May closed with negative returns, although 2021 YTD data is positive: SFRR -1.23% (+1.00% YTD), SFPG -3.4% (+2.98% YTD) and SFQS -1.2% (+10.7% YTD), while the MSCI World closed at -0.41% in EUR.
In May, the rotation towards cyclical and inflation-sensitive sectors has regained prominence (Eurostoxx 50 +1.63%). The excellent results of the companies that led growth during the pandemic have gone unnoticed, and markets are now looking for profitability in poorer quality sectors. The US inflation data for April, released in May, hit the spotlight: Consumer price index rose by 4.2% in April vs. the same month last year (estimates were that it would only reach 3.6%). Excluding energy and the more volatile food components, the rise was of 3%. Markets’ initial reaction was as expected: falling bond prices and stock market rotation from long-term growth sectors to cyclical sectors and commodities. Luckily, the Fed quickly shed light on this upsetting data and stated that this rise should be considered temporary and not representative of what is expected in the coming months, and that it does not plan to take restrictive measures in the short term. As a result, the fall in bonds and sector rotation, which largely reversed in the second part of the month, was contained.
For equity portfolios as a whole, this past month resembled March 2021. Assets which had risen the most during the pandemic were cashed to buy those that had suffered most. However, the financial information released by companies tells a different story: Growth companies are beating expectations, which were already high, and the companies that depend most on economic cycles still have plenty of dark clouds ahead of them. Although the banking sector has risen sharply, discounting future inflation and interest rate hikes, we expect interest rates to remain substantially below inflation, which is also unlikely to get out of control without full employment. Tourism will live a good recovery, while for the leveraged segments in this industry, such as airlines, financial tensions will curb growth and profitability. In commodities, perhaps the most cyclical component of the economy, volatility is very high. While demand is recovering, the productive sector is still in the process of recovering and may continue to push prices up; however, there are already strong messages from the Chinese government announcing that it will intervene. With interventionist governments regulating and limiting investors’ profits, expectations for long-term appreciation in these sectors are at a high risk of vanishing in the medium term. These doubts began to permeate the market on the 13th of May, when the Nasdaq began to rebound, reaching a 5.5% rise by month end. Our equity positioning remains overweight on long-term, high quality growth. We had previously added to the cyclical component of our portfolios investing in companies we considered financially robust, and, during May, we increased the weight in early Growth stocks taking advantage of corrections. In semiconductors, which is the most cyclical component we had in the portfolio, we have already started to substantially lower exposure.
Regarding currencies, the EURUSD has behaved similarly to cyclical assets. Its intraday highs, however, came somewhat later, on 25 May (1.2267), still below those at the beginning of the year (1.2350). Since then, it has mostly moved below 1.22, and its trend is still undefined. We remain significantly short on this asset (short EUR, long USD) as the United States will most likely begin withdrawing stimulus before Europe, making the USD more attractive.
Hedging management has been our most active area: when markets in general are expensive, our policy is to increase hedging. In this case, encouraged by the positive momentum of cyclical sectors, we decided to do so through options strategies that would not entail any cost if indices remained in a sideways range, as they did. There were a couple of volatility spikes where we opted to pre-emptively reduce risk, but we have resumed our return capture strategies through options and derivatives, our first choice when markets are calm. In our hedged portfolios, current hedging levels are equivalent to pre-pandemic months (around 60%), although we are more active in options to contain cost as we see no catalysts for large corrections in the short-term.
In conclusion, it is once again a good entry time for growth-biased and index hedging strategies. To date, the value vs. growth valuation has recovered as much as it did in the months following the 2008-2009 crisis, which leaves plenty of room for growth to increase vs. value and vs indices in the coming months.
