The Widening Gyre

To twist the (almost certainly apocryphal) Chinese curse: we now live in interesting times. The first full month of US President Donald Trump's second term concluded with a bizarre series of meetings at the White House, most notably a relatively conciliatory meeting with UK Prime Minister Keir Starmer on 27 February, followed by a chaotic meeting with Ukraine’s President Volodymyr Zelenskyy a day later.

Trying to make sense of this Trump administration feels like a futile task, given the propensity for rapid changes in narrative, but for one’s sanity, one must strive to remain optimistic.

The optimistic path goes something like this: Trump is simply stating – albeit rather frankly – some home truths to the rest of the free world: that NATO in general, and Europe in particular, have relied disproportionately on US military support, and that they need to up their game.

The response so far has been on point: European countries have announced increases in defence spending and are coordinating plans to work together in the face of Russian aggression, without support from the US.

But (so the Panglossian might continue), when push comes to shove, the US will ultimately side with its long-term allies and other democratic nations in any global conflict. One must hope that the current episode of disagreement between former close allies is merely a more public airing of previously private grievances and nothing more ominous. At least global financial markets do not reflect significant concern that the long-standing order of political alliances is about to be rewritten.

Equity rout

Outside of politics, the wider market picture last month was one of deteriorating fundamentals. Markets began selling off around 19 February, coinciding with three pieces of negative news. Firstly, UK year-on-year CPI came in at 3.0%, 0.2% higher than analysts’ expectations. Secondly, Walmart issued poor earnings guidance, citing pressure on consumers. And thirdly, the release of the Federal Reserve meeting minutes highlighted increased inflationary pressures and less urgency to cut rates. Two days later, the University of Michigan Consumer Sentiment Index recorded its lowest level in over a year, significantly below expectations. Taken together, the picture is one of rapidly deteriorating consumer buying power in the face of stickier-than-expected inflation.

Equity markets took the hint. On 21 February, the S&P 500 recorded its worst day of the year at that point, and despite relatively market-positive news from the German election (votes in line with polls, no surprise outperformance from the far-right Alternative für Deutschland (AfD)), markets continued to sell off through most of the last week of the month. However, none of the concerns around sticky inflation are particularly new, and market technicals have ensured that previous dips over the last three months were quickly bought. Indeed, the S&P 500 staged something of a rally in the final hours of the last trading day of the month – somewhat at odds with the geopolitical turmoil unfolding concurrently at the White House.

And so, we find ourselves once again at a possible inflection point: if equities rally back to their highs, it suggests that the weight of capital seeking a home in equity markets may outweigh concerns about fundamentals over the next few months (after all, ‘buy-the-dip’ markets can become a self-fulfilling prophecy for a time). However, markets now feel potentially more fragile than they have in several months. Geopolitics remains noisy, trade tensions persist, and a continuation of inflation concerns, and weaker corporate earnings could push US equity markets lower.

Key drivers of hedge funds' performance: An early February snapshot

Equity Long/Short (ELS):

• Generally, US equities were weak in February, while equity markets in the rest of the world performed well due to lower exposure to highly-valued technology companies
• Earnings season continued into February, with all eyes on Nvidia toward month-end. A risk-off tone was apparent across the US Technology, Media, and Telecommunication (TMT) space, driven not just by hedge funds but also by retail investors. This spurred a selloff and unwind in US momentum, while European momentum maintained its strong start to the year
• ELS performance was strong through mid-month, but some weakness emerged in US and global managers toward the latter half. As noted above, pressure on performance was most apparent in sector-focused TMT, consumer, and, in some cases, healthcare managers
• Positive sentiment towards Asia continued early in the year, as managers looked to benefit from repositioning of exposures away from the US

Credit:

• It was a volatile and modest risk-off month for credit, driven by global growth concerns. US Treasuries rallied, credit spreads widened slightly, and equities were negative. Investment grade credit outperformed, supported by duration
• Corporate credit managers were generally positive for the month, with managers that had exposure to certain convertibles, including some China-related American depositary receipts (ADRs) and tech or healthcare names benefiting from positive idiosyncratic events (exchanges, new issues) outperforming
• High Yield Long/Short and Capital Structure Arbitrage strategies were generally positive contributors to performance, despite index volatility and macroeconomic noise
• Structured Credit managers were also up in February, driven by ongoing strong carry and modest spread tightening across certain sectors

Event Driven:

• February appears to have been a positive month for Event Driven strategies overall, particularly in Asia Special Situations. Merger deal activity was similar to January – steady but unremarkable
• Of the announced deals, the more interesting ones for the hedge fund community were: Italy’s BPER Banca bidding US$4.5 billion for Banca Popolare di Sondrio, the latest transaction in Italy’s banking sector; Prosus acquiring Just Eat Takeaway for approximately €4.1 billion; and Mitsui & Co. acquiring a 40% stake in Rio Tinto’s iron ore project, Rhodes Ridge, for US$5.34 billion
• Japan’s Seven & I could not secure the financing required for a US$58 billion management buyout (MBO) to ward off a US$47 billion rival offer from Alimentation Couche-Tard, which increases the likelihood of the Canadian takeover bid
• Some post-restructuring situations continued to re-rate positively, including Atalian and Atos. Other restructuring highlights include: Idorsia finally agreeing to a restructuring with creditors, which will see its bonds extended and a new money provision introduced; and KTM (the motorbike manufacturer) agreeing to a restructuring plan in which only 30% of its €2 billion debt will be paid back to creditors, with confirmation by the courts expected in June

Macro strategies:

• It appears to have been a positive month for Discretionary Macro managers at the time of writing. Although ‘Trump Trades’ have broadly struggled since the president's inauguration in January, managers seem to have monetised the volatility well, suggesting they have not been drawn into overtrading the capricious news flow
• Japanese macro themes contributed to performance, particularly those biased toward Japanese yen longs, as the currency rallied on narrower yield differentials and weaker risk sentiment in the latter half of February
• Emerging markets continued to bolster returns. Ukrainian credit and longs in Central and Eastern European (CEE) FX performed well on increased hopes for a ceasefire in the Russia/Ukraine conflict, despite material noise at the end of the month. Venezuela and Lebanon profited in non-performing credit; however, there was some giveback in widely held Turkey and Argentina themes
• US fixed income trading posed challenges. Cross-market themes, notably those against euro area fixed income, struggled, while directional shorts lost money as Treasuries rallied. Shorter-dated curve steepeners detracted, while longer-dated structures (e.g., 10s30s) added. Elsewhere, performance in US swap spreads improved as they tightened, driven by both Fixed Income Relative Value and Directional Macro strategies

On-the-radar:

• The short-term focus remains on the push for peace in Ukraine. European leaders appear united with Zelenskyy, and the immediate concerns around geopolitical risk centre on whether Trump can be persuaded to support a peace plan
• Outside of politics, fundamental data will become increasingly important over the next few months, given the apparent weakness of the US consumer and the persistence of global inflation