Table of Contents
Investment Manager’s Monthly Report
On a net basis, the SAR Plus Strategy was up 0.43% in May 2022, to leave it up 10.33% year to date.1
An important theme during the month related to fears of a slowing in the US economy. There was a shift in the tone of macro- economic data, with May witnessing predominantly weaker-than-expected outcomes (both from labour and product markets). Consumer price data recorded declines in the year-on-year headline and core inflation rates, providing some hope that the peak may be behind us. There appeared to be increased chatter in corporate circles about a possible recession.
Initially, markets reacted to the news by continuing the trends evident during the first four months of the year – with stocks selling off and the dollar appreciating. However, the last week of May saw a sharp reversal in equities – with the S&P 500, for example, having fallen by 5½% in the first three weeks of May, rallying strongly to leave it about flat for May as a whole. Many other developed markets saw similar trajectories. In addition to month-end buying associated with rebalancing flows, equities were helped by signs that, in the face of weaker-than-expected economic activity, the Chinese authorities took a number of policy measures, including a cut in the key mortgage rate, to help promote demand and help ameliorate the impact of their “Zero-Covid” policy. Equity demand was also supported by talk that the Fed might pause later this year. All in all, the MSCI World index registered a gain of 0.1% for the month. With regard to US sectors, as is typical at the late stage of the business cycle, Healthcare, Utilities and Energy outperformed the market.
Weaker growth indicators, small declines in annual inflation rates and the talk of a Fed pause also led to shorter duration US fixed income markets rallying, with the Eurodollar contract for June 2023 implying an interest rate 36bp lower than at the end of April. With 2-year yields down 16 basis points, and 10-year ones down just 9bp, this part of the curve witnessed bull steepening. In contrast, further out the yield curve saw a bear steepening, with 20- and 30-year yields both up 5bp. In contrast to the US, policymakers at the ECB were deemed to be “hawkish” during the month. Consequently, yields moved higher across the curve. Italian 10-year yields, for example, rose by 35bp over the month, with their German counterparts up by about half that amount, and their 2-year equivalents up by 24bp. So, the German curve flattened, and the 2-year differential with the US narrowed significantly.
In currencies, the main theme was also one of reversals. The euro, for example, depreciated about 1½% against the US dollar over the first half of the month, but then appreciated by nearly 3½% during the second half, to leave it up just shy of 2% for May as a whole – helped by the large change in the interest rate differential discussed above. For May as a whole, the dollar depreciated by just over 1%. A number of commodity currencies did well, especially the Brazilian real, which appreciated 5% against the US dollar.
Commodities saw a much more mixed picture than in recent months, with double-digit percentage gains in the energy complex, but significant declines in metals and in the agricultural sector.
The energy sector saw gains across most components, reflecting the continued war in the Ukraine and further EU sanctions, low inventories, low refining capacity and signs that Chinese demand would start picking up again,
Industrial metals prices dropped back as it became clear that economic activity was disappointing expectations. Palladium and nickel saw the biggest drops, of more than 10%, with aluminium not far behind. Platinum and copper held up best. Given the greater dependence on industrial demand, silver fell by more than gold during the month.
In agriculture, prices were driven by growing speculation that international efforts to find ways to access some of the stockpiles in Ukraine might bear fruit. This was associated with some grain prices ending the month significantly lower than their intra-month high, and palm oil prices falling heavily. Idiosyncratic factors have also played a role. For example, gains in wheat prices coinciding with falls in corn prices were in part due to signs of a US drought easing too late for the former’s winter crop to benefit, but in time for the latter’s.2 Cotton price falls were likewise driven by supply considerations: US plantings, for example, are currently equal or ahead of their 5-year averages in all 12 states where the crop is grown.
Performance attribution: May
Table 1 summarises SAR Plus performance by asset class and by investment style for the month of May.
Notes: Attribution figures are gross internal trading returns calculations excluding fees, expenses and cash interest. Holdings-based analysis is used to illustrate significant performance drivers and is not intended to be a formal accounting of returns. Holdings are subject to change. Totals may not add up due to rounding. The table covers the period 1 May 2022 to 31 May 2022
Past performance is not a guarantee or reliable indicator of future results.
May witnessed losses for our strategies in three of the asset classes that we trade – currencies, fixed income and commodities – and notable gains in one of them: equities. With regard to investment style, our directional strategies (i.e. value, macro, sentiment, inter-market linkage and carry models) made a positive contribution whilst our relative value strategies detracted from performance.
In terms of equity markets, as markets fell and then rallied towards month end, our directional models needed to be agile. The directional models were able to capitalise on the initial decline in stock markets and succeeded in locking in some of those gains on the short side. Our trading of the US, Australian and Canadian markets was most profitable for us. Overall, our net equity exposure ultimately fell from -45% on 3rd May to -7% by month-end (taking a small net long position in- between). In our US equity sector model, we were also able to take advantage of our positioning in late-cycle sectors with the surge in the price of energy stocks benefiting us most: our long position here made it into the “top 10” trades for the month.
Within the commodity complex, we made money in energy, but these gains were more than offset by losses in metals and agriculture. With regard to natural gas, we made money through our long positions in the US which were partially offset by losses on our longs in Europe. Our losses in agriculture were mainly associated with corn, palm oil and cotton. We lost a little in metals (industrial and precious alike).
In foreign exchange, the largest detractor was our equity risk mitigation model, which was positioned predominantly for “risk off” trades, and thus in stark contrast to April, when this strategy helped us. The sharp reversal of the euro during the second half of the month proved to be the most painful FX move for us in May. But we also made significant losses trading the British pound and the yen. On the other hand, some of our long commodity-currency trades benefitted us – with the Canadian dollar, Brazilian real and Mexican peso the best performers.
Turning to fixed income, the losses were split between our directional and relative value ones. Within the latter, the country- based models were mixed, while the yield curve slope model struggled after a strong start to the year. Within our directional trading, our short positions in the 10-year area in the UK and in Canada represented two of our “top ten” winners in the overall portfolio in May.
Changes in positioning & Outlook
With equity markets having rallied somewhat towards the end of May, our strategies have changed their underlying assessment of prospects: our net exposure to equities went from short to long and then finally ended the month close to flat. In fixed income, our models are running a small short. We remain long the US dollar. In the commodity sphere we continue to have only a small long, focused in energy and crops.
We continue to recognise that there remains huge uncertainty, not only as regards how the Ukraine war will play out, but in terms of how the US economy will respond to the policy tightening that is being deployed. Equities are unlikely to bottom until investors become more confident that the Fed can execute a “soft landing” – i.e. until it is felt that the Fed can pause tightening while having avoided a recession. We continue to suspect that the “soft landing” probability is lower than the consensus forecast suggests, in which case a recession materialises – either because additional tightening than is priced in has to be delivered, or because the economy weakens by more than is currently expected in response to the tightening already priced in. Obviously, the timing of a possible recession will have different implications for the time path of asset prices. Moreover, bear market rallies are a fact of life and need to be navigated too.
Accordingly, our models will need to be highly responsive to forthcoming news.
1 Past performance is not a guarantee or reliable indicator of future results. The returns presented are net of fees, based on the highest fee available – which are not applicable to all investors. Please see pages 4 to 7 for additional performance details.
2 See, for example, “Easing Drought Too Late for US Wheat While Corn, Soy May Gain”, by Tai, A., US 2022 Crop Prospects report, Bloomberg, 1st June 2022.