Saxo Stronghold USD – Q2 2019 commentary

Market overview

Volatility in financial markets rose in the second quarter as the trade tensions between the US and China continued to worsen and economic data continued to weak. OECD’s leading indicators on the global economy continue to be below trend growth and falling suggesting elevated probability of a recession within the next 6-9 months. The current slowdown is clearly driven by a slowdown in the manufacturing sector being on the frontier of the current reconfiguration of production due to US and China trade tariffs.

As the economic data and in particularly inflation expectations continued to decline central banks delivered significant dovish messages in June indicating imminent rate cuts from the Fed and ECB something already priced in by the market. In addition, expectations for renewed quantitative easing (QE) have risen as well. As a result, June delivered very strong returns across all asset classes and the second quarter ended with positive returns for all asset classes except for commodities.

On top the central bank cavalry coming to the rescue the market also reacted positively to the G20 meeting ending with the US and China agreeing to keep talking about trade without any further short-term escalation in tariffs. However, the tensions between the US and China are still centered around technology and thus tensions and downside risk can easily resume.

Portfolio performance

(Performance is net of all fees)

• The best performing position in the portfolio has been the exposure to US minimum volatility equities, which especially gained by the movement in the stock market in the beginning of June.
  
  
• The only position which has delivered a negative return over the quarter is exposure to US momentum equities. After the great beginning of June for US equities, the portfolio added exposure to US momentum stocks. However, as the momentum faded, this position has given a slight negative return.  

Changes to allocations

The large returns in the stock market this year made the portfolio increase its exposure to US equities to take part in the gains. This was done both by increasing the exposure to equities with a high price momentum, but also equities with a relatively low volatility. To remain diversified, the portfolio also attained exposure to real estate. The position in the low-risk 1-3 year US government bonds was sold off, and the exposure to US mortgage-backed securities was decreased. When entering Q3, the portfolio thus has a significant exposure to equities, supported by more defensive positions credit bonds and a slight exposure to long-term government bonds.

Portfolio weights (%)

The past quarter demonstrates how the quantitative approach to risk management allows the portfolio to benefit from the gains in the equity market, but still keep a part of the allocation in more defensive assets, to be prepared for periods of high volatility. 

Outlook

The global equity market has continued to rise, despite a consistent decline in global leading indicators, which historically has been associated with underperformance of stocks versus bonds, and the market is expecting a response from the central banks. Furthermore, the following quarter will be dominated by the continuing trade talks between US and China, and the previous quarter has shown that event small changes in the sentiment of the trade talk can results in large market responses.

The Stronghold portfolio enters the third quarter of 2019 with a significant exposure to equities, albeit with a part of the allocation in government bonds. The large fluctuations in the markets in May increased the volatility past months, and thus the portfolio keeps a noticeable exposure to lower-risk assets to be prepared for downturns.