Currency & Sector Liquidity Analysis Report: Q1 2019

April 30, 2019

In times of market turbulence, active portfolio managers may increase in cash by selling off a proportionate percentage of securities within the portfolio. They also 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’ first-quarter cash deployments, and what it might tell us about fund managers’ thinking on market direction.

In this 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.

Average portfolio weights for world currencies

Chart 1 illustrates the mean cash percentage in Canadian investment funds for nine major currencies in sequential order from January 2019 to March 2019. The U.S. dollar posted a 3.7% decline month-over-month decline for the period ended March 31, 2019, while the Canadian dollar gained 5.1%. Similarly, the Japanese yen (JPY) lost 35.2%, the euro (EUR) broke even, the British pound (GBP) gained 110.2%, the Swiss franc (CHF) advanced 72.6%, the Australian dollar (AUD) dropped 32%, the New Zealand dollar (NZD) gained 378.3%, and the Chinese yuan (CNY) was flat.

U.S. and Canadian cash on hand

Chart 2 illustrates the mean cash dollar value in sequential order from January 2019 to March 2019. The U.S. dollar had a net position of $3,444,208,867 for March 2019. The Canadian dollar had a net position of $4,023,725,992 for March 2019.

It is evident now that the markets overreacted in the selloff during the last few weeks of 2018. The S&P 500 Composite Index is at the brink of breaking out to a record high above 3,000, and with the U.S. economy growing at a strong 3.2% in the first quarter of 2019, it seems likely that we will continue to see record-breaking performance in American stock indices.

It is also evident from the Graph 1 above that U.S. dollar deployment is on the rise, and with some highly anticipated IPOs coming to market, we expect further deployment in the coming quarters. Sector equity funds mandated to invest in technology have long-time unicorn Uber in their crosshairs, looking for a US$91.5 billion valuation. Lyft Inc., on the other hand, has been in negative territory it debuted at the end of March. The U.S. Federal Reserve continues its dovish stance, but with impressive growth data, the probability of a hawkish turn is rising. Tariffs and import quotas on China have helped slow down the “Made in China 2025” initiative.

Canadian markets have also performed well since the beginning of 2019. The Bank of Canada has cited commodity price weakness as well as a housing price slowdown in key urban markets as reasons for holding interest rates steady in the coming months. The S&P/TSX Composite Index has not seen a positive year since 2016, although there is some hope that rising infrastructure spending and upward pressure on crude oil prices will support the Canadian stock market in 2019.

The U.K. story remains the same, with some analysts arguing that the British pound has entered oversold territory. The most interesting part of the analysis is the turn of weighting in the Chinese yuan, partly due to the rising 2019 growth estimates by the International Monetary Fund and the improvement of trade tensions with the United States.

European Union cash is on the rise, as powerhouse Germany is expected to see the weakest year since 2013, partly due to U.S. protectionist policy. The GDP growth estimate was revised downward by 50% to 0.5% from 1.0%, mostly due to manufacturing sector weakness.

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 and the bullish or bearish sentiment in these investment categories. The accompanying table shows the top and bottom 10 out of 54 applicable sectors based on the mean ratio of over 3,000 investment funds with a mandate to invest in the corresponding sectors.

The red highlights the 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 highlights the 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.

Q1 2019 Summary

Looking at our previous Q4 2018 Liquidity Analysis Report published in February, we find that Financial Services Equity was significantly overweight at -1.36%. The iShares S&P/TSX Capped Financials Index ETF (TSX: XFN) returned 10.20% in the first quarter of 2019. The analysis demonstrates that fund managers were able to forecast this sector efficiently.

In other sectors, we observe that crude oil’s recovery has contributed to strength in the Commodity category, and Sector Equity has bounced back from last December’s lows as the NASDAQ has recovered all its losses from the last quarter of 2018.

Greater China Equity should be on everyone’s radar, too, as an increasing number of ETF products focusing on Chinese technology and equity come to market.

Meanwhile, the real estate slump and downward revisions to EU growth have led to underweighting in the Real Property category.

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