Fund Manager
Frank Mersch
After putting in two solid months of gains in April and May, global equity markets came apart in June as crude oil and a host of other commodities surged to new highs while financial institutions were once again under attack. The S&P 500 had its worst month since September 2002, declining 8.60%, while the NASDAQ fell an even greater 9.10%. The resource-insulated TSX managed to lose only 1.68% on the month, with double-digit gains in gold and fertilizers stocks offsetting sharp losses in virtually all other sectors. Of particular note, oil and natural gas rallied 9.9% and 14.1% respectively, while the energy sub-index only managed a gain of 1.65%. This suggests to us that investors have become uncomfortable with the potential impact of high commodity prices on the overall economy, and that even energy stocks will have a difficult time benefitting in this environment (for more on these topics see our weekly blog, Viewpoint).
In modest contrast to equity markets, the economic data over the past month has been cautiously optimistic. Final U.S. GDP growth for the first quarter came in at 1.0%, while retail sales grew 1.0% over the past month (the past three months are running at a healthy 8% annualized rate), and the job market lost (only) 62,000 jobs. Conversely, consumer confidence remained at recessionary levels, consumer price inflation stayed above 4% and the service sector (as measured by the ISM Non-manufacturing Survey) continued its three-year deceleration and now sits in contraction territory. On the other side of the Atlantic, the European economy grew 2.1% in the first quarter, although with retail sales growing an anemic 0.2% and industrial production growth fading rapidly, the economy will remain under pressure. Both the ECB and the U.S. Federal Reserve kept interest rates steady in the month despite inflation above their comfort zones. Both central banks need to find a way to manage inflation expectations down while at the same time keeping monetary policy loose in order to cushion their respective decelerating economies. Unfortunately for the central banks, food and energy inflation are two of the most visible components of overall inflation, and given their current high levels, they are serving to anchor inflation expectations even higher than would otherwise be warranted. In the medium term we would expect consumer spending to be depressed in the U.S. and Europe, and for global economic growth to be impacted accordingly. Ultimately we would expect that it will take a marked decline in energy and food prices, either via increased supply or reduced demand, to engineer an environment of robust growth.
As we have observed in recent months, positive returns are being found in an increasingly slim number of market sectors. Over the past few weeks, even energy stocks appear to have lost their upward momentum as investors appear to be discounting lower commodity prices in the near-future. While we have reduced our energy exposure over the last few weeks, it still plays a central role in the portfolio, as do agricultural stocks and select base metals. Lastly, we expect the setting for financials to continue to deteriorate (and we’ve been shorting banks accordingly), and continue to hold cash levels far above historical norms. For the month, the fund was up 5.08%, owing to the sector overweights/underweights described above.
Front Street Canadian Hedge - Monthly Commentary
Date Published
Related Fund(s)
Fund Manager
After putting in two solid months of gains in April and May, global equity markets came apart in June as crude oil and a host of other commodities surged to new highs while financial institutions were once again under attack. The S&P 500 had its worst month since September 2002, declining 8.60%, while the NASDAQ fell an even greater 9.10%. The resource-insulated TSX managed to lose only 1.68% on the month, with double-digit gains in gold and fertilizers stocks offsetting sharp losses in virtually all other sectors. Of particular note, oil and natural gas rallied 9.9% and 14.1% respectively, while the energy sub-index only managed a gain of 1.65%. This suggests to us that investors have become uncomfortable with the potential impact of high commodity prices on the overall economy, and that even energy stocks will have a difficult time benefitting in this environment (for more on these topics see our weekly blog, Viewpoint).
In modest contrast to equity markets, the economic data over the past month has been cautiously optimistic. Final U.S. GDP growth for the first quarter came in at 1.0%, while retail sales grew 1.0% over the past month (the past three months are running at a healthy 8% annualized rate), and the job market lost (only) 62,000 jobs. Conversely, consumer confidence remained at recessionary levels, consumer price inflation stayed above 4% and the service sector (as measured by the ISM Non-manufacturing Survey) continued its three-year deceleration and now sits in contraction territory. On the other side of the Atlantic, the European economy grew 2.1% in the first quarter, although with retail sales growing an anemic 0.2% and industrial production growth fading rapidly, the economy will remain under pressure. Both the ECB and the U.S. Federal Reserve kept interest rates steady in the month despite inflation above their comfort zones. Both central banks need to find a way to manage inflation expectations down while at the same time keeping monetary policy loose in order to cushion their respective decelerating economies. Unfortunately for the central banks, food and energy inflation are two of the most visible components of overall inflation, and given their current high levels, they are serving to anchor inflation expectations even higher than would otherwise be warranted. In the medium term we would expect consumer spending to be depressed in the U.S. and Europe, and for global economic growth to be impacted accordingly. Ultimately we would expect that it will take a marked decline in energy and food prices, either via increased supply or reduced demand, to engineer an environment of robust growth.
As we have observed in recent months, positive returns are being found in an increasingly slim number of market sectors. Over the past few weeks, even energy stocks appear to have lost their upward momentum as investors appear to be discounting lower commodity prices in the near-future. While we have reduced our energy exposure over the last few weeks, it still plays a central role in the portfolio, as do agricultural stocks and select base metals. Lastly, we expect the setting for financials to continue to deteriorate (and we’ve been shorting banks accordingly), and continue to hold cash levels far above historical norms. For the month, the fund was up 5.08%, owing to the sector overweights/underweights described above.