O’Connor Global Multi-Strategy Alpha Monthly Letter

Markets in July saw some significant index, sector and factor rotations, following a more dovish than expected consumer price index (CPI) print combined with the surge in probability of a second Donald Trump presidency (see figure 1). This probability declined again toward month-end, following President Biden’s decision to step down from re-election and his endorsement of Vice President Kamala Harris as the new Democratic candidate.

Adding to some of this volatility, we have seen speculation that the US will tighten restrictions on semiconductor capital equipment exports to China. This weighed on the semiconductor sector as a whole and led to the largest five-day outperformance of the Russell 2000 index over the Nasdaq 100 index that we have seen since 2001, as shown in Figure 2. At its peak on July 17th, the Russell 2000 outperformed the Nasdaq 100 by more than 13 percent over the preceding five days. It should be noted, however, that while we believe continued tension in this area of trade is likely, we also believe a wholesale blanket ban on exports to China is unlikely given the dependence of certain key US semiconductor companies on cashflows generated from these exports. Cashflows from China ultimately help develop the US semiconductor industry. 

July was also marked by a number of important Supreme Court rulings, which have potentially altered both the influence that certain federal agencies can have in policymaking as well as changing the statute of limitations for plaintiffs who believe they are harmed by federal agency rules. This may lead to increased legal uncertainty in the short run – as we anticipate many legal challenges against recently issued or planned rules – but less regulatory volatility in the long run. We think this environment will have plenty of investment implications, specifically for energy transition-related value chains, which is an area of our focus.

Despite extreme rotation and unexpected volatility in markets recently, we continue to observe encouraging performance across many areas of our multi-strategy portfolio, which have benefitted from this backdrop. This broad-based contribution can be observed across our main verticals of equity long/short, global event driven and credit relative value. This speaks to our diversified approach and desire to allocate to more differentiated and less crowded areas.

For all the likely continued noise and volatility surrounding US elections in particular, we expect earnings to be a trigger for lower correlation and increased dispersion. We have noticed that management teams within the same industries have made different assumptions on the pace of economic recovery in the second half of the year. Similarly, different parts of the cost base are seeing varied inflationary trends, while portfolio change paired with M&A activity and plans around debt issuance are all leading competitors down different paths.

We remain vigilant around potential crowding and election-related risks and continue to ramp up our exposure in areas like Latin America and the Middle East who each have their own macro and policy cycles that offer less correlated alpha return streams and do not necessarily move in sync with the US.