Redwood Diversified Equity Fund
September 14, 2015
Global equity returns moved into negative territory for the year, as China’s slowing growth and concerns that the first Fed rate hike in almost a decade could be slated to occur in less than a month, both of which weighed on market sentiment. The August turbulence in global markets has produced significant shifts, including a 7.0% fall in global equity prices, currencies of Emerging Market countries having depreciated significantly against the G4 nations, and global oil price volatility is the highest it’s been since 2011.
While the speed and magnitude of these movements resembles past episodes in which financial crises have emerged, global activity indicators have, on balance, remained consistent with a modest pickup in the pace of growth. Additionally, despite the turbulence in financial markets, there is no sign of unusual stress in short-term funding markets or of a credit crisis in any large EM economy.
We think the possibility of a September hike in the Fed funds rate has slipped below 50%. With the global growth outlook slowing and the dollar rising, a September hike could exacerbate declining risk appetite. Although we continue to view economic activity in the US as solid, justifying a modest rate hike, we believe the Fed is unlikely to begin a hiking cycle in this environment for fear of destabilizing markets further. Delaying lift-off will allow the Fed time to assess whether the market turmoil, reflects greater weakness in EM economies, particularly in China.
Investment Outlook and Positioning
Global stocks today remain 15% below the cycle peaks reached only three months ago. Our view remains that the recent fall is only a correction, creating an opportunity to put our almost 40% cash position to work. It remains our belief that the US economy will be one of the few to deliver consistent growth; as such we remain overweight the US economy relative to Emerging Markets. We have started to do work on increasing exposure to Europe. In contrast to the US, where the expansion is five years old now, the Eurozone is in the early stages of a rebound from the double-dip recession. The current upcycle is only seven quarters old and the ECB is committed to expansive monetary policy. We remain underweight exposure to China and commodities as we expect continued volatility and uncertainty and see downside risk to consensus 2015 growth forecasts of 6.8%.
We continue to maintain an overweight position in technology in our portfolio. Tech stocks have been among the best performers within the US market YTD, and we expect this to continue in the months ahead as longer-term trends in earnings and cash flow growth remain favorable while balance sheets are extremely strong. Valuations also look quite attractive from a historical perspective. Despite the sector’s recent outperformance, multiples have only moved marginally higher in recent months with forward price multiples currently trading at significant discounts both to their longer-term historical average and relative to overall S&P 500 multiples.
Global equities fell 7.0% in August as investors considered the impact of a continuing slowdown in the China economy. Returns were negative in all sectors, all major regions, and all countries in the MSCI All-Country World Index.
Asia and Emerging Markets performed the poorest with seven countries in these regions falling more than 10%. The healthcare (up 6.6%) and consumer discretionary (up 2.3%) sectors are the best performing sectors YTD, while Energy (down 18.3%) and Materials (down 12.0%) are the worst performers.
The S&P 500 Index posted a negative 6.2% return for the month (the worst monthly decline since September 2011), the TSX/S&P Composite was down over 4.5%, and the Redwood Diversified Equity Fund was down over 8%.