This month of July has been very calm after June was disrupted by the trade war. Investors have taken more risks, after being relieved that no trade sanctions were set between the USA, Europe and other NAFTA countries. On the Chinese side, the government has softened its monetary and fiscal policies. Finally, the price of industrial raw materials continued to trend lower.
During July, the S&P 500 increased by 3.60% and the Philadelphia Semiconductor index increased by 4.09%, erasing its June losses. The NASDAQ index, hit a record high and ended the month up 2.15% despite a poor performance from Facebook and Netflix, which fell by 11.18% and 13.77% respectively. Globally, the tech sector outperformed this month and extended its excellent June performance by remaining the best-performing sector in the S&P 500.
On the currencies side, the USD continued to appreciate slightly, particularly compared to other G7 currencies.
In developed countries such as the US, the UK and Western Europe, equity prices rose along with government bond yields. Also, in Japan, the 10 year yield was up 3bps (from 2.2bps to 5.2bps).
In the US, the spread between the 2-year and 10-year yield curve hit a 10-year low of 24 bps on July 17 and ended the month at 29 bps. Globally, the US yield curve continue stabilising.
The HFRX Global Hedge Fund EUR was down 0.41% on the month of July.
July was a good month for the strategy, helped by positive momentum among equity indices. European managers posted low but positive numbers, while US managers benefited from positive trends in semiconductors and internet stocks. Healthcare was also positive thanks to diminishing fears over drug pricing in the US. Short selling remained a difficult exercise during the month. We believe that a steeper interest rate environment should be positive for short alpha generation.
According to a recent Morgan Stanley prime brokerage survey, volatility, central bank intervention and higher rates are generally viewed as positive for global macro managers. On the other hand, geopolitics are viewed as the biggest negative. Managers were in general able to make money thanks to bearish positions in Turkey and China.
Trend-following strategies posted negative returns, especially those with a large allocation to commodities. Dispersion among monthly returns within this strategy was quite high. The Societe Generale CTA index was down 1% and some funds are down more than 15% YTD. In the meantime, quantitative equity strategies were roughly flat on the month, with some funds suffering from a correction of the momentum style factor.
We kept our fixed income arbitrage allocation at the same level. Managers’ returns were flat to positive, depending on their regional focus. Overall, the very low interest-rate volatility and steady investor positioning in G3 bond markets is less supportive for the strategy.
Nevertheless, thanks to its positive convexity bias, we maintained our allocation in the sector.
Since the beginning of the year, all of the managers in this space have delivered strong risk-adjusted returns, while being positively exposed to volatility.
While the ongoing tariff dispute between the US and China has maintained pressure on all asset classes in Asia, South America benefited from robust performances both on the fixed-income & equity markets.
If the outcome of the trade war has an overall negative impact, Donald Trump’s policy will have led to a sharp mark-down in prices that will become an opportunity at some point.
Managers’ returns clearly depended on their regional positioning.
Merger arbitrage had a challenging month in July. The impact of the trade war between the US and China had a profound effect on the strategy’s performance due to the collapse of the NXP Semiconductors acquisition by Qualcomm. The HF industry was very heavily-positioned in this trade and the deal break announced on July 25th caused spreads to widen in other situations.
However, looking to the second half of the year, the outlook for merger arbitrage remains favourable. Pending transactions generally have strong strategic rationales and highly committed buyers.
We believe that we are in the late stages of the credit cycle with default rates and spreads nearing historical lows. Nevertheless, we are closely monitoring distressed managers, due to the potential of high expected returns, but broadly remain on the sidelines.
We see a growing number of US hedge funds specializing in distressed assets starting to raise money in anticipation of the next economic downturn.
The tight spread level, coupled with the low volatility environment despite strong outflows in the asset class, support our negative view on the strategy.