“If the message of 2017 was ‘growth without inflation,’ 2018 looks vulnerable as this favorable tradeoff is bound to deteriorate through 2018...We forecast a 5% to 10% drawdown in the major markets in the next six months, largely driven by concern over higher interest rates.”
These lines in the Q4 2017 commentary of Calamos Phineus Long/Short Fund (CPLIX) explain how the fund was positioned at the start of the year—and the fund’s performance over the last week.
(While the time period is too short for us to cite here, we encourage advisors to research CPLIX on your favorite data provider site. The actively managed long/short equity fund is doing what advisors need it to do for their clients. For additional insight, see the difference in CPLIX’s correlation to the S&P 500 versus other funds in the Morningstar Long/Short Equity Funds category.)
January was a month when investors shouted “just get me in,” says Co-CIO and Senior Portfolio Manager Michael Grant. “These types of over-excited price moves rarely end quietly. Part of our role, as hedged managers, is to lean against this kind of risk, which is why our net exposures moved to the lower end of our range.”
Grant presented the below chart at a meeting in January, saying, “This is a sentiment measure slide that I’ve followed for 30+ years. Whenever it gets to an extreme, you want to lean against the wind.” He specifically pointed to momentum-driven passive money as responsible for extending the euphoria. The reversal of passive flows adds additional uncertainty to the outlook.
A Turning Point
With the market of the last few days validating his earlier concerns, Grant says, “It’s no longer just about earnings, but earnings and interest rates.” This is a new paradigm for investors because prior market stress since 2008 has always been led by deflation.
“The bond proxies will no longer work as defensive havens,” he says.
Last year marked the climax for financial conditions in the U.S., according to Grant. Equities can still “win” this year but not as easily as in 2017. He continues to think of 2018 as “a topping year” and one likely to frequently test its major moving averages. While not necessarily a negative, “it certainly changes the character of the progression of equities.”
The portfolio manager believes that price multiples for leading U.S. equity indices may have peaked, due to a higher cost of debt. Grant calls the yield breakout of long-dated Treasuries a leading indicator of a major turning point for the volatility of all major financial assets. For the first time since 2008, he says, “the return of genuinely normal monetary conditions is a credible prospect.”
Because the cost of debt has been more influential in this investment cycle than the cost of equity, equities will be highly sensitive to changes in the Federal Reserve outlook. Watch the March Fed meeting for signs of an inflection, suggests Grant.
Ultimately A Buyer
Grant expects this extended consolidation with rising volatility to dominate markets in coming months. “Our ultimate objective is to buy this move once the passive excesses have run their course,” he says, because this is not yet “end of cycle.” As Grant highlighted in early January, 2018 can be described as late-cycle for equities, but that is not the same as “end of cycle.”
The key is what to buy once the dust settles. Grant believes that early 2018 is as good as it gets for a range of cyclical sectors. “It is time to shift away from the industrial part of the economy, back to the consumer,” he notes. Grant remains positive on the financials sector as the fund’s primary cyclical play.
Many still want to buy the defensive and consumer staples stocks after periods of uncertainty, but this will be a mistake, according to Grant.
“There is no new deflation risk on the horizon,” he says. Profit growth will continue into 2019, which is why this is not yet “end of cycle.” In the short term, he says “capital preservation is our focus, but investors should not assume that defensive stocks will outperform if deflation is no longer the enemy.”
Grant remains negative on China, which he views as more vulnerable to the return-to-normal of U.S. monetary policy. The symptoms of credit stress continue to rise in China.
For more on how CPLIX is being actively managed, watch these videos with Michael Grant. Financial advisors, for more information about CPLIX or Grant, talk to a Calamos Investment Consultant at 888-571-2567 or firstname.lastname@example.org.
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Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
Data as of 12/31/17
The principal risks of investing in the Calamos Phineus Long/Short Fund include: equity securities risk consisting of market prices declining in general, short sale risk consisting of potential for unlimited losses, foreign securities risk, currency risk, geographic concentration risk, other investment companies (including ETFs) risk, derivatives risk, options risk, and leverage risk.
Class I shares are offered primarily for direct investment by investors through certain tax-exempt retirement plans (including 401(k) plans, 457 plans, employer-sponsored 403(b) plans, profit sharing and money purchase pension plans, defined benefit plans and non-qualified deferred compensation plans) and by institutional clients, provided such plans or clients have assets of at least $1 million. Class I shares may also be offered to certain other entities or programs, including, but not limited to, investment companies, under certain circumstances.
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Morningstar U.S. Funds Long/Short Category: Long-short portfolios hold sizable stakes in both long and short positions in equities and related derivatives. Some funds that fall into this category will shift their exposure to long and short positions depending on their macro outlook or the opportunities they uncover through bottom-up research. Some funds may simply hedge long stock positions through exchange-traded funds or derivatives. At least 75% of the assets are in equity securities or derivatives.