July 2018 Market Commentary & Fund Spotlight
In July, the Canadian equity markets saw style rotation from large and small cap growth stocks to large cap value stocks, however year-to-date, value stocks continue to lag the returns posted by growth stocks. Canadian bond universes returned to negative territory as a result of the Bank of Canada rate hike and speculation of another hike before year end. The notable bond universe exceptions which were able to carve out gains in July were the Barclays Emerging Market Bond Index and the BofA ML High Yield Index.
South of the border, equities continued to post strong gains due in part to strong corporate earnings and economic growth, despite a late month sell-off in technology stocks, led by Facebook and Netflix. Concerns over tariffs and trade wars have not had as much of a negative impact on US equities as one might have expected. However, the yield curve continues to flatten, which typically foreshadows slower growth to come. After two Federal Reserve rate hikes in March and June 2018, the spread between 2 and 10-year Treasury yields has narrowed to less than 30 basis points.
Globally, there has been weakness in developing country equities, currencies and commodity prices. Many analysts consider copper prices to be a good leading indicator of global growth and the economic cycle, because it is used widely in construction, infrastructure and equipment manufacturing. Since its June peak, copper prices have fallen nearly 14%, to levels not seen since May 2017. Though the relationship between copper and future growth is not foolproof and should be considered in combination with other indicators, this could be an early warning sign for slowing global economic activity.
July 2018 Fund Spotlight
Our featured manager in July is a manager with a long-and-short-value with catalyst style. Traditionally, this manager has exhibited very consistent monthly returns, however they are down -3.78% YTD. To better understand this manager’s uncharacteristically weak performance, we must look as various factors that have been influencing returns.
On July 16, Bank of America published an analysis of the performance of the S&P 500 in the first two quarters of 2018 and found that if you were to exclude FAANG stocks, the S&P 500’s return would have been negative as shown below.
Therefore, managers who have either underweighted or excluded the largest of the tech stocks have experienced anemic returns thus far in 2018. The energy sector was another bright spot in Q2 after a rotation from a weak first quarter. Sector rotation is one of the hallmarks of the later stages of a bull market.
Another factor influencing this manager’s performance is that the value style has been out of favour. The value style is typically characterized by investing in companies with low price-to-earnings ratios, low price-to-sales ratios and a higher dividend yield. The S&P 500’s price-to-sales ratio is currently at the highest level it’s been since 2001. This suggests that the growth and momentum styles are currently investor favorites. A similar theme is playing out with price-to-earnings ratios, which are in the higher range and reflective of the later stages in a cycle.
This month’s featured manager has experienced significant headwinds this year due to their style being out of favour. However, if they stay the course and remain patient, the reward when style rotation finally arrives is well worth the wait. We continue to believe that quality active management will deliver the most attractive risk adjusted returns for the average investor, and this fund manager’s long track record of success is proof of that.