Artemis Strategic Assets Fund update

Source for all information: Artemis as at 31 December 2023, unless otherwise stated.

Our ‘Market Driver Models’ (MDM) turned less negative on equities but remained very negative on government bonds. They have moved to maximum positive on credit. Within equities, the models are negative on emerging markets and became more negative on Europe relative to the US. In fixed income, the models continue to point to a steepening of the US yield curve.

The quarter began poorly for markets with many asset classes experiencing a third consecutive month of declines in October. However, sentiment turned sharply at the end of the month and most markets enjoyed a sharp rally into year end. Against this backdrop, the fund delivered a positive return in October and an overall return of +1.0% over the quarter. This was ahead of the benchmark but behind the IA sector return.

Our strategic long in US 2-year bonds added value and we have been taking profits. In the tactical MDM basket, our short emerging markets vs. US equity position added value. This was offset by the short in UK gilts which rallied significantly.

Market backdrop

The attack by Hamas on Israel at the beginning of the quarter led to a sharp sell-off on concerns over heightened geopolitical risk and the potential for an escalation of the conflict. Additionally, continued strong economic data from the US fuelled expectations of ‘higher for longer’ rates and the impact on equity valuations and the broader economy.

Markets rebounded sharply in November and December, reversing weakness in the preceding three months. Both equity and fixed income markets were buoyed by rising expectations of a soft landing and a dovish pivot (lower interest rates) from global central banks.

The broad-based rally was sparked by the FOMC meeting where Fed Chair Jerome Powell stated that financial conditions had ‘tightened significantly’ and it gathered steam following the release of the October US CPI data. Bonds rose sharply, with the US aggregate bond index posting its strongest monthly return in November since the mid-1980s. The NASDAQ rose more than 10%, outperforming the 9.1% return of the S&P. European and EM equities also rallied.

Performance/Portfolio Activity

The fund rose 1.0% during the quarter, behind the peer group return of 5.5% but ahead of the target (CPI +3%, which was 0.2% for the quarter). The fund continues to demonstrate low correlation to traditional assets, a key objective of the strategy. Since the change in fund manager, the fund has shown a low correlation to equities, bonds and commodities (see below):

Over the quarter we consolidated our Market Driver Models to focus on the highest-quality drivers. The models turned markedly negative on government bonds but moved to maximum positive on credit. Within equities, the models are negative on both EM and Europe vs. the US. In fixed income, the models suggest a steepening of the US yield curve.

Our strategic positions continue to do well, offsetting some weakness in the MDM and FX premia strategies and showing a high degree of diversification in the portfolio. Within the strategic portfolio the materials equity sector trade and 2-year US rate long position were the top contributors.

The FX risk premia strategy underperformed. In particular the long euro, short Polish zloty position cost c.0.13%, before we were stopped out of the FX premia bucket a week before month end.

Within the MDM portfolio, the short UK gilt position detracted as gilts rallied sharply. The short in financials also detracted. The position hit our downside target and we cut it entirely – in line with our strict stop loss policy. Partially offsetting this was strong performance from our EM vs US equity short – one of our best performing trades during the period.

Outlook

The market’s interpretation of a dovish pivot led it to price in further rate cuts in 2024, beginning as early as March, leading both equities and bonds to rally in December.

US economic data, notably in the labour market, hasn’t really been sufficiently weak as to imply a recession is imminent, yet over 150bps of rate cuts are already priced for 2024. In the short term, therefore, some retracement in the rally in bonds, and a pause in yield curve steepening (short-dated yields falling faster than long-dated yields) is somewhat likely. Equally, this could put pressure on US stocks, which enjoyed a strong rally in December.

Nevertheless, we are moving into a period when developed market inflation is falling toward central banks' targets, and this gives them greater flexibility to reduce interest rates in response to weaker growth. Once rates start to be cut, then equities and bonds typically appreciate in price terms.

However, once economic growth begins to slow significantly, corporate earnings will roll over, and stocks will actually fall as the economy moves into recession, this is likely to happen sometime in 2024 across most major economies.

Our US equity sentiment indicators continue to signal extreme optimism, implying that a reversal in stocks is still likely in the coming months. This is further supported by earnings revisions that are declining in most major indices. However, we recognise that while more and more rate cuts are priced in this year, implying financial conditions will ease, this can provide a temporary boost to stock prices.

The rebound in European equities has been for similar reasons, with a slowdown in 2024 expected although the European Central Bank have been pushing back against the market’s rather optimistic rate cuts. As one of Germany’s largest trading partners, the slowdown in China is likely to continue supressing activity in the European manufacturing sector, and the region’s energy costs remain highly susceptible to unpredictable geopolitical events.