What Happened To Risk Assets In Q2?



Dear Investors,


Attached are our latest views on global financial assets. Trade wars dominated the headlines in Q2. We are not experts on trade protectionism (we doubt many are). At Astoria, we are militant about focusing on doing what we do best: portfolio construction, macro-economic & quantitative research, building diversified portfolios, and investing for the long run. At Astoria, we strive to take your hard-earned capital and invest in securities where there is a margin of safety. Astoria believes the combination of your long duration capital and our long duration investment strategies is a unique and an attractive risk/reward. Do not hesitate to contact us with any questions you have.


Best, John Davi

Founder & CIO of Astoria Portfolio Advisors


General Overview of Risk Assets

  • Astoria typically does not put out market commentary recapping what previously happened as our research is forward-looking by design. Given the increase in volatility in Q2, we have been asked for our interpretation of what’s transpired and what it means for multi-asset investing for the balance of 2018.


  • Market pundits have argued that trade wars are the reason why the markets have sold off aggressively in certain parts of the world (namely EM equities). While trade wars are important and on the margin negative, Astoria believes the real drivers behind the weakness are 1) liquidity is declining in ‘18, 2) global growth has decoupled 3) inflation is rising, on the margin.



  • Market pundits have argued that the economy is in the latter stages of the business cycle. At Astoria, we think the cycle is over. Astoria believes the economy has entered into a new cycle where there is no longer an embedded put from central banks. QE provided investors with a floor to financial assets and unfortunately that floor is being removed.




  • President Trump continues to play chicken with China. Astoria is not an expert on trade wars. Even if some claim to be experts in the trade protectionism space, there is a reasonably high probability those experts aren’t skilled in portfolio construction. Astoria has modeled for higher volatility in 2018 as we are investing in liquid alternatives, gold, cash, and assets which have lower correlations to traditional equity and fixed income markets.


  • Given where front end US rates are trading, short duration spread products are providing investors with an attractive place to park money. We think the front end of the US curve is significantly more attractive compared to a traditional credit product such as US high yield. Our bearish views on US high yield credit remains intact.


  • Astoria has been vocal in owning commodities. There has been tremendous dispersion YTD partially due to trade wars, as well as due to fundamentals. Lean hog (+44%), Crude oil (+22%), Lean hog and feeder cattle (+17%) have led the rally while gasoline (-21%) and soybean (-17%) led the decline. Astoria has taken an indexed based approach by using the Bloomberg Commodity Index which is only down 0.90% YTD.


  • Astoria continues to watch copper (-10% in June) as an indicator of global economic slowdown.


  • Concerns of Fed rate hikes and its balance sheet reduction has led to a disruption in funding markets. The US Libor OIS spread rose 475% increase from November 2017 to April 2018 (see chart below). It is estimated that the Fed’s balance sheet will decline by $1 trillion in 2020. We remain very concerned about the method in which the Fed’s balance sheet is eventually reduced.

Source: Bloomberg, Astoria

  • Is Astoria bearish? No. We are managing our portfolios to invest in equities where there is a margin of safety and we are harvesting these strategies in a cost-effective manner for the long run. In Astoria’s view, the overarching theme in one’s portfolio should be value, quality, and mixing in other factors (we like momentum, carry, & trend) to further enhance your portfolio risk characteristics.


  • What do we expect for the H2 2018? We are not market timers, forecasters, or attempt to predict what could happen. Given our Founder’s background in Quantitative & Derivatives research, Astoria looks at all the distributions of outcomes and assigns probabilities to them. Our goal is to take our investors’ long duration capital, harvest our investment strategies in a cost-effective manner, and to include portfolio diversifiers to smooth out our portfolio returns over varying economic cycles. The quantitative factors that Astoria is harvesting are persistent, pervasive, robust, and have been time-tested for decades.


  • Next, we will go through each of the major asset classes to review what happened in Q2 and our views going forward.


Summary

  • Market volatility picked up in the 2nd quarter as trade wars escalated, global growth diverged, the US Dollar strengthened, and US yields continued their upward trend. The rally in the US dollar negatively impacted Emerging Markets to a large degree. The US Federal Reserve continued with its rate hiking program and the European Central Bank (ECB) announced its intension to end its Asset Purchase Program in December 2018. Both measures will result in liquidity declining which we argued in our Q4 ’17 and Q1 ’18 commentaries would negatively impact equity prices. Astoria continues to advocate investors to diversify their portfolios to help navigate turbulent markets and to help accomplish their long-term investment goals.


US Federal Reserve

  • As widely expected, the US Federal Reserve raised interest rates by 25bps in the June FOMC meeting and forecasts two more rate hikes before year end which will bring the Fed Funds rate to 2.25-2.5% by the end of the year. The Federal Reserve Chairman, Jerome Powell, has indicated that he would take a ‘symmetric’ approach to inflation. This implies that the Fed will allow inflation to rise above 2%, at times, to encourage economic growth.


  • Given the robustness of business confidence and tight labor markets, Astoria believes the Fed is on track to deliver a 25bps rate hike at each quarter in 2018. The Federal Reserve has now hiked interest rates seven times since December 2015. It’s important to keep in mind the big picture. Over the past two years, the global economy and financial markets have absorbed Fed actions reasonably well. Moreover, in the context of accomplishing your long-term investment goals, short term moves are difficult to predict and provide an opportunity to rebalance one’s portfolio.

Tariffs

  • President Trump has escalated trade tensions further by indicating that a 10% tariff would be placed on $200 billion of Chinese imports, in addition to the 25% tariff on $50 billion of imports announced in March and to be implemented on July 6. The Chinese Ministry of Commerce has threatened to apply U.S. goods with their own tariffs. While we are not experts on trade protectionism policies, we would point out that China owns over $1 trillion of US government securities (approx. 30% of all outstanding securities). Nobody stands to win in a trade war and we continue to grapple with the longer-term investment implications.


US Earnings & Valuations

  • US economic data has been strong in recent months. The Conference Board US leading 10 economic indicator index remains at 50-year highs (see chart below), the NFIB small business survey remains near a record high (see chart below), unemployment is at the lowest level since 1969, and the Atlanta Fed GDP Now Forecast is 4.086% as of July 2, 2018. The Labor Department reported that for the first time ever, there are more open jobs than there are unemployed Americans.


  • There was a clear rotation out of cyclical orientated stocks and into more defensives in the second quarter. We expect this rotation to continue as investors grapple with trade war concerns.


  • The S&P 500 forward P/E ratio was 16.1x as of June 2018 which is inline with its average over the past two decades (16.1x). Broadly speaking, Astoria does not think US large cap stocks are expensive at these valuation levels.