June 2019 - Central banks’ prop up risky assets - Systematic Fund Manager's Comments

Trade concerns, political indecision and slowing growth all abated in June, as markets were increasingly focused on central banks’ rhetoric. The Fed reinforced investor expectations for an interest rate cut in 2019, while the ECB suggested additional eurozone stimulus could be necessary. China’s market rallied on news that Beijing and Washington officials would resume their negotiations, after talks faltered in May. There appears a palpable disconnect between the central bank-led rally with investors unwilling to price in their downside risks, and leading indicators which continue to soften; a bad omen for the business cycle and corporate profits. Further downside risks to the global economy could translate into an outright earnings recession, a scenario which is not reflected in most investor portfolios. With risks (liquidity and market) quietly seeping into portfolios, as outperformance becomes concentrated amongst a small portion of the market, we believe that a fundamentally driven, all-cap approach can offer a degree of downside protection for the coming months

PMI contracting

Several PMI indicators have crossed the 50 mark recently, with countries like China, Spain, UK joining the Germany, Japan, South Korea, that shifted earlier in the year in signs of economic contraction territory. Indicators in the US are not glowing either, with the tax cut plan having now little effect on growth expectations, and the central bank leeway to galvanize investors confidence reducing increasingly.

Source: Bloomberg, RAM Active Investments, as of 30.06.2019

Inverted Yield Curve

Historically, inverted yield curves have been a decent indicator of recession risk. Central banks have the possibility to be aggressive in their action to temper a potential slowdown in the economy, but when earnings momentum starts to falter and the investment cycle decelerate, it is hardly possible to fully offset recessionary pressure simply by cutting rates. Amongst market pundits, there are more voices arguing that given the low level of interest rates globally and the fact that central banks have extensively explored unconventional measures, any significant boost to the economy needs to come from fiscal policies.

US Treasury Yields – Spread

Source: Bloomberg, RAM Active Investments, as of 30.06.2019

These first signs of a potential cycle-end in the market mean investors should more than ever focus on:

• Quality: the ability of firms to run their operations on a self-standing basis and to refinance themselves even in the case of more adverse financing conditions should be at the forefront of stock selection in a late-cycle phase
• Liquidity: the situation in stress periods could be drastically different from what can be observed in normal market conditions and managing dynamically this downside liquidity risk is essential
• Diversification: while market uptrends are built through several quarters/years, downturns happen very fast and with an amplitude that is hardly predictable. Therefore, diversification is of outmost importance, especially at this point in the economic cycle.

We are convinced that our highly liquid, diversified and quality-biased long-only and long/short solutions across regions and market caps are well adapted to the current investment environment. Finally, RAM’s proprietary market impact models reduce liquidity risk and costs, scaling down positions with limited liquidity while maximizing expected alpha.