Federated Prudent DollarBear Fund (C) FPGCX
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|A IS||Mutual Fund||Alternative and Objective-Based||World Bond|
Generally speaking, 2014 was a year shaped by unusually muted volatility—that is until the fourth quarter. In this final reporting period for the year, markets were everything but calm, and volatility was anything but low. The culprit responsible for all the instability was oil. Declining oil prices were the single largest destabilizing force in the closing months of 2014. Even the impact of augmented stimulus by both the ECB and Bank of Japan paled in comparison to the rapid decline of benchmark oil prices (WTI). Clearly, the hardest hit were the oil-producing economies, but ramifications were widespread and reverberated through practically every asset class.
Early in the fund’s reporting period, the Bank of Japan unexpectedly eased monetary policy, due to concerns that a decline in oil prices would weigh on consumer prices and suppress inflation expectations. The central bank decided to increase the pace at which it expands base money to about 80 trillion yen ($726 billion) per year. Just as notable, Japan’s colossal Government Pension Investment Fund (GPIF), owning as much as $1.1 trillion in assets, announced a holdings redistribution. Specifically, the fund would increase its equity holdings to 25%, from the prior 12%. This two-tier announcement sent the yen reeling lower in excess of 5% against the U.S. dollar (USD) in just two days.
Japan’s real GDP unexpectedly contracted by 1.6% quarter-over-quarter; this was following a 7.3% plunge from the preceding quarter. The GDP contraction took Japan into a technical recession; its fourth in just six years. This disappointment pressed Prime Minister Abe to take yet more aggressive action. The prime minister countered by delaying pending tax hikes until 2016, and also disbanded the lower house in parliament. The Japanese yen lost further ground against every single currency in G10 and ended the fiscal year down 12.08% against the USD.
The broader macro environment continued to conspire against the commodity-bloc countries, namely Australia, New Zealand and Canada. Sluggish economic data out of China in conjunction with falling commodity values hit the currency of Australia fairly hard. Australian GDP disappointed, registering a modest 0.3% quarter-over-quarter, versus estimates that were forecasting nearly double the outcome. Third-quarter GDP data highlighted the impact of falling commodity prices, and the subsequent retrenchment in mining investment. Fueling matters further, The RBA (central bank of Australia) was fairly explicit throughout the quarter with its unease towards excessive Australian dollar strength. The Australian dollar was one of the worst- performing currencies in the last reporting period, placing slightly ahead of the yen.
Fund management has long outlined the perils of peripheral disinflation migrating into Europe’s economic nucleus, namely Germany and France. By the fourth quarter of 2014, this unwelcomed scenario had become common news. German industrial production fell more than projected in the reporting period, and factory orders fell to five-year lows. These were material symptoms strongly inferring that Europe’s largest economy was beginning to deteriorate. Shortly after, aggregate eurozone GDP figures came in a sliver better than expected. However, the nominal pickup was meager, to say the least. A 0.2% increase to growth was hardly an encouraging argument for the European Central Bank. Making matters worse, French inflation statistics continued to contract and the Spanish economy was squarely engulfed in flat out deflation.
The worsening outlook in Europe incited central bank authorities to further boost their quantitative easing initiatives. ECB president Mario Draghi obtained consent from other council members to materially increase the central bank’s balance sheet target "moving toward the levels of March 2012." This objective was nearly a full one trillion euro expansion. More importantly, the composition of the proposal was just as important as its notional increase. The scope of asset purchases was materially expanded to potentially include sovereign bonds and corporate debt. As a consequence, the euro concluded the reporting period down 4.22% against the dollar.
U.K. and the Nordic Economies:
The British economy, which had been firing on all cylinders for the first half of the year, began to exhibit emblems of economic fatigue in the fourth reporting period of 2014. As early as October, manufacturing, housing and factory orders all began to moderate off their highs. This downturn in British economic activity seemingly persuaded the Bank of England to be more cautious in its November minutes statement. Subsequently, the British pound fell to its lowest level against the USD in more than a year as prospects for the Bank of England diminished. The British pound surrendered 3.92% against the U.S. dollar in the fourth quarter, but was one of the better-performing currencies on a relative basis.
Deflationary pressures from the EU have undermined Swedish consumer price inflation, which remained considerably below the central bank’s 2% target. In response, the Riksbank (Swedish central bank) cut its repo rate to 0% and tempered its future guidance.
A reversal of fortune was a distinguishing trademark for Norway in the fourth quarter of 2014. Despite its AAA rating, vigorous labor markets and an exceptional balance of payment account, Norway’s umbilical tie to West Texas Intermediate (WTI) crude proved too much for this oil exporter to shoulder. Not only did the Norwegian krone lose formidable ground against the USD, but astonishingly fell to its lowest levels against the euro since 2008. In a surprise move, Norway’s central bank cut its main interest rate for the first time in more than two years and signaled it may ease again next year in response to plummeting oil prices. Among the G10 economies, the Norwegian krone was the worst performing currency against the USD, weakening in excess of 13% in the fourth quarter alone.
The fourth quarter 2014 return for Federated Prudent DollarBear Fund was -4.07% (Class A Shares at NAV). The return for the inverse of the USD Index was -5.04% for the same period. The fund’s absolute performance was hurt by U.S. dollar strength versus all of the fund’s currency holdings, as well as from losses in gold stocks.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than what is stated. Other share classes may have experienced different returns than the share class presented. To view performance current to the most recent month-end and for after tax returns, click on the Performance tab. Performance does not reflect the maximum 4.5% sales charge for Class A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance.
The fund’s performance in the fourth quarter outperformed its respective benchmark, the USD Index. The outperformance was largely due to a significant underweight in the euro, relative to the fund’s index. The fund also benefited from an underweight allocation to the Japanese yen relative to the USD Index.
This past fiscal year was earmarked with low volatility, geopolitical tension, disinflation, commodity disruptions and central bank policy disparities. The key question for the months to come will be which components of this global opus fade into history, and which factors are more likely to carry over. Mapping the course of inflation next year will prove pivotal in deriving secondary macro narratives and investment opportunities. Inflation expectations will most likely define commodity, equity, currency and bond markets.
China may very well prove to be the fulcrum by which the direction of global inflation tips next year. Too rapid of an economic slowdown in China could very well propel the global financial system deeper into disinflation or potentially deflation for some emerging economies. However, Chinese authorities appear keenly aware of this potential concern, and thus far have proven very adept at managing the elasticity between domestic reforms and growth.
As Fed policy continues to normalize, so should the levels of risk premiums. A higher volatility environment is not sympathetic to higher beta sectors. As such, we remain cautious on the commodity-centric countries, like Australia and Canada, that are characteristically higher beta in nature. Furthermore, a number of countries have embarked on deliberate campaigns designed to keep currency valuations at a discount. The central bank of Sweden stands out among this group. Consequently, we have greatly mitigated exposures to these countries, and will most like continue to do so in the coming months.
Geopolitical concern is an extremely complex matter to address; it is inherently an exogenous risk. Successfully deployed in 2014, fund management will continue to guard against these capricious events with active allocations to gold holdings. Country selection was yet another effective tool in mitigating geopolitical variance. This is a staple characteristic of the fund, which endeavors to maintain its holdings mostly in developed and liquid countries.
Finally, divergence among the world’s major central banks was a major theme in 2014, and is very likely to remain a central influence in the coming year. The pace, more so than the action itself, by which the United States begins to tighten monetary policy will be key. Meanwhile, both the European Central Bank and the Bank of Japan are scheduled to infuse massive amounts of liquidity into their economies in an effort to rouse inflation. This growing policy chasm should bode well for the U.S. dollar, and keep both the yen and the euro on the defensive. Fund management continues to favor underweight allocations, relative to the USD Index, to both the euro and the yen.