Switch to risk-on but dispersion in return shows mixed opportunities

All equity style sectors generated gains for July. The EM index ETF is the only major style down for the year. Global markets outperformed more localized US markets as measured by mid and small cap indices. Growth has been the best style index this year with returns exceeding 11 percent. While performing well this month, global equities have still lagged for the year based on growth and earnings differentials versus the US. Nevertheless, there are some concerns about short-term trends in smaller cap indices as well as growth and value indices.

All equity sectors also showed gains for July; however, the dispersion in performance is significantly greater for year to date returns. Consumer discretionary, health, and technology are the leaders for the year. Finance, materials, and utilities are laggards. Trend models are signaling some short-term concern for the technology sector.

Country equity ETFs also produced strong gains for the month with double digit returns for Mexico and Brazil. Year to date returns show high variation in returns with the average country return being negative.

Bond performance was negatively correlated with equity returns. Long duration Treasury bond ETFs generated the poorest performance while credit sensitive and EM bonds posted positive returns consistent with risk-on behavior. Trend models signal lower returns for duration sensitive sectors. The credit sectors show upward trend signals.

The general signals for asset classes suggest being long risky asset classes and avoiding safe assets. Portfolios with equity tilts should perform well in August based on current price-based signals. Markets are looking through political noise and focusing on economic and earnings based fundamental signals.

Sector trends show significant changes over last month

Our tracking models for the end of July show that there have been changes in direction for all major sectors. This would usually suggest significant loses for trend managers but the relatively mild volatility and the slow reversals allowed for adjustment of signals to mitigate loses.

Equity indices moved higher around globe while bonds reversed and sold-off. Between good economic numbers and the worst fears not being realized, the market moved to risk-on positioning. Rates suggest that quantitative tightening will continue. The dollar rally slowed which cause precious metals to move sideways. The energy rally also slowed albeit there is a large dispersion in market views. Commodity markets were mixed but the strong grain price declines in June have started to reverse, but soft prices are trending lower.

Given the sector reversals between June and July, it is hard to say what will be the potential winners for August. With vacations for many this month, position changes will be limited without a major economic surprise.

If there are no trends, there will be no gains - Managed futures slightly negative on range bound market behavior

July  proved to be a classic reversal from less risk appetite to risk-on behavior. Global equities, which were weak in June, reversed on the expectations of stronger growth and earnings. This was bad news for trend-followers positioned for further market declines. The switch in risk appetite caused bonds to move lower. The strong growth, higher inflation, expected larger supplies, and expectations for continued Fed QT placed added pressure on Treasuries.  Credit markets moved in-line with equities. The range bound currencies helped international assets but did not allow for trading gains. Commodities were mixed with energy prices moving lower and grains seeing some buying pressure after large declines last month. All of these reversals did not help intermediate trend traders. 

While it is a consolation that core portfolio holding have been positive this year, investors are expecting less pain from this defensive strategy. A long history suggests that the average return for this style will not see long periods of stress; however, any change in return patterns will be predicated by an economic dislocation which has yet to occur.

July performance shows risk-on appetite

First look at the data to see what weighted market opinion is telling us. July marks a reversal to more risk-on behavior with strong gains in large cap US stocks as well as international and emerging market equities. While small cap, growth, and value indices all did well, the broader international concerns affecting risk behavior have abated. This positive global view was also seen in the international bond markets. The dollar rise from a desire for safety was contained and more range bound. Along with international bonds, credit markets improved with tightening spreads. The only losers for the bond sector were long-duration Treasuries and commodities. 

Away from the headline grabbing FAANG stocks, the markets have responded to the higher economic growth story which culminated with a 4% second quarter growth announcement. The combination of continued good economic news and a dampening of trade war rhetoric led to a more hopeful market. While trade war discussions with China are still a market focus, the news with the EU is more suggestive of compromise or even a new trade deal with better terms. Of course, these trade discussions almost always exclude autos and agriculture which are industries that hold special appeal by the EU. 

While the link between economic growth and equity prices is not always definitive, we can say that the announcements of tech firms like Facebook, Netflix, or Twitter do not represent signals for where earnings will go for the average firm. The growth story and its impact on wages and inflation will still be the key driver for the rest of 2018.