A major market rally in the last two months of 2023, in both the equity and bond markets, has left the impression that it had been a good year for financial assets. But without these two months, the results would have been quite lacklustre. Many investors are nevertheless now showing considerable enthusiasm for 2024, anticipating that central banks will soon begin a series of interest rate cuts. But we have our doubts.
Our results for 2023 reflect a prudent approach at a time when the markets lacked direction and were highly volatile. In this way, we successfully protected capital, but this defensive approach, and a few negative outcomes in the M&A and convertible bond segments left the fund flat for the year. In response, we have undertaken a number of initiatives to drive better results in 2024.
Financial markets are generally expected to be quieter during the summer months, providing just the right level of volatility for us to profitably manage our various arbitrage strategies. This period prepares us for the fall, when market volatility is at its highest, with all the risks that this entails.
The third quarter of 2023, however, proved to be the exception to the rule. Equity markets initially performed well in July, but just when many market participants might have been tempted to let their guard down, the markets turned around and logged a quick correction in the first three weeks of August. And September would prove to be even more volatile.
Far From a Smooth Ride
In the financial markets, there are certain events that can grab all the attention, but in the process they may hide a somewhat different reality. On equity markets, for example, last quarter’s sudden infatuation with artificial intelligence drove up all stocks closely or even remotely related to this industry. As a result, the second quarter produced major gains in some of the stock market indexes. But this masked a tenser situation in many sectors, as the March banking crisis continued to fuel fears among investors. As for the convertible securities market, it hit a rough patch, for no apparent reason.
In the midst of a banking crisis
It is not uncommon that something out of the ordinary will occur and suddenly change the trend in markets. Such abrupt changes are usually accompanied by high volatility. The first quarter of 2023 certainly provided a good example, when a run by depositors on a regional bank in California, the Silicon Valley Bank (SVB), triggered a sharp reversal in the upward trend in bond yields and a precipitous drop in stock prices over just a few trading sessions.
Our year began well enough, with our fixed income arbitrage strategies performing very well. Our other strategies were generally performing as expected, apart from a few developments in M&A transactions, which are discussed below.
What a Year It’s Been!
No doubt most investors will be pleased to finally have 2022 behind them. Throughout the year, much was made of the downturn in equity markets – and rightly so, with the S&P 500 ending the period down almost 20%. But we can’t forget the bond markets, which were ravaged by rate hikes during the year. The Canadian Universe Bond Index, which includes over 900 different bonds and had posted positive returns almost every year for decades, slumped 11.7% in 2022. As a result, there is no safe haven for investors looking to count on a balanced portfolio. Fans of portfolios built on an asset allocation of 60% in equities and 40% in bonds – the traditional portfolio – suffered major, almost unprecedented losses.
The last quarter saw our hedge fund deliver on one of its primary roles: preserving our investors’ capital. All the traditional asset classes once again posted negative returns in the third quarter, although the declines were less dramatic than in the first two quarters of the year. The Amethyst Arbitrage Fund produced a good positive return in the third quarter due to its diverse range of non-directional arbitrage strategies.
This was also the case in the first quarter. But it should be recalled that in the second quarter, the central banks admitted that they had underestimated the inflationary risks. This sent bond prices into a rarely seen downward spiral that forced us to chalk up some significant losses. We were confident that we could recover from much of that drop, given the nature of our arbitrage strategies, and this is what transpired. Much of the ground lost has now been regained. Although 2022 will probably be remembered for the losses incurred by many investors, we are confident that, in the end, the Fund will post positive results. Here follows a discussion of what happened in the third quarter, along with a sense of what the last quarter of the year may bring.
The stock markets were in flux throughout the first quarter. With the exception of Toronto’s S&P/TSX index, which managed to stay afloat, all the U.S. and European indices posted significant losses. Although the markets recovered rather well in the first two weeks of March, they then fell further, and the second quarter proved to be even worse. But the rout in the stock market was only compounded by the debacle in the bond market.
What a Quarter!
Not often do we see the equity and fixed income markets both post losses ─ even small ones ─ in the same quarter. But that was the case last quarter, and the losses were significant: approximately 5% on the S&P 500 and Dow Jones indices, and over 9% on the Nasdaq. Canada’s stock market nevertheless posted a healthy gain of over 3% due to the heavy weighting of the commodities sector. But it was the exception.
The situation was even worse in the bond markets. A sharp rise in bond yields, which peaked in March, resulted in negative returns of around 7% on the bond indices. Conservative investors who held balanced portfolios of stocks and bonds in this period suffered sizeable losses.
While 2020 may have required relentless hard work to recover from losses caused by the surreptitious arrival of COVID-19 in the first quarter, 2021 also presented its fair share of events, sometimes unusual and each requiring a response. This included social networks being used to manipulate the stock markets, with surprising and sometimes worrying results. We also saw considerable volatility in the bond markets, as the comments made by central bankers sometimes defied analysis and provoked confusion. In short, 2021 was not short on drama, all the way to the finish line.
In the last quarter, the M&A business was affected by some unfortunate and unexpected events. However, our varied strategies and many diverse positions produced a positive overall result. Here follows a closer look at how all this transpired.
Once again, the past quarter has demonstrated how the Amethyst Arbitrage Fund is well served by its diverse arbitrage strategies and the many positions it manages. Two of our three main strategies generated positive returns, resulting in a reasonable result overall.
On the other hand, some segments of our fixed income segment suffered as bond markets were dealt their fair share of chaos, to say the least. In keeping with our disciplined approach to risk management, we exercised caution, liquidating some positions where limited visibility prevented us from concluding that the risk was behind us.
As the last quarter of 2021 begins, we now find ourselves in a good position, convinced that the Fund will end the year profitably. Here follows a discussion of what happened in the third quarter and what we envision from now until the end of the year.
Even though we faced some adversity in implementing our yield curve arbitrage strategy, the fund performed well overall in the second quarter. And we are confident that, going forward, we can build on this momentum, despite a striking dichotomy between the state of the economy and financial asset valuations, the impact of having a new Democratic administration in the U.S., and the uncertainties surrounding the timing of changes to the Federal Reserve’s (the Fed’s) monetary policy. Let’s see how all of this relates to our key strategies.
Even though the financial markets were a disaster just 12 months ago, euphoria reigned in the first quarter of 2021. The markets had become fertile ground for good returns due to a new President in the White House, who brought an end to the chaos of the last few years, more than enough fiscal and monetary stimulus and, above all, a surprisingly rapid roll-out of a massive vaccination campaign. And yet...
Following the desperate situation in March, by the last quarter of 2020 we found ourselves almost in a state of exuberance. The year will be remembered for the markets’ quick and spectacular turnaround. Once it was confirmed that the COVID-19 pandemic was spreading with virulence in Europe and America, the financial markets were left ravaged at the beginning of the year and many managers lost their bearings. The rout continued until it became clear that governments and central banks could organize a rescue that would at least be temporary, and that science, with stunning efficiency, could provide the glimmer of hope we so desperately needed.
Given that each of our three main strategies generated positive returns, we are well placed to end the year in positive territory, just as we had hoped at the end of the second quarter.
Although this last quarter was quieter than the previous two, the factors provoking considerable volatility in the financial markets – COVID-19, a highly uncertain economy, and the U.S. elections – are still very much with us. We therefore believe that our investors’ best interests over the next few quarters will be well served by the Amethyst Fund’s approach, which is based on achieving an absolute return with less volatility.
In comments made on March 23, Jerome Powell, Chair of the U.S. Federal Reserve (the Fed) suggested that the financial markets would recover in the second quarter. He confirmed that a liquidity shortage was rapidly developing in all sectors of the economy, and he offered his assurance that the Fed would do whatever was necessary, and use every resource imaginable, to fill these gaps as required. That was all it took: a substantial rebound in the second quarter erased much of the historic rout in equity markets during the first quarter.
Even in an environment where equity markets were already shaken during the last 10 days of February, the Fund nonetheless posted an altogether very acceptable result, down barely 0.5% for the first two months of the year. But March would prove to be much more difficult.
While we would have liked to add a few percentage points to the fund’s return for 2019, but for that we would have had to relax our risk management criteria, and that was not something we were willing to do. In a period of very low interest rates, the search for yield continued to drive a growing number of investors toward equity markets. These markets had a spectacular year, despite fears of an economic slowdown due to trade wars and the ongoing chaos in political and economic management in the United States.
Summer began as if the financial markets would be relatively calm. The recovery in mergers and
acquisitions, which had started in the previous quarter, quickly lost momentum. But the markets
still delivered some surprises, as we know can happen. Air Canada announced its intention to
acquire all the outstanding shares in Air Transat, and bond rates suddenly became highly
volatile in early September. Once again, our diversified positions allowed us to post a positive
return for the quarter. Now let’s take a more detailed look.
Not all accidents on the financial markets are avoidable. There were situations in the last quarter that tested our resilience. But once again, by diversifying the overall portfolio well and focusing on arbitrage opportunities day-in and day-out, we were able to post results that are, at the very least, acceptable.
While we would have liked to add a few percentage points to the fund’s return for 2019, but for
that we would have had to relax our risk management criteria, and that was not something we
were willing to do. In a period of very low interest rates, the search for yield continued to drive
a growing number of investors toward equity markets. These markets had a spectacular year,
despite fears of an economic slowdown due to trade wars and the ongoing chaos in political
and economic management in the United States.
By mid-December stock markets had become so volatile that the financial markets were under a cloud of fear. Despite a rally that began on Christmas Eve, the markets racked up record losses for the month of December and were down sharply for the year. At year end, the S&P/TSX composite total return index was down 5.4% on the month, and down 8.9% on the year. The bond markets were also buffeted from all sides.
Concerns that hacking represents a national security risk have become so serious that we now need to factor them into our transactions in the mergers and acquisitions market. An unusually high rate of failed transactions led us to examine why this happened, and we have taken the necessary measures to manage this risk.
Throughout the second quarter there were hopes that the U.S. administration would finally understand that imposing tariffs, first on steel and aluminum and then on a long list of Chinese products, could only be bad for both the U.S. economy and the global economy. This hope quickly faded. The trade war between the U.S. and China began on July 6, when President Trump confirmed that he was imposing tariffs on $34 billion of Chinese products. An eye for an eye, a tooth for a tooth: as promised, China’s leaders quickly responded by imposing tariffs on the same amount of goods. However, the Americans then raised the stakes, announcing new tariffs on products worth another $200 billion, only to be quickly matched by the Chinese. With the improvisation and chaos that seem to govern decision-making at the White House, it is impossible to have any sense of where this trade war will end. What we do know is that an economic shock is inevitable.
We have known for several quarters that volatility would return to financial markets eventually, and it finally did in February, with a vengeance. The S&P 500 VIX volatility index, wich slumbered below its historical average of 16 for almost all of 2017 and even began under 10, shot up as 50 in early February.
Une croissance économique mondiale synchronisée, des bénéfices des entreprises en forte expansion, l’adoption d’une réforme fiscale majeure aux États-Unis et des tensions géopolitiques qui s’apaisent quelque peu ont marqué l’actualité économique et politique du quatrième trimestre. Tout cela a permis la poursuite de la hausse des marchés boursiers et a poussé en fin d’année l’indice S&P 500 à 2674, soit un gain d’environ 20 % depuis un an, un résultat certainement supérieur aux attentes des stratèges financiers les plus optimistes.
Economies are doing very well, thank you. In spite of the expected impact from the hurricanes, the U.S. economy’s growth in the third quarter surprised most observers, reaching 3% according to the initial estimates of the U.S. Department of Commerce. Growth in the previous quarter stands at 3.1%. In Canada, even though we knew that the 3.7% and 4.5% growth achieved in the first two quarters of 2017 was unsustainable, the projected rate for the third quarter is still 2%. So the final figure for 2017 is expected to be approximately 3%. Annualized growth of the global economy now stands at around 3.7%, and the manufacturing indicators (global PMIs) are almost systematically reaching unprecedented highs.
The replacement of the Affordable Care Act (Obamacare) would have funded significant tax cuts in the U.S. and underpinned both economic growth and investors’ enthusiasm.
Donald Trump’s arrival in the White House has had an impact on markets as much as minds. The spectacular market surge that began the day after the November 7 election returned in a second wave in February following his inauguration as 45th President of the United States of America. But after a few weeks, it became evident that he would face an uphill battle turning rhetoric into action.
The climax of the fourth quarter of 2016 was undoubtedly Donald Trump’s election to the White House and, probably more so, the Republican majorities in the House of Representatives and the Senate. After a shaky night, risk assets reacted positively the following day. The new president is in a strong position to implement, without too much opposition, his stimulus program, combining tax cuts and increased public spending.
Until recently, the expansion of global central bank balance sheets seemed con-demned to increase indefinitely. But (thankfully), monetary policy makers have had a serious wakeup call: quantitative easing (“QE”) is less and less economical-ly effective and potentially harmful in the setting of risk premiums via negative short-term interest rates.
A multitude of risk factors have unsettled the markets during the first six months of the year. Britain’s decision to exit the European Union (51.9% vs 48.1%) has sent shock waves through financial markets and rattled investors who underestimated its risk. It is the most recent and blatant example of the growing global trend towards protectionism. It will have tremendous repercus- sions on the geopolitical landscape including this fall’s US election.
The first quarter of 2015 saw weaker than anticipated economic data south of the border. However, accompanying this slowdown in consumption, which was deemed temporary, was a new injection of stimulus to the global financial system. In theory then, we have a recipe for US stock prices to rise in the coming months, that is, unless geopolitical risks spoil the mix…