Saxo Stronghold EUR – Q3 2019 commentary

Market overview

Q3 had all the ingredients for a negative quarter, with escalation rhetoric in the US-China trade war, worsening macro data, US money market stress, the ECB launching QE as well as a tiering system on excess reserves, and an attack on the world’s largest oil processing facility in Saudi Arabia. But despite these events, asset classes behaved well during the quarter with only small blips of volatility. The Stronghold EUR portfolio delivered 4.3% return net of fees, driven by strong performance in global bonds and minimum-volatility equities. 

Stronghold EUR has reduced its equity exposure during the quarter as the sharp decline in momentum equities in early August and later mini crash in US momentum equities in September caused the volatility structure to change to a degree where high exposure became too risky.

In Q4 financial market performance will be dictated by the Q3 earnings season and the outlook of companies, the Fed’s decision about liquidity injection and rate cuts and the US-China trade talks and their outcome. We don’t have high hopes for any salvation on the US-China trade talks. Our view is that central banks are behind the curve on policy and that the global economy will slip into a recession. 

Portfolio performance

(Performance is net of all fees)

• The best performing position has been the exposure to global minimum-volatility equities contributing 2.4%-pts to the performance over the quarter. Investor demand for low-volatility stocks has been driven by the uncertain macro backdrop.
  
  
• The second-best contribution to the portfolio came from momentum equities contributing 0.8%-pts to performance over the quarter. Despite this fact, the quarter included a mini crash in US momentum equities which forced the model to reduce its exposure to momentum equities.
  
  
• The portfolio’s exposure to inflation-linked bonds also added positively to performance as longer rates fell during the quarter lifting the value of inflation-linked bonds.
  
  

Portfolio changes

During the two first quarters of the year the Stronghold EUR portfolio increased its exposure to risky assets. But during the third quarter, the model has significantly reduced its exposure to momentum equities and shifted the exposure in global government bonds 7-10Y and Euro-covered bonds. The main driver of this risk reduction has been the mini crash in US momentum equities during the quarter.

Portfolio weights (%)

 *Hedged into EUR

Outlook

With the OECD’s global leading indicators continuing to decline, we remain negative on the global economy and equities. We expect the fourth quarter to be volatile as companies will likely make more layoffs and asset write-downs to lower the base for growth comparison in 2020. The Stronghold EUR portfolio has become more defensive during Q3 and is well positioned to weather volatility in Q4 should the economy enter a recession.

The key risk for the portfolio is rising rates combined with lower equities which could hurt performance — but this would require significant financial turbulence. The portfolio also has high USD exposure through its minimum-volatility equities, so if the USD weakens substantially it will have a negative impact on the portfolio. Minimum volatility equities have been raised by many market commentators as a crowded trade. In September there were signs of a rotation out of them, but it quickly reversed.