid support sooner rather than later. Looking back to 2008-2009 – or even as far as 2001-2003– we see no symptoms that we are facing such a deep crisis as those were.

The most uncomfortable aspect of the current market scenario is that both indices and market sentiment are bearish, creating uncertainty as to when is the best moment to increase exposures or decrease hedges. In our case, we are keeping a 50% hedge; our portfolios include assets with an excellent outlook and a discount that provides a considerable safety margin. We have exited our long position in 10Y US bonds as we think it is unlikely that the current situation will end in an inverted yield curve: neither will the FED uncontrollably increase the short end, nor is the inflation outlook low enough to warrant a rise to these bonds. We are maintaining our short position in bunds for the same reasons. As a hedge, we hold a short position in USDJPY as the USD is still showing signs of being overbought, while the JPYs defensive stance remains unchallenged in case of a deepening of the crisis.