Correction in March continues—disagreeable development of fund price

In March, the correction at the stock markets, which had started in February, continued. In contrast to the previous months, Mellinckrodt’s performance was not stellar, with the biggest decline of the fund price to date since the fund was launched. The extent of the decline is comparable with the cumulative decline in the crisis months January and February 2016.

This was caused by various aspects. The decline of the tech shares in the U.S.—heavily weighted at Mellinckrodt—and its effect on technology stocks in Europe is certainly one of the main reasons. But two other effects were just as significant for the development of the fund price. New in March was that especially second-tier Swiss stocks such as Schindler, SGS, and Bucher suffered a disproportionally high price decline. Especially the development last week is reinforcing the impression that Switzerland is currently suffering intense capital flight. The result is a negative price development of the Swiss franc compared to the euro. Unusual in March was that Switzerland—as opposed to previous correction phases—wasn’t a safe harbor with a more stable development compared to Germany. The highly capitalized pharmaceutical stocks Novartis and Roche stabilized the Swiss leading index. Unfortunately, we weren’t able to realize this stabilizing effect with our selected Swiss second-tier stocks.

Another reason for the negative performance was the strong hedging of the fund which we had implemented since the middle of the month. This affected the fund price negatively in the last week of March as the stock exchange rose sharply, but the stocks in the fund participated in this upward trend only disproportionally low. Hedging costs were higher than gains from the stocks. As an undesirable result, the fund price declined further.

As consequence from the development in March, we have decided to change the hedging of the fund. We don’t use primarily the DAX for hedging any longer but hedge relative to the shares of the individual countries and segments. That has already worked well in the first half of April, with a significantly more stable development of the fund price. However, the fund price has participated disproportionally low in the rise of the stock exchanges as the capital preservation continues to be our priority. The light is still YELLOW rather than GREEN.

Noticeably, in the first quarter of 2018 the price declines focused on the liquid part of the stock market. Large caps were affected more than small caps. Should the correction at the stock markets continue, we can expect the small caps to catch up on the downward trend—with the usual delay—and then fall quite quickly and more sharply than the broad market. In addition, small caps are much harder to hedge with futures than large caps. When you compare the performance of stock funds in the first quarter, don’t forget to look up at Morningstar how high the average market capitalization of the assets in the particular fund is. Mellinckrodt is showing a comparably high value with an average market capitalization of 5.5 billion euro. That is quite different for some of the well-known funds. And we don’t intend to invest more in small caps again. We believe that the illiquidity risks simply remain too high..

Outlook

It is hard to say whether or not we’ve seen the lows of the year 2018. The stock exchange environment remains unclear. Our risks systems continue to indicate YELLOW rather than RED. A crash is not imminent. But the warning signs are increasing. For example, there is noticeably much talk about the supposed rise in raw material prices. At the same time however, the price for copper, which can be considered a good indicator for the economic cycle, is in downturn. As a result, we have significantly reduced our stock positions with Glencore, whose revenue is allotted to almost 50% in copper. We have performed similar reductions in positions for technology assets. However, with companies in the areas of vacuum, semiconductors, and robotics, which we focus on, no similar signs of weakness are noticeable as with industrial metals. We therefore feel more optimistic about this area. Regardless, we have expanded our investments in the areas energy (oil) as well as consumption and pharmacology. Late-cycle industries and topics are currently interesting.

But with all the bad news we need to point out that history has taught us that in the 60’s and 80’s, when the U.S. had decided on similarly big tax cuts, this had a significant impact. The respective upturns in the economic cycle took approximately twice as long as they normally do. Consequently, there is a not so small probability that Trump’s tax cuts could cause us to be only in the middle and not yet by a long shot at the end of the economic cycle.

But this positive outlook can only become reality when interest rates don’t rise too quickly and too sharply—and this, in turn, can unfortunately not be ruled out. And the kick-off of the reporting season in the U.S. on Friday showed furthermore that the trees don’t grow to the sky. U.S. banks presented good figures, but a subsequent exhilarating price development could not be observed. Probably more so a “sell on good news.“

On balance, the environment for strategies that bank on the selection of individual stocks, remains favorable from our perspective. Chances to peform better than the indexes are absolutely intact.

Sunny weeks are ahead—hopefully not only in nature but also at the stock exchange.