May saw a re-escalation of trade concerns globally as trump not only continued to take aim at China but unexpectedly increased his rhetoric towards Mexico as well. Markets are starting to discount the likelihood that a trade deal between China and the U.S. by the G20 is unlikely to come to fruition - a factor that has already started to weigh on business confidence and capital investment at a time when global economic data has already been weakening. We have seen a marked deceleration in economic data globally as witnessed through Global PMI’s a proxy for industrial production momentum. We note the market hard largely ignored this weakness (Chart 1), believing it was likely temporary in nature and would rebound in the second half. There has been a tendency over the past several years for weaker data in the first half of the year to see recoveries in the 2nd half however the growing prospects for a prolonged trade war is a much more tangible headwind this time around. Furthermore, Trump’s willingness to threaten further tariffs on Mexico while the country was in the process of ratifying Trumps very own trade deal (USMCA) blows his legitimacy in the Chinese trade negotiations. Chinese officials recently noted their concern about the ability for any deal to be upheld even if they come to compromise on key issues.
The Trade situation seems relatively binary with the G20 meetings in late June offering either an escalation of trade concerns and more downside or a resolution and likely better equity performance. We currently have market hedges that are close to current S&P 500 levels and have hedged directly several names with Chinese trade exposure. We fortunately had limited exposure to industrials or semiconductors, two of the worst performing sectors last month. This was due to our belief that earnings expectations were too high for these sectors and valuations which already reflected accelerations in growth that were challenging to envision. While this helped us avoid some losses in key sectors, our exposure to energy has been impacted on concerns over global growth in demand. This has occurred despite already historic low valuations that in our minds offer margin of safety if crude prices were to continue to fall. The vast majority of our energy exposure is outside of Canada with holdings in producers who sell into the Brent crude market or have exposure to the U.S. Permian basin. Typical of our energy holdings are free cash flow yields well over 10%, solid balance sheets and growing production.
We used the opportunity of recent weakness in healthcare stocks to re-enter several positions in the sector. We had lowered our weighting in the spring considerably on the expectation of increased rhetoric from more left leaning members of the democratic party. After a considerable sell-off we’ve repositioned in several medical device companies and diagnostics businesses. We feel both sectors will be more defensible in a more uncertain U.S. medical reimbursement environment. The Medical device industry has historically been a deflationary pricing industry and therefore is likely to be less of target compared to drug manufactures. Both sectors offer long-term secular exposure to emerging market growth as well as double digit earnings growth and mid to high single digit revenue growth potential. We also re-entered our position in Anthem. While we do see some near-term political saber-rattling risk and have hedged the position using put spread collars into the democratic primaries.
Finally, the ongoing decline in yields across the curve continues as global central banks turn more dovish. Historically, this would be seen as a negative for banks however we note that banks profitability has been improving over the past several years even with limited improvement in yields. We continue to hold substantial positions in financials, particularly U.S. banks and a large insurance company. We expect our U.S. banks (Bank of America and Citigroup) to score well in upcoming Fed stress tests CCAR and we believe both banks are well positioned to increase capital return to shareholders going forward.
Until next month,
The Enhanced Team.
Source: Ninepoint Partners, Bloomberg
1 All returns and fund details are a) based on Class/Series F shares/units; b) net of fees; c) annualized if period is greater than one year; d) as at May 31, 2019; e) inception date for Ninepoint Enhanced Equity Class is 04/16/12. The index for the Ninepoint Enhanced Equity Class; Ninepoint Enhanced Long Short; and Ninepoint Enhanced Long Short RSP is 50% TSX & 50% S&P 500 (CAD) Blended Index and is computed by Ninepoint Partners LP based on publicly available index information. The index for the Ninepoint Enhanced US Equity Class is S&P 500 TR USD and is computed by Ninepoint Partners LP based on publicly available index information.
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