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Monthly Fund Comment
With the oil price surging another $10 this month to over $140 barrel, equity markets were hit hard by aggressive selling and the MSCI world index finished down over 8%. June also proved to be a topsy-turvy sort of month for bonds. It started badly, as rising commodity prices finally took their toll on inflationary expectations. European bonds performed particularly badly in this phase, as the European Central Bank surprised everyone and announced their intention to hike interest rates in July, despite clear signs that the Eurozone economy is clearly slowing. The markets quickly moved to discount not just one hike, but several. However, bonds stabilised and recovered in the second half of the month as falling equity markets caused investors to rethink their pessimistic interest rate expectations.
The currency markets also remained focussed on inflation risks and the likely policy response by central bankers during June. The lack of clarity about central banks possible actions has added to investors uncertainty about the outlook for currencies. The most affected currency was the New Zealand dollar which experienced a dramatic sell–off following an explicit statement from the Reserve Bank of New Zealand (RBNZ) that it was likely to cut rates later this year. Despite further poor headlines from the financial sector, sterling held up exceptionally well and was the best performing G10 currency over the month.
With the oil price surging another $10 this month to over $140 barrel, equity markets were hit hard by aggressive selling and the MSCI world index finished down over 8%. June also proved to be a topsy-turvy sort of month for bonds. It started badly, as rising commodity prices finally took their toll on inflationary expectations. European bonds performed particularly badly in this phase, as the European Central Bank surprised everyone and announced their intention to hike interest rates in July, despite clear signs that the Eurozone economy is clearly slowing. The markets quickly moved to discount not just one hike, but several. However, bonds stabilised and recovered in the second half of the month as falling equity markets caused investors to rethink their pessimistic interest rate expectations.
The currency markets also remained focussed on inflation risks and the likely policy response by central bankers during June. The lack of clarity about central banks possible actions has added to investors uncertainty about the outlook for currencies. The most affected currency was the New Zealand dollar which experienced a dramatic sell–off following an explicit statement from the Reserve Bank of New Zealand (RBNZ) that it was likely to cut rates later this year. Despite further poor headlines from the financial sector, sterling held up exceptionally well and was the best performing G10 currency over the month.
With the oil price surging another $10 this month to over $140 barrel, equity markets were hit hard by aggressive selling and the MSCI world index finished down over 8%. June also proved to be a topsy-turvy sort of month for bonds. It started badly, as rising commodity prices finally took their toll on inflationary expectations. European bonds performed particularly badly in this phase, as the European Central Bank surprised everyone and announced their intention to hike interest rates in July, despite clear signs that the Eurozone economy is clearly slowing. The markets quickly moved to discount not just one hike, but several. However, bonds stabilised and recovered in the second half of the month as falling equity markets caused investors to rethink their pessimistic interest rate expectations.
The currency markets also remained focussed on inflation risks and the likely policy response by central bankers during June. The lack of clarity about central banks possible actions has added to investors uncertainty about the outlook for currencies. The most affected currency was the New Zealand dollar which experienced a dramatic sell–off following an explicit statement from the Reserve Bank of New Zealand (RBNZ) that it was likely to cut rates later this year. Despite further poor headlines from the financial sector, sterling held up exceptionally well and was the best performing G10 currency over the month.
The persistently high price of oil and attendant inflation concerns drove world equity markets sharply lower in June, and the MSCI world index was down 8.2% on the month in dollar terms. We are now within touching distance of the January lows.
It is very hard to see past the oil price at the moment. Oil has risen by over 40% this year and technically still looks to be in a healthy uptrend. This may be the result of excess speculation, or it may be the result of a fundamental shift in the supply-demand structure of oil prices; either way we are now approaching the psychologically significant $150 target, identified by the influential oil hedge fund manager, Boone Pickens, a couple of months back. The Fund is currently underweight energy stocks in anticipation of a correction around these levels, though we would see any meaningful pull back as an opportunity to get nearer to the benchmark.
Fears about inflation stem from the high oil price and from high food prices. The concern is that higher input costs will be passed through into higher prices for goods and services. If this translates into higher wage demands, then we will have the start of an inflation problem. This is possible but unlikely given rising unemployment rates in the US. Ultimately a global slowdown and deflation in the West may prove to be more of a risk.
We reduced our exposure to India last month, on concerns about inflation and prospects for weaker growth as the result of interest rate rises. Our discipline has now forced us to cut Asian exposure more generally, as the region has underperformed significantly. We have however increased our Japanese exposure as an offset to this.
June saw the biggest drawdown for the markets since 2002. It was the large cap based Dow Jones that took the brunt of the storm. From its October high, the Dow is now down over 20% and according to some market commentators, this is official bear market territory. The financials continued their downward spiral, with speculation that the banks will need to raise more finance and cut dividends. Lehman Brothers was one name mentioned that was possibly having liquidity problems, a rumour that was quickly denied by the company. The Federal Reserve kept overnight rates at 2%. The accompanying statement said that overall economic activity continues to expand, partially due to firming in household spending. However, the Fed expects economic growth will face the burdens of tight credit conditions, housing contraction and the rise in energy prices. Since the statement, the odds of a hike in lending rates have subsided.
Within the Fund itself there has been no real change of tack, other than some tweaking of names around the edges. We continue to be underweight financials and consumer cyclical stocks, two of the worst performing sectors over the month. We banked profit in some of our higher beta industrial names and put the money to work in existing positions. We also added to energy names as well as topping up some holdings. However, we remain cautions of demand destruction at these levels. We are continuing to run an extended cash position as we believe that the benefits outweigh the risks in current market conditions.
Asian equities continued their retreat amidst indiscriminate selling as the bears asserted full control over global markets. Sentiment within the region has fallen to extremely low levels, with any rallies being used to book profits and position portfolios defensively. The underlying themes driving markets at the moment are clear – inflation and oil. Whilst Japan was expected to be the one developed market to benefit from rising inflation expectations, an evaporation of risk appetite has resulted in the story failing to play out thus far. Of the estimated $7 trillion in Japanese household savings hiding under Mrs. Watanabe’s mattress, very little (if any) has found its way into domestic equities, with the preferred destination still foreign currency markets that are a relative safe-haven in these volatile times. Exporters are also suffering as American consumers start to feel the pinch from $140 oil. As for Asia, the two previously mentioned themes are dominating market performance, with rising input costs also expected to result in weaker than expected quarterly earnings results. Inflation continues to dominate the headlines, with all-time high figures announced in several countries, and monetary tightening measures being taken negatively despite the large falls already seen this year. Indeed, a number of markets (Indonesia, the Philippines, Vietnam and particularly India) are experiencing indiscriminate selling due to high inflation levels, deteriorating current account positions and central banks that are perceived to be behind the curve. Within the Fund, our decision not to be lured into an overly aggressive Japan weighting has been the right one in the short-term, although we will be looking to increase our exposure selectively as stocks come back to attractive entry levels. We have a healthy allocation to gold and mining-related services which are expected to perform well in this environment.
European equities collapsed in June, suffering the worst monthly performance since January this year, as a shadow was cast again over global equity markets. Renewed fears over banks asset quality and capital adequacy did resurface but credit crisis concerns gave way to increasing inflation risks. With the ongoing weakness in the US dollar and continued strong demand, crude oil traded above $140 per barrel. This together with soaring food prices contributed to Eurozone inflation reaching a 16 year high of 4%. Despite a backdrop of slowing growth, both the US Fed and ECB seem determined now to raise rates in order to counteract inflation, with expectations in the market that the ECB will increase interest rates as early as July.
The Fund achieved an outperformance relative to its benchmark of 2.05% on the month. Continuing to be underweight financial related areas paid dividends as banks, life insurance and real estate were amongst the weakest sectors. The Fund’s exposure to fertiliser and agricultural chemicals (best performing sub-sector) accounted for around 1.3% of alpha. Stocks such as K S, Yara and Syngenta all experienced healthy share price appreciation, driven by upgrades to earnings whilst still only trading at below or close to mid-cycle P/E multiples. Weather related and political disruptions to prospective supply has led to significant grain price inflation (corn 22% on the month) resulting in a healthy outlook for fertiliser demand. mining, industrial metals and oil equipment sectors stood out as the relative winners benefiting the Fund’s overweight stance. Pharmaceuticals enjoyed the best sector relative and this is an area where the managers are currently seeking new investment opportunities.
Faced with such nervous markets and poor investor sentiment, towards the end of the month the managers started to “de-risk” the portfolio. Top-slicing of larger positions were carried out particularly in sub-sectors which had enjoyed a strong run and are therefore, more susceptible to a set back in the current environment. Some portfolio insurance has also been taken out in the form of put options on the DJ Eurostoxx.
China and India mirrored their Asian counterparts, falling sharply on the month as oil and inflation continue to dictate market activity.
Despite being one of the few economies globally where the inflation situation looks set to improve in the second half of this year, the bears have full control of China’s market and equities continue to be sold-off aggressively. Food prices, which make up anywhere between 30-50% of core CPI depending on estimates, are stabilizing or falling as the supply response finally kicks in. We believe this combined with the base effect should result in headline inflation stabilizing at 4.5-5.5% by year-end. During the month the government announced a series of fuel increases to more closely align local and international prices and an estimated $3 billion in subsidies to help poor families cope with rising costs. Government finances are in excellent shape and as long as $140 oil is only a temporary situation, the cost can be absorbed.
India’s woes continued, with the market one of the worst performing globally on a year-to-date basis. The speculative money flows that had pushed the indexes in parabolic fashion to record levels at the start of the year are being firmly unwound as worries persist over the oil price and inflation. Indeed with the price of crude now at +$140, government subsidies are now running at an enormous 4% of GDP and threatening to open an enormous black hole on the government’s balance sheet. With further monetary tightening policies likely to be announced sooner rather than later and corporate earnings likely to negatively surprise given soaring input costs, further market downside cannot be ruled out. Within the Fund we remain overweight China (including a healthy exposure to Taiwan), with a bias towards soft and precious commodities, consumer staples and Chinese financials.
The views expressed in this web site represent the collective views of the Ashburton investment team and the Ashburton external advisers, which will change with altering market conditions and may not necessarily be reflected in the composition of managed portfolios. Past performance is not necessarily a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.
