SFRR closes the month at -3.69% (-25.73% YTD), SFPG closes the month at -5.33% (-28.96% YTD) and SFQS closes the month at -5.17% (-21.42% YTD). In the same period, S&P 500: -4.24%, Nasdaq 100: -5.22%.
The month started well, continuing the rally that started in mid-June. The 100-day moving average of both the Nasdaq and the S&P 500 was surpassed and the rise was halted at exactly the 200-day moving average of the S&P 500, which is usually associated with the limit between bull and bear markets. We are therefore still in a bear market but with a substantial difference with respect to the phase experienced until mid-June. With the information available and analysing the historical behaviour of the stock market, it is still most likely that, since June, we are in a floor formation phase, in which the market can remain for months with strong rises and falls within a wide sideways range.
The factors that continue to dominate short-term market movements remain the following:
- Inflation: Declining already, but not at the expected pace. For the month of August inflation in the US fell to 8.26% (data released on 13 September), down from 8.52% in July and 9.06% in June. Energy and agricultural commodity prices have started to fall but, excluding those components, Core inflation has not yet shown signs of weakness (Core Inflation US was 6.32% in August, 5.91% in July and 5.92% in June).
- Monetary policy: The Fed continues to set the global pace of monetary tightening, stating that it will prioritise controlling inflation over promoting growth and employment. Any negative inflation data is interpreted as a future tightening of monetary policy and precipitates falls. Conversely, a gradual reduction in inflation, which we expect to see in the coming months, will ease the tension that is currently dominating the market. The USD continues to rally, in line with expectations of interest rate hikes. The more rates rise, the more it yields against the Euro and the more it appreciates. The ECB has identified the weakness of the Euro as a negative factor for the evolution of the economy because of the inflation we import from products bought abroad. Despite the weakness of the Eurozone economy, the ECB started raising rates in July, increasing deposit rates by 0.50% to 0% and raising them by a further 0.75% in September. The evolution of the EUR/USD will depend, to a large extent, on the differential between US and European interest rates. The USD is still in an uptrend but could reverse as soon as the FED stops raising rates and the ECB still has rate hikes ahead.
- Russia-Ukraine war: It has taken a back seat and the latest news (weakening of Putin’s position in the Duma and the advance of the Ukrainian army) have had a very limited impact on the market. The price of oil and its derivatives has fallen since mid-June and the European Union maintains that its dependence on Russian gas has been substantially reduced from 40% to the current 9%.
In this phase of floor formation, we continue to take advantage of dips to recover positions in portfolios. Depending on the scenario in the coming months, the optimal positioning may vary:
- Scenario 1: Low growth or moderate recession due to the strength of demand with slightly declining inflation and prolonged high rates: good for USD. Bonds and stocks in sideways range. Take advantage of declines to increase position.
- Scenario 2: Strong recession with rising inflation: further rate hike. Initially bullish for the USD and bearish for bonds and stocks until a new low is found. At some point in the future the market will discount rate and inflation declines due to the recession and the trend will reverse for the USD, stock market and bonds.
- Scenario 3: Sharp recession with deflation due to abrupt reduction in aggregate demand. Rate cuts will be discounted by the market in the short term. Bearish for USD (except for possible safe haven effect) and bullish for bonds. In the stock market, better performance of Growth vs Value in an environment of a downtrend in indices that will reverse due to a change in the Fed’s discourse. The minimum would be lower than in Scenario 2, but the recovery would also be faster due to the return to expansionary monetary policy.
Our main scenario is scenario 1 (60% probability), followed by scenario 3 (30%) and with lower probability scenario 2 (10%). In this regard, we keep cash in managed accounts and portfolios because of the moderate probability of recession but we have been constructive since June, trying to take advantage of downturns to increase exposure.
In the funds that can use hedging, Sigma Real Return and Sigma Prudent Growth, we have incorporated a trend following system that will allow us to increase and reduce short market positions more dynamically to capture more of the upside when the final market recovery begins. We are now 10 months into the crisis since the November 2021 highs and valuations which, adjusted for earnings, have corrected significantly, opening up buying opportunities that we have not seen since the Covid 19 crisis in March 2020.
Finally, we would like to close this commentary by adding our condolences for the death of Mr. Javier Marías Franco, an illustrious figure of Spanish literature, who passed away on Sunday 11 September. His extensive work will remain for generations to come. He was a regular candidate for the Nobel Prize for Literature, but it was his critical spirit and profound and precise prose that positioned him as one of the most influential and renowned writers in recent history.
