By Eric Sturdza
Following a correction of -9.8% peak to trough, from 19th September’s highs to 15th October’s lows, the S&P 500 Index flared up to set new record highs a mere twelve trading days later, eventually posting its third strongest month in 2014 (+2.32%).
This “flash correction”, rather benign with the benefit of hindsight, shook markets in ways not experienced since before QE3: the VIX Index, (a popular measure of market volatility) a proxy for hedging demand, reached highs reminiscent of 2011, while treasury markets experienced a level of volatility associated with disruptive events such as 1998’s Russia/LTCM crisis.
Unsurprisingly, forces behind this bona fide correction were an interaction of macro and micro factors; the former were mostly related to global GDP growth concerns with particular emphasis on Europe and were exacerbated by both an underwhelming ECB response and, chiefly, the imminent termination of the Federal Reserve’s Quantitative Easing. A continuing decline in crude oil prices and other commodities (even net of U.S. Dollar strength) provided further worries of falling global demand, correlating with weak German and Chinese industrial productions and reinforced fears already mirrored in the beaten-down forward inflation expectations.
Naturally, the deteriorating news flow relating to the Ebola outbreak accentuated risk sensitivities. On the micro side again, the context was an already fragile one with generally below average liquidity and an important source of equity demand as corporate buybacks slowed as companies entered their pre-earnings blackout periods. Against this backdrop, the record IPO of Alibaba Group (incidentally marking the top of the market in September) coupled with important unwinds by leveraged funds, further pressured liquidity increased risk-aversion. With risk-aversion begetting risk-aversion, the edginess and tight stop-losses of some investors was on display in many forms during the month, including the -7.5% intraday drop of the semiconductors index (now fully recovered) on negative guidance from unrepresentative Microchip Technology Inc.
The Fund performed well during this volatile period, outperforming the S&P 500 Index both during its down leg (ca. +2.1% relative performance) and upside (ca. +0.7% relative performance).
Catalysts for the market’s quick bounce included an initially soothing commentary from the FED (the President and CEO Mr. Bullard’s call for a pause in tapering, which did not materialise), somewhat comforting European Banking Stress Test results and later, a surprise increase in the Bank of Japan’s own QE on the last day of the month. Most importantly, the perception surrounding many of the above-mentioned issues evolved positively. This, together with the oil price fall being seen as a potential consumption tailwind, which when combined with recent constructive US economic and earnings data, appears to be cementing a mild, yet positive growth environment.
The Fund performed well during this volatile period, outperforming the S&P 500 Index both during its down leg (ca. +2.1% relative performance) and upside (ca. +0.7% relative performance). The source of this outperformance was primarily stock selection, with investee company’s high quality profiles generally protecting from large draw-downs and then appearing as bargains when optimism returned.
Further, the Fund’s already decent cash position at the end of September grew in the first week of October, as a result of what was viewed as a somewhat underwhelming opportunity set and often challenging and deteriorating, Momentum/Value tradeoffs. The Manager initially disposed of Resmed and Align Technologies and later in the month, T. Rowe Price Group on soft earnings, and DaVita HealthCare Partners on valuation. The excess cash allowed for additional downside protection and importantly, opportunistic buying in the second half of the month; as such the Investment Adviser was able to initiate positions in highly attractive companies, long on its radar, at discounted valuations such as: Teledyne Technologies, The Walt Disney Company, Polaris Industries, Anheuser-Busch InBev, Constellation Brands and two high quality semiconductors, Skyworks Solutions and Avago Technologies. MasterCard was also added at the end of the month following strong earnings.
(i) underwhelming top line global GDP
(ii) central bank activism
(iii) lack of investing alternatives (as described in the latest quarterly commentary)