September 2022 – Sideways drift persists amid high volatility since June

SFRR closes September at -7.15% (-31.04% YTD), SFPG -9.62% (-35.79% YTD) and SFQS at -9.56% (-28.93% YTD), while the MSCI World posts month end returns of -9.26% in USD, the S&P 500 closes at -9.34% and Nasdaq 100 at -10.6%.

September Highlights:

  • Strong ups and downs in sideways markets from June to September
  • Oversold markets
  • US stronger than Europe and China
  • Inflation contention and bond market stabilization in the coming months
  • The nuclear war threat points to a cold war that, as it could last for years, won’t shape investment strategies in the long run. No matter what, concentrate in the US and reduce Europe.
  • In anticipation of improved financial markets in 2023, we are in an accumulation (buy) phase

The 15 June-15 August rally gradually faded away, vanishing completely on the 30th of September. Although markets rallied 20% at the beginning of the quarter, they fell back to lows at period end. This extremely volatile environment is driven more by macro data than by fundamentals. August inflation, published in September, was higher than expected and triggered fears of further monetary tightening by the US Federal Reserve.

It is the first time since 1975 that both bond and equity markets have accumulated 3 consecutive negative quarters in the US, starting to signal more to “buy” opportunities than to “sell” opportunities. Indices are extremely oversold at quarter end, considerably increasing the probability of a rebound.

Right now, the correlation between US bonds, stock markets and EURUSD is very high: any change in the US 2-year bond price immediately triggers a proportional move in stock markets and EURUSD rates.

Markets are torn between inflation and recession, or a combination of both, with the added uncertainty of a possible nuclear threat. As managers or investors, the decision we must make is whether to take advantage of the falls to buy, or to make the most of the rises and sell.

On the one hand, we know that falls of 25% to 35% in the stock market are usually good buy opportunities, and that the duration of crises in bear markets is significantly shorter than in bull markets. Approximately 80% of the time markets are bullish and 20% bearish. After 11 months of crisis (20 for the sectors that benefited most from the post-Covid monetary expansion) we feel that we must be closer to the end of the crisis than the beginning. The question is not whether we should be accumulating positions in quality companies –the answer to this is clearly yes– the real question is whether we should risk waiting a little longer to try to fetch lower prices. Over 2022, bullish rallies have been as fast or faster than bearish ones.

The bearish arguments are that rates will rise above the estimated 4.5-4.75% by year-end 2023, that inflation will not be contained as quickly as expected, and that corporate earnings will be hit hard by the economic slowdown and rising costs while the FED will fail to take steps to check the fall. Part of this scenario is discounted in current prices, which could fall further if US bonds worsen or if a geopolitical –war or credit– event occurs aggravating the current selling panic.

The bullish arguments are that inflation will tend to ease, that the FED will not need to raise rates further than it is already expected -since companies continue to make money–, that bond and equity prices are already reasonable, that household and corporate savings will support price increases, and that the huge amounts of cash accumulated in funds and portfolios needs to be invested to avoid its depreciation, dragged by inflation and taxes.

Both views are reasonable and that is why we are in a sideways market, with each new piece of information bringing us closer to one or other scenario, triggering sharp rises and falls.

Our positioning leans towards a scenario of contained inflation, considering that energy and commodity prices -some of which have fallen up to 40%- have dropped from highs. This takes time to feed through to the inflation data, but it will eventually arrive. In addition, it seems inflation could have indeed peaked in July. After Powell’s last speech, US job openings have fallen sharply, surpassing the 2001 dotcom and 2008 financial crises declines, and are quickly reaching Covid lows. This will also impact wage inflation moderation in the coming months, which has so far been running rampant. House prices are already starting to suffer from rising mortgage costs (above 7% in the US). All this anticipates lower inflation in the future, requiring a less hawkish discourse from the Fed than at present. Although the Fed will continue to be on guard, markets will stabilize if the pace of rate hikes slows down.

Is falling inflation really a run-up to a deep recession? Our forecast is that there will be a moderate recession in the US and a stronger one in Europe, and that not all sectors will be affected equally. With healthy corporate and household balance sheets, several lines of secular industrial growth, and financial assets already trading at attractive prices in the bond and stock markets, there are enough real pillars of growth for the global economy to withstand an eventual worsening of financial conditions. In particular, areas such as digital transformation, energy transition, public investment in defense, and access to natural resources continue to pick up, while the consumption of services and the renewal of tourism –easing of Covid restrictions in China and reopening of its airspace – have also increased. The biggest risks are in the US real estate sector –lagged by the rising cost of mortgages– and in low-growth, low value-added sectors.

With this scenario in mind, we continue to accumulate in quality companies with sustainable growth, low debt, and solid balance sheets, mainly in the US market. In the medium term the revaluation of these companies will be remarkable, although it is difficult to foresee when the rise will begin. With such an oversold market and so many risks putting pressure on prices, the initial rise could be strong and the opportunity cost of being out of the market may be too high.

To increase protection in the event of a return to a bearish vs. sideways scenario, we have incorporated a more accurate trend following system than the one we had been using, as it combines trend following and mean reversion to capture profit on dips without compromising future recovery. We have gradually incorporated this strategy in the Sigma Real Return and Sigma Prudent Growth over September, and it has been fully implemented since October. Had it been in place since the beginning of the month it would posted returns of 5.4% on the S&P 500 and 3.2% on the Nasdaq, which would have substantially improved our Fund’s monthly results.

This new hedging system would have accumulated a profit of between 30% and 40% on Nasdaq and SP500, respectively, since 2014 in a clearly bullish period thanks to the gains accumulated in the downturns of 2015-16, 2018, 2020 and 2022 and losing little in the upturns. We feel this is a very important development that will allow us to take advantage of future recoveries to a much greater extent than our previous hedging strategy did.