A Rising Tide Lifts Most Boats

The broad-based market upswing in the first half of July has benefitted risk assets globally. That follows the release of better than expected economic data in the US and China, suggesting that fears over the strength of the global recovery have been exaggerated. Meanwhile, the clearer political picture in the UK, following the appointment of Theresa May as the new Prime Minister, and the victory of Abe’s ruling coalition in the July 10th upper house election in Japan also contributed to boost investors’ confidence.

Equity markets bounced back markedly in Europe and Japan as a result. In addition, value stocks outperformed defensive segments such as quality/ low beta stocks. Credit markets also rallied, with high yield spreads tightening significantly both in Europe and in the US. Meanwhile, sovereign bond yields moved higher due to the improving macro picture.

In the hedge fund space, the rising tide lifted most boats. With the exception of CTAs which are defensively positioned, all other hedge fund strategies tracked in the Lyxor Hedge Fund Index were in the black last week. Directional strategies, such as Special Situations within Event-Driven and long biased L/S Equity outperformed. The hedge fund strategies that performed best last week were those that suffered the most in June when markets were in risk aversion mode.

Going forward, the environment remains clouded by many uncertainties which prevent us from adding risk to portfolios. We believe the US earnings season is likely to bring some positive surprises, but on the other hand, the continued depreciation of the Chinese Renminbi is a source of risk. The FOMC meeting on July 26-27th is likely to take notice of the strong improvements in the US labor market. We do not expect a rate hike considering the lack of evidence on the impact of Brexit on the US economy. However, we would not be surprised to see a moderately hawkish Fed statement in order to guide very dovish market expectations. Our defensive stance translates into a continued preference for hedge fund strategies with moderate market directionality, such as Merger Arbitrage and L/S Equity variable bias, among others.