China and the U.S. entered into an economic war in May and the markets suffered. Very quickly we have moved past the stage of trade tensions, trade frictions, a trade dispute, or even a tariff war between two superpowers. At month end, tariffs were also announced on Mexico. Given the ratcheting up of national security rhetoric associated with Huawei, rare earth materials exports to the U.S., and immigration, we are closely monitoring these situations but do not expect the volatility, which we warned investors about in our year-end letter, to end soon.
In May, the S&P 500(1) was down -6.6%, putting it up +9.8% year-to-date. International equities decreased -4.8%, according to the MSCI EAFE Net Index(2), while Emerging Market stocks lost -7.8%, according to the MSCI Emerging Markets Net Index(2), over the same period. Brazil, a country with only about 25% of its GDP exposed to trade, was up +0.7% last month. Greece, Russia and China have the highest year-to-date equity index returns (5) of the major markets. China’s return may result from the many fiscal and regulatory easing changes over the last year.
Equally shocking was the reduction in global interest rates although credit returns were less dramatic. The 10-year Treasury yield (1) declined 0.38% to 2.13% in May, which contributed to the Barclays US Aggregate Total Return Index (1) gaining 1.8% in May (interest rates and bond prices have an inverse relationship). The yield on 10-year German government bonds reached -0.213 %( 4) at month end, its lowest level ever. The Barclays US High Yield Index (3) fell -1.2% with only modest credit spread widening.
We believe that the business cycle has progressed to Late Cycle. After the yield curve inverts, a recession is typically a year away, and equities tend to rally in the last months of the expansion. Increased exposure to the late cycle factors – Value, Size (i.e., small stocks), and Momentum – is usually beneficial.
Last month, Momentum was the second best performing factor behind, not surprisingly, Low Volatility. Value and Size were underperformers. We are overweight the Size factor based upon its higher-growth rate than many large-cap peers, more exposure to the domestic economy (i.e., not tariffed), and cheaper valuations relative to its historical average than most factors. This exposure may also be immunized from any anti-trust actions.
We find ourselves in an environment where investors appear to be chasing growth and Low Volatility positions at almost any cost. The growth chasing is similar to the late 1990s on the back end of the technology boom which set the stage for a prolonged period of outperformance for active managers. The search for Low Volatility is a similar momentum trade as investors are looking what has worked since the market started topping. Consequently, the Low Volatility Factor has become quite expensive versus history.
As we start June, the stock market seems to be heavily oversold. According to the Bespoke Investment Group, “Since 1900, there have only been seven 7-week losing streaks and just one 8-week losing streak.” The last week in May was week seven. As one might expect, June is off to a great start with the S&P 500(1) up +4.4% month to date through 6/7. Our portfolios continue to have a healthy exposure to U.S. stocks, diversified via the late cycle factors discussed above. We also remain committed that geographic diversification, a long-term approach and tactical risk management will likely pay off over the full market cycle as various investment opportunities present themselves.
As always, we remain focused on helping clients achieve the return objectives in their financial plans, despite the current market difficulties. If you’d like to schedule a time to speak with your CIG Capital Advisors professional, please contact 248-827-1010.
(1) Calculated from data obtained from Yahoo Finance, as of 6/7/19
(2) MSCI, as 6/7/19
(3) NEPC, as of 6/7/19
(4) Bloomberg: “Trade War Traps ECB with Bund Yields at Record Low”, 6/4/19
(5) MSCI China A 50 Index, MSCI Greece Index, and Russia ADR/GDR Index as of 5/31/19, Price only in USD
This report was prepared by CIG Asset Management, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.