Currency & Sector Liquidity Analysis Report: Q2 2019

August 5, 2019

Active portfolio managers may increase cash by selling off a proportionate percentage of securities within the portfolio, or they might make calculated bets on earnings and macro-level events by using cash balances to increase overall exposure to the market, ultimately increasing risk. By analyzing the deployable cash in investment funds, we can assess the street’s market sentiment and get a fix on the liquidity of investment funds on a cash and cash-equivalents basis. Here’s a look at funds’ second-quarter cash deployments, and what it might tell us about fund managers’ thinking on market direction.

In this second-quarter report, currency analysis excludes all cash equivalents, such as bonds with less than one year to maturity and collateral cash held to fulfill debt covenants. We believe that by excluding these items, we can home in on the deployable cash in investment funds and assess the street’s market sentiment. We then further analyze the liquidity of investment funds on a cash and cash equivalents basis categorized by sector to help us understand which verticals portfolio managers are currently overweighting and underweighting.

This report also includes the liquidity data for newly created CIFSC categories for Liquid Alternative mutual funds.

Average portfolio weights for world currencies

The table below illustrates the month-over-month growth rates for the world’s major currencies.

Chart 1 illustrates the mean cash percentage in investment funds for nine major currencies in sequential order from April 2019 to June 2019.

U.S. and Canadian cash on hand

Chart 2 illustrates the mean cash dollar value in sequential order from April 2019 to June 2019. The United States dollar had a net position of $3,596,782,139 for June 2019. The Canadian dollar had a net position of $4,224,457,550 for June 2019.

U.S. dollar deployment continues to rise as the economy maintains positive growth and stock market indices surge to record highs. Jerome Powell, Chairman of the Federal Reserve Board, was much criticized by U.S. President Donald Trump earlier in the year for not cutting the federal funds rate.

But with the Fed’s July 31 rate cut now on the books, the American stock indices are expected to continue rallying. Initial public offerings (IPOs) have been one way for investors to add alpha into their portfolios, with companies like Uber Technologies Inc. (NYSE: UBER), Beyond Meat Inc. (NSD: BYND), and Pinterest Inc. (NYSE: PINS) trading above their IPO prices. In addition, the rental residence sharing company Airbnb will likely be the next hot IPO coming to market this year.

U.S. GDP grew at a 2.1% annual rate in the second quarter, and while lagging last year’s numbers slightly, the American economy continues to operate at near-full employment, with solid wage growth and inflation contained. However, unresolved trade tensions with China continue to hamper business sentiment.

The Canadian market has been a tough one to navigate in the past quarter. While the market is up year to date, some specific verticals continue to outperform significantly relative to others, including financials, industrials, and mining.

Natural gas prices have since reverted back to their long-term mean, while gold prices have enjoyed a double-digit increase. The precious metals sector in particular has done very well for the materials- and metals-dominated TSX Exchange.

The Canadian dollar has gain strength against the greenback, and the mortgage rules stress test has also been watered down to help improve affordability, perhaps lending some support to the housing market. These two developments together, have the potential to help boost Canadian stock markets.

However, fund managers seem to be a little more wary of the Canadian market, and have engaged in some profit taking. The table below shows the multiple Canadian equity categories that have the highest liquidity ratios, which could spell future underperformance. At this point, it looks like large-cap Canadian equity is still bullish while small- and mid-cap Canadian equity might require some high conviction positions.

Chinese markets are doing well on an annual basis with much of the trade problems, including operating restrictions by numerous foreign government on Chinese government-controlled telecom Huawei, having tail-wind effects. European markets have pulled back and may be slow to react to recent monetary hints about a more expansive monetary policy from European Central Bank president Mario Draghi.

The United Kingdom is on global watch as new Prime Minister Boris Johnson takes over leadership of the governing Conservative Party from Theresa May, widely seen as a weak an ineffectual leader. With GDP cash rising 11.5% month-over-month, the downfall in the pound may finally be at an end, and money managers may finally be looking to reenter the market that was obliterated with May’s mish-mash of Brexit uncertainty.

Investment Fund Liquidity Ratio

The Investment Fund Liquidity Ratio is calculated as the amount of cash in a fund relative to its total assets. It is important to assess this ratio when analyzing investments and allocating capital. It has the power to give incredible insight into the overall flow of capital into specific verticals as well as the bullish or bearish sentiment in these investment categories. Listed in the table below are the top and bottom 10 out of 58 applicable sectors based on the mean ratio of over 3,000 investment funds with a mandate to invest in the corresponding sectors.

The red section highlights sectors with the highest ratio, which translates into underweighting their respective indices. This could mean that portfolio managers are expecting negative performance in these categories.

The green section highlights sectors with the lowest ratio, which translates into overweighting their respective indices. This could mean that portfolio managers are expecting positive and alpha generating returns in these categories in the short term.

Review and outlook

Financials continue to show strength, with Canadian banks posting above-average earnings. In our previous report, commodity was significantly overweight at 0.8927%, resulting in a double-digit increase in the price of gold, with many of the largest mining companies trading at highs on the TSX and TSX Venture.

One notable change from the last report is that the Real Estate category is no longer a top-10 underweight category. Hinting at some positive news for the sector, mortgage stress test rule changes and potential rate cuts could be potential catalysts for performance among Real Estate funds.

Corporate and high yield fixed income are seeing some difficulty, as Treasury Inflation Protected Securities (TIPs) yields have fallen drastically.

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