Counterpoint Tactical Income and Tactical Equity June 2016 Fund Update
Counterpoint Tactical Income Fund Update
The Fund remains invested in high yield credit. As of June 21, the BofA Merrill Lynch High Yield Bond Master II® Index yields 7.28% versus the April 30 level of 7.58%. Over the same period, WTI front month crude has risen 9% from $45.92/barrel to $50.12. Stability in commodities and risk assets in general has enabled high yield to deliver solid returns. Meanwhile, US equities have drifted slightly upward despite the recent “Brexit”-driven selloff in risk assets.
Beyond the fuss around Brexit, we see the July non-farm payrolls report as the next major catalyst in global markets. The June report showed an increase of 38K jobs versus Bloomberg survey expectations of 160K. Two weeks after the release, Fed governors responded by tempering forecasts concerning the timing and aggressiveness of future rate hikes. The US 5 year yield reacted quickly, falling 30 basis points from June’s starting levels to June 15 lows.
Net Monthly Change of US Employees on Nonfarm Payrolls
The market responded by dramatically reducing forward rate expectations. Since the beginning of the year, the US 5-year has seen a drop from almost 1.80% to 1.07% just a week ago. This almost 75 basis point reduction in annual yield implied a cumulative “give-up” of approximately 3.9% of total return on an undiscounted basis. Put another way, the Federal Reserve would only be able to hike rates once per year over the next five years to enable the investor in that 1.07% yielding 5-year note to not overpay, assuming 1.80% was a fair priced initial yield expectation.
US 5 Year Government Yield
Given the historical context, such a move might only be justified if the global economy plunges into recession. Other indicators are not yet supporting such a trend. A look at manufacturing and services PMI data shows the US economy is still in a stable state, despite recent deceleration (with manufacturing PMI data likely impacted by the ongoing oil and commodities swoon).
Manufacturing (Yellow) and Services/Non-Manufacturing (White) US PMI Data
If jobs data does indeed turn positive in July or August, and the world does not blow up from an adverse Brexit vote, election uncertainties, and other unknown factors, we see interest-rate-sensitive assets (treasuries, high quality corporates, municipal bonds, even dividend-focused equities) as particularly vulnerable to downside price risk. If the “good news” is to resume, this should be supportive of credit and equity in the long run.
As usual, we must remind investors that our Fund positioning is quantitative and is dictated by price movement in the high yield corporate debt asset class, not the factors discussed above.
Counterpoint Tactical Equity Fund Update
The Fund is still positioned in a “risk-on” manner. This has been a small benefit to performance. Since the end of April, the market rose on positive economic news in the US and then fell amid uncertainty surrounding Britain’s EU membership. Improvements in factor performances during the last few months were supportive to Counterpoint Tactical Equity, as the reversal in behavior across several factors we noted in a previous update has dissipated. For example, underperformance from momentum firms in March and April has completely reversed in May and June. Factor returns seem to be returning to long-run averages, and we are seeing this effect in our own portfolio. For example, stocks in our short portfolio as of April 29th have actually declined an average of 2.9%, whereas long positions rose by an average of 1.4% over the same period. This suggests that the stocks we selected because of their factor exposures were well-chosen.
Factor Returns: Russell 2000 Quintile 1 minus Quintile 5 Return Spread
Source: S&P Capital IQ (June 21, 2016)
As a reminder, Counterpoint Tactical Equity invests in stocks which have exposure to multiple anomaly factors. A summary of returns from several individual factors styles – some of which Counterpoint Tactical Equity uses in its stock selection – are provided by S&P Capital IQ above.
Return Spread is the difference between the top quintile and bottom quintile returns, seeking to eliminate the broad market return to show performance on a factor. Size is a blend of returns to market capitalization and total revenues. Top quintile represents highest market capitalization and revenues. Volatility is blend of factors to total standard deviation in annual and recent month periods as well as beta to the broad market. Top quintile represents highest volatility stocks. Analyst Expectations represents factors such as realized earnings surprise versus expectations measures, and estimate diffusion (the net change in analyst expectations of earnings results). Top quintile represents the blend of signals that signify positive developments for companies relative to baseline expectation. Historical Growth represents a blend of factors including 1 year changes in cash flow and earnings per share. Top quintile represents those companies which have historically exhibited the highest growth rates. Price Momentum is a combination of momentum factors (i.e. recent 12 month return, five day returns, nine month returns). Top quintile represents stocks that have had the best recent price performance. Earnings Quality represents measures that describe the quality of earnings including net profit margin and stability of net income. Top quintile represents stocks which excel in these measures. Capital Efficiency refers to a firm’s ability to deliver excess returns relative to its cost of capital. It includes a blend of ratios such as return on equity, return on invested capital, and share issuance. Top quintile signifies companies that excel in these measures relative to the rest of the market. Valuation factors are variety of metrics some as book to market, earnings to price, sales to price, and cashflow to price. Top quintile represents stocks which excel in these measures.
The BofA Merrill Lynch High Yield Bond Master II® Index is an unmanaged index that tracks the performance of below investment grade U.S. denominated corporate bonds publicly issued in the U.S. domestic market. The referenced indices are shown for general market comparisons and are not meant to represent the Funds.
Past performance is no guarantee of future results. There is no assurance the Funds will meet their stated objectives. Investors should carefully consider the investment objectives, risks, charges and expenses of the Counterpoint Tactical Equity Fund and Counterpoint Tactical Income Fund.
This and other important information about the Fund is contained in the prospectus, which can be obtained at counterpointmutualfunds.com or by calling 844-273-8637. The prospectus should be read carefully before investing. The Counterpoint Tactical Equity Fund and Counterpoint Tactical Income Fund are distributed by Northern Lights Distributors, LLC member FINRA/SIPC.