July 2024

“It was a splendid summer morning and it seemed as if nothing could go wrong.”  John Cheever

The political world continued to provide non-stop action in July with an expected result in the UK but a surprise in France, where the winning parties were flipped (from right to left) but with the same gridlocked end-state.  Things also began heating up in the American campaigning season after an attempted assassination on one candidate and the decision of the sitting president to not seek re-election, the first time that’s happened since volatile 1968.  The next three months will see a surge in electioneering activity but given the fractured environment at present the outcome will once again come down to a handful of states.  It will also be very close and will likely be contested in the courts by whichever party loses.  How the market deals with that prospect remains to be seen, but complacency evident in this month might be misplaced.  Given the renewed speculation on the Federal Reserve cutting rates in September and signs of economic slowing (soft ISM data) in the US, to coincide with already existing slower European economies, it could very well make for interesting post-summer markets.

For the moment however, investors remained unfazed by noise emanating from political circles.  While the SPX showed some intermonth volatility it ended +1.1%, while US bond yields fell sharply, almost completing the recovery back to the low levels of last year end.  From these levels we will need to see supportive data likely to consolidate the Fed’s inclination to cut at the next meeting.  The current shape of the curve indicates that expectations have also returned to the multiple cut scenario we experienced last year.  The BOJ midmonth rate hike was also a big factor, as it led to significant corrections in both the NKY index and JPY.  The currency move was driven by unwinding of very crowded FX carry trades (short JPY/long USD etc), a move likely to please the central bank but be disruptive to macro hedge funds.  Given the thin markets of summer it is difficult to know how the currency trade will ultimately play out, but it is another variable to take into consideration.

July also saw earnings reports for most European banks; and on the whole results were quite constructive and the bank equity index posted a strong performance to close at the highest level in years.  In terms of market reaction to individual names, the story was a bit mixed, with the first signs of “the best is behind us” and fears over future NIM compression.  In our view this fear is overdone.  While absolute levels of NIM may have peaked, we are highly unlikely to return to emergency interest rates and therefore well-managed institutions will continue to generate capital even in a lower growth environment.  The very high levels of capitalization and low valuations compared to profitability leave room for future rerating. Bank credit markets were also positive on the month in relatively quiet trading.  Against that backdrop the fund’s A shares rose +1.81% with credit contributing +189bps in gross performance and equities +21bps.

Next month will likely begin with the unwinding JPY carry trade weighing heavily.  August is notorious for volatile markets; and We bear the scars of many of those events (Kuwait invasion, failed Soviet coups, Russian default etc) and it must be remembered that sometimes these crises are very short-lived.  We remain fairly defensively positioned and would likely be adding risk if our entry levels are reached.