June Holdings and a Look Ahead

Below are the TCquant holdings for the month of June. As the portfolio settles into a rhythm, our turnover rate is greatly reduced this month. Notably, we dropped HMC as motor sales continue to decline across the US, but replaced it with CPS, an auto parts supplier. We primarily selected CPS on a quantitative basis. It certainly faces similar headwinds to HMC, but is more sector-oriented and has been our top performer thus far in June. We also continue to hold CVS. The market greatly undervalues it prior to its acquisition of Aetna. We expanded our total number of equities selected this month for greater diversification benefits and lower residual risk.

Our top performers besides CPS thus far have been DG and FDC. FDC is a fundamentally strong company with significant earnings growth projections and provides exposure to the outperforming tech sector. In a different vein, DG is a value buy following its steep selloff after an earnings miss that was attributed to poor weather conditions. So for this month, we technically lag our benchmark by 15bps. However, this is entirely because we missed out on the positive stock swing the weekend of June 5th, when we were not invested. On a purely apples-to-apples basis, we are ahead of the benchmark by about 0.5% while maintaining 2/3rds of the risk.

Looking ahead, the markets will be focused on similar themes as in past weeks: inflation, interest rates, and most importantly, trade talks. Between Trump’s summit with Kim Jong-un and a full economic calendar, it could prove for a volatile week.

Inflation numbers will come in the form of the CPI on June 12th and the PPI on June 13th. Consensus estimates put both the core CPI and core PPI at increasing 0.2% for the month of May. Any deviation to the upside will likely spook markets, as it would provide more support for four rate hikes rather than three this year. A 0.1% increase could potentially benefit equities, but best case the consensus estimate is met.

Interest rates will almost certainly be hiked at the Fed’s meeting on June 12th, with the announcement coming on the 13th. The market prices in a 91.3% chance for a rate hike at this meeting, but it could be affected by a weak reading on the core CPI number that comes out the same morning as the meeting. The markets currently expect a total of three rate hikes in 2018. The probability of four hikes has risen slightly over the past week. So far, as equity investors we’ve been happy to see the 10-Year Treasury Yield remain below the psychological 3% threshold, but I expect the 10Yr benchmark to comfortably exceed 3% after the Fed’s meeting.

Outside of the US, the ECB meets on June 13th and may for the first time publicly acknowledge an end to the bond-buying program. ECB economists point to the strength of the EU, which is entirely misplaced. The EU has started to lag in global growth and will feel more pain the faster the ECB makes moves that increase interest rates. This is a nuanced topic, but for support note that ECB head Mario Draghi recently noted “a loss of momentum that is pretty broad based across countries and all sectors.” Further, the Citi Economic Surprise Indicator, which measures consensus estimates versus actual results, is nearing its lowest level since 2011.

Finally, Trump’s talks with Kim Jong-un will be the biggest market-moving activity this week. Signs are mostly positive heading into the talk, with promises of economic development in NK in exchange for total denuclearization. A positive outcome would boost markets and be a major win for the Trump administration. Trump has signaled his usual willingness to walk away from a bad deal, but there’s no doubt the US is battling on too many fronts, so I would not be surprised to see some sort of compromise reached.

Outside of North Korea, tariffs on steel and aluminum imports from Canada and the EU continue to weigh on the market. Gary Cohn resigned over his dislike of this strategy, as taxing inputs to goods affects too much of the economy. The G7 meeting this weekend only solidified the continued existence of the tariffs. Mexico has also entered the mix with the imposition of $3B worth of import tariffs. Importantly, the EU and Mexico have seen their economies stagnate in recent weeks and have more to lose from a trade war. The Mexican peso has also depreciated significantly. With any luck this situation can be resolved over the next few months, and trade policy can return to dealing with China and intellectual property theft. Overall, we see the trade situation worsening slightly before agreements are reached, and the markets will respond accordingly.

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