Forge First Asset Management August 2019 Commentary: Underleveraged consumer may continue spending for longer than the more bearish prognosticators believe they’ll be able toJacob Wolinsky
Forge First Asset Management commentary for the month ended August 31, 2019.
This August earned another gold star at upsetting an investor’s most popular month for family holidays. Four years ago, our family was in the south of France when China decided to revalue its currency lower. Equities promptly fell 11% in a week. While by now, almost 3 years into Trump’s term, investors have become accustomed to an unfortunate and growing ‘gloves off’ way of conduct, it was unsettling to read, this time while we were in the UK, NY Fed President Dudley’s suggestion that the FOMC shouldn’t cut rates just to spite Trump. While Dudley’s quickly retracted comment didn’t impact markets, it was symptomatic of how chaotic the macro ecosystem has become as traditionalists fight to stop the attempted single-handed rebalancing of world order.
Yet markets were anything but balanced during August, thanks to ramped up trade war rhetoric & actions, rising temperatures in various geopolitical hotspots, and signs that the strongest component of the global economy, the US consumer, might waver. As a result, 16 of the 22 trading days during August saw the S&P 500 have intraday moves of at least 1% compared to just 2 in July and 1% daily moves numbered 10. However, as seen in the graph on the below left, despite heightened volatility equities remained range bound between 2840 & 2940. Upside was capped by economic fears (Germany entered a recession, roughly 20 countries saw their yield curves invert), while equity yields & TINA combined to maintain a bid for stocks (US 30 year fell below 2% for the first time ever).
While all US indices fell during August, the 17% climb in gold stocks enabled the TSX to gain +0.22% or +0.43% including dividends. This strength in gold equities overrode weakness in metals (-17%) and energy (-8%) to enable resource stocks to be up for the month, as seen by the red line in the graph on the above right (white vertical line marks August 1st). Further, the orange line in that same graph shows that the price of shares in the much touted “short Canadian banks trade” fell 4% during August. Interestingly, it’s worth pointing out that the US bank index declined -7.7% during the same time frame.
Meanwhile the above table highlights that the Forge First Long Short Class F Lead Series gained +0.48% net of fees, boosting its year to date net return to +5.14%. The one-year net number for this fund now sits at +8.22%. In contrast, our Forge First Multi Strategy Class F Lead Series fell -0.79% net of fees. Year to date, the net return of this fund is +3.58% and its one-year net gain is +6.40%. Winning sectors for the funds included materials (gold), REITs, utilities, financials & our ETFs. In contrast, consumer and energy stocks were in the losing column. Also given our view that market uncertainty remains very high, we reduced gross exposure levels to just below 100% for each of the funds towards the latter part of August, ahead of September, historically the worst calendar month for stocks.
From the perspective of net exposure, the funds continue to be biased towards ‘safety’ complemented with a weighting in gold. In other words, our largest net long exposures are in REITs, utilities (though think alternative vs traditional utilities) and gold stocks. We’re modestly net short financial equities and net long energy (owning Canadian oil versus short US oil). We view broadly diversified sectors including technology, consumer & industrials as an amalgam of businesses as opposed to a ‘pure sector play’, and are net long each of these sectors. Of course, as is a rule with our funds, each of the funds holds a diversified short book consisting of single stocks & ETFs complemented by index puts on equity markets.
Looking ahead, frankly we could copy the outlook portion of last month’s commentary and end right here as little has changed and the same concerns remain. It’s true that China’s economy appears to be struggling a little more than Beijing expected at this juncture. The basis for this statement is illustrated by the graph on the below left, showing the country’s decreased market share of US imports. However, beyond allowing the RmB to passively depreciate to offset the majority of tariff-induced changes to the country’s terms of trade and provide a modicum of stimulus, it’s clear that China plans to tough it out and not, for example, stimulate its housing market. Cognizant of the financial leverage in his country, Premier Xi Jinping appears content with real GDP growth that has a ‘5’ handle on it versus the vaunted 6% number of last year.
Meanwhile in the US, their industrial sector is in a recession and in light of the trade war, that outlook remains lousy. Also, with forward deficits already exceeding US$1T, it’s tough to imagine growth-inducing stimulus coming from Washington. However, having said that, it’s worth highlighting that recent legislation has boosted federal spending by $320B ahead of next year’s election. Consequently, future ‘heavy economic lifting’ continues to be up to the US consumer. Yet recent surveys such as the University of Michigan Consumer Sentiment survey shown on the above right indicates that the impression of consumers towards both present and expected conditions have both fallen to levels last seen during H1 2016. Also, while the survey did not contain a specific question about trade, one-third of all respondents referenced concerns towards this topic.
To be balanced, it’s important to acknowledge that borrowing costs for the consumer have fallen significantly, and likely will continue to do so. Meanwhile the jobs market remains healthy. So, there’s little question that the (generally) underleveraged consumer may continue spending for longer than the more bearish prognosticators believe they’ll be able to. However, put simply, if trade rhetoric and/or the impact of trade actions catalyze a change in the spending attitude of the US consumer, it’s probable that the global economy will enter a recession during the next 6-12 months.
Consequently, our funds will maintain their conservative positioning for the foreseeable future. And while we’re stock pickers not macro traders, we remain vigilant towards potentially market moving events. To us the biggest probable near-term market moving events are the meetings of the ECB (September 12th) and the FOMC (Sept. 18/19th). The only certainty from these events is that monetary policy is going to get easier, although perhaps not as easy as financial markets are currently demanding from central bankers. However, given the unfavourable demographic trends that we’ve written about in the past and that are highlighted in the graph on the below left, it’s unlikely that interest rates will help the relative strength of US bank stocks vs the S&P 500 much in the near term (see graph on the below right).
Amidst all this noise, the team at Forge First will continue to stick to our discipline of managing diversified portfolios that are focused on owning companies that generate free cash flow and shorting companies that are either burning cash or which are dependent on tapping public markets. Sticking to this discipline has enabled our funds to complement solid returns (see table 1) with the strong risk metrics highlighted in the table below during the 7 years we’ve been managing the funds.
As always, thank you for your consideration, please visit our website for information on our funds.
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