Managed futures hit with trend reversals, but opportunity potential in July

The managed futures index from SocGen was down over 2% for the month with price declines in many major financial markets over the last week. Similar performance has been found with other indices; however, those managers with more commodity diversification have fared better. 

Total returns for stocks were still slightly positive for the month. Bond returns were cushioned by interest income. The extent of the market impact can be seen in our simple chart for 10-year Treasury notes. Prices have moved below the 20, 40, and 80-day moving averages which suggests that large trade adjustments from long to short may have occurred. Given the sharp decline, there were limited accrued profits from earlier trades. Given the higher volatility, many traders have lowered new position sizes. 

Managed futures for the last 12 months have matched the performance of bonds and commodities. This has made some investors cautious about adding managed futures exposure, but a turn in trends and sentiment may reverse performance gaps. We have found that strong price reversals across multiple asset class may first pull performance lower but may then lead to higher returns over longer periods if these new trends show persistence. Market divergences start with a reversal of the status quo.

Trend environment looking stronger - Loses in June may lead to profits in July

Trend traders were hit with a number of significant reversals in major asset classes near the end of the month. Bonds were rocked with a possible ECB  "taper tantrum" albeit it is early to say that this will be like what was seen in the US. No two market tantrums will ever be the same. Equities are in a trend decline in Europe and the US has started to trend lower although the month still generated positive gains for many investors. There is an equity rotation away from large cap indices, but it is hard to take advantage of in futures. The dollar also trended lower near the end of the month only to see some gains in the last two trading sessions. Many commodities moved higher on weaker supply reports and oil products has bounced off the declines from the past few weeks.  Last week was the major reversal period. 

It is clear that loses will have to be taken when markets reverse trends. Being non-predictive, trend-following always gives back some profits when there are major changes across an asset class. The issue is always whether the development of new trends will generate enough profits to more than offset the loses from reversal. Trends need time to develop in order to generate profits. Opportunities are often based on the fact that a number of markets within a sector seem to all being giving the same signal. Our trend sector monitor suggests that the breath of markets showing reversals and signaling new trends indicates that there may be good profit opportunities this month. Traders can be fooled but there is a growing change in market sentiment that may turn buyers cautious. 

Sector performance mixed with potential roll-over of trends

2017 has been a risk-on year. It started with a risk-on sentiment for the US with the Trump trade and moved to a global phenomenon; however, as we end the first half of the year there is a growing level of concern across many market sectors. Short-term moving averages and break-out indicators have turned negative for a number of styles indices in June. While all major sectors except for value are positive for the year, there is the view that uncertainty and volatility may start to swamp the risk-on euphoria. Fears of over-valuation may be a topic of discussion, but money flows and price action over the last six months have told a different story.

The bond sectors that all showed strong performance last month are starting to generate more mixed returns. June was not kind to bond investors. Most indices were down for the month on a price basis with coupon interest cushioning adjusted returns. A number of short-term moving average and break-out models have turned negative. Short-term indices are the only sectors for bond protection.  

While the finance sector jumped at the end of the month on news of positive stress tests, many sectors showed strong declines. The technology, utilities, and consumer stables all declined by more than three percent for the month. Health care is now the best sector even with the health reform uncertainty in the US Congress. Sector dispersion suggests there is less common thinking on overall market direction.

Country returns showed declines especially in the EU. Nevertheless  June loses were not able to offset the strong first half of 2017 for many countries. It is interesting that South Korea and Mexico are market leaders in spite of the geopolitical uncertainty in Asia and the continued trade uncertainty with NAFTA. Fear of policy and political unknowns did not dampened investor behavior in the first half of 2017.

End of month disruption did not offset gains for month - the upward path on holiday

In spite of the market anxiety during the last week of the month, most major indices generated positive returns for June. The only exceptions were the emerging market bond index (EMB), the Bloomberg commodities index (DJP) and the Barclays Aggregate index (AGG). It was surprising that small cap, value and growth all posted strong gains after falling behind global and large cap equities. Bonds were generally positive even with the turbulence in the last week.

The S&P 500 index was more volatile given the back and forth of 1% move days. The market has not seen this type of volatility in 2017. There were major jumps in the VIX index which has been exceptional calm over the last six weeks. The bond index (TLT) fell about three percent in the last week of the month yet it still generated a gain for the month. The bond decline was driven by the belief that ECB tapering may begin sooner than expected. This was based on a speech from ECB President Draghi which was "clarified" the next day. In general, there is a growing pessimism in bond markets that a cut in liquidity will negatively affect portfolio balances. Earlier in the month bonds rallied on the view that growth and inflation would be lower than expected. 

While not demonstrated in monthly performance, we see a very uncertain bond market that is vacillating between growth and inflation concerns and a view that a tapering of central bank policies will have a negative impact on supply even if necessary for normalization. Equities are responding to an end of the Trump trade coupled with high valuations. Exhaustion of the same old investment stories leads to conservative behavior. This is likely to show itself through the summer.