3rd July 2023
June Performance Review
Dear Investor,
As usual we will start the month having a quick look at what the markets did in the previous month, our themes, and then the thematic portfolio performance.
Looking at the chart above, we can see that best performance came from Japan with the broad Topix index rallying 7.5 %. This was closely followed by the S&P 500 followed by Hong Kong, Commodities and Emerging Markets with Gold dropping to the bottom of the leaderboard.
Our theme performance is shown below and our Japan and “Other commodity” themes did extremely well, with the latter experiencing some reversion after the prior two months of weakness.
Please see the Themes section of the website for a breakdown of our current investment themes.
Energy rallied with India also doing well, as money continued to flow there (likely being redirected from China).
The thematic portfolio performance is detailed below and made 2.5% for the month, with the biggest contributors being Japan and Energy. The biggest detractors were our short US position and Precious Metals.
Japan continues to perform (please see Commentary #2 for our initial thesis on Japan), and we continue to like the market as a “cheaper” developed market with an expansionary monetary policy and an increasingly shareholder friendly environment together with actual economic growth ahead. Our stock picks are also doing better than the overall index which enables us to get a better return with less exposure.
As we noted in our last commentary there were signs of froth in certain sectors of the market but this hasn’t stopped the market continuing higher. Until the outlook changes, this will be a market to add on pullbacks. While the market may seem “overbought”, this condition can be worked off by going sideways rather than correcting.
The yen continues to weaken as there is no adjustment to the Bank of Japan’s Yield Curve Control where 10-year interest rates are pegged at 0.5%. Yes, 0.5%. Now the million Yen question is how long this can last for. Interest rates continue to move up in the rest of the world. As we noted last time, Canada, Australia, the US all recently raised rates and show no signs of stopping yet.
We also had the following news from Europe:
ECB in no mood to pause after lifting rates to 22-year high
FRANKFURT, June 15 (Reuters) – The European Central Bank raised euro zone borrowing costs to their highest level in 22 years on Thursday and said stubbornly high inflation all but guaranteed another move next month and likely beyond that too.
The quarter-percentage-point move was the ECB’s eighth consecutive interest rate hike since it badly misjudged the tenaciousness of price rises early last year, and took its policy rate to 3.5%, a level not seen since 2001.
And from the UK:
New York Times 22nd June
Bank of England Raises Rates More Than Expected, as Inflation Persists
“We know this is hard,” the central bank’s governor said, after increasing interest rates half a point, to 5 percent.
And after this shocker, we get this follow up reported in the FT on the 28th June:
Bank of England governor signals interest rates likely to stay higher for longer
Speaking at a European Central Bank conference in Sintra, Portugal, Bailey suggested markets were wrong to think rates would fall quickly from a peak reached around the end of this year.
Financial markets have currently priced in UK interest rates rising from 5 per cent to 6.25 per cent at around the end of the year, before beginning to fall during the spring or summer of 2024.
If you pay attention, you can see there is theme here. Rates are staying higher for longer. We have stated multiple times that a lot of the drivers of inflation are structural in nature, and that the covid driven supply chain constraints had some impact in the short-term (which are now being worked through) but it was more the response to the self-imposed lockdowns that started the ball rolling.
In certain regions, we have seen this where reported inflation had come down from Covid/Ukraine induced spikes but then started moving up again.
Now Japan is fighting this “trend” of higher rates, as are many other non-Western countries. While Japan is a special case, the other countries have something in common. We will discuss this in a future commentary, but in summary, they all started raising rates earlier than in the West and they didn’t pay people to do nothing. To be continued….
To repeat from an earlier commentary
“Japan, on the other hand is in a sweet spot. It is not raising rates and running easy monetary policy, despite inflation running higher than expected. The key here is that the Bank of Japan is focused on real wages, and they are not at their target yet, despite unemployment going lower”
From the Nikkei newspaper on the 16th June:
BOJ would rather do too much easing than too little: Gov. Ueda
Japanese central bank sticks to ultra-easy policy, bucking global trend
TOKYO — The Bank of Japan’s governor on Friday said he would rather carry out too much monetary easing than too little, after the central bank decided to keep its ultraloose policy intact despite anti-inflation tightening in other countries.
Speaking to reporters after the BOJ’s nine-member board unanimously decided to maintain its yield curve control (YCC) policy — under which 10-year Japanese government bond (JGB) yields are guided to around 0% and short-term rates to around minus 0.1% — Ueda highlighted the central bank’s two-decade struggle to end deflation.
The sweet spot continues:
Japan Retail Sales Growth Accelerates; Consumer Confidence Strengthens
Despite high inflation, Japan’s retail sales grew at a faster pace in May suggesting strong contribution by private consumption to economic growth, official data revealed Thursday.
Elsewhere, a monthly survey published by the Cabinet Office showed that consumer confidence improved to an 18-month high in June as households were more positive about income growth and employment.
Retail sales registered an annual growth of 5.7 percent in May after rising 5.1 percent in April, the Ministry of Economy, Trade and Industry reported.
The pace was also faster than economists’ forecast of 5.4 percent.
Sales increased for the 15th straight month in May. The latest growth was driven by higher demand for automobiles, medical and cosmetic products.
And now in another groundhog day moment, we move to China and the continued negativity surrounding its prospects! We discussed this last time and nothing much has changed. While the Hong Kong market bounced a little this month (again after losing a lot in the previous month) it is now only 20% from the low incurred after the “shock” removal of Hu Jintao from China’s 20th Party Congress in October 2022. This was a real capitulation event for global investors who threw in the towel and called China “uninvestable.” (We discussed this in Commentary #1)
The market could potentially revisit that low but with valuations so depressed and sentiment so stretched, it would be a time to load up if that happened.
The US/China sparring continued this month with Blinken, the US secretary of state, visiting China in an attempt to “repair relations”. The day after he returned, President Biden called Xi a “dictator”. Business as usual…
Talking about business, we already discussed the high-profile CEO visits in the last couple of months and we recently had the following out of China, where the strategy continues to be that of persuading corporates of the benefits of doing business with China. Given politicians get most of their funding from corporates, this is one way of opening a wedge against the current geopolitical frictions.
China Shifts Approach Toward De-Risking With Appeals to CEOs
When the US first embraced “de-risking” to get Europe on board with measures to deny key technology to China, officials in Beijing dismissed the term as no different than decoupling. Now they are trying a new strategy: Redefine the concept.
Chinese Premier Li Qiang last week acknowledged the legitimacy of de-risking while speaking to CEOs on a trip to Germany, but said it should be decided by business leaders instead of governments. He also warned that risks shouldn’t be “exaggerated” — opening a discussion on what exactly poses a serious threat to national security.
India continues to perform well, and we will increase the allocation this month. We discussed India in depth in commentary #12 but we didn’t dwell too much on its relationship with the US other than how India was now an alternative for moving some production to from China. There is also the geopolitical aspect.
Now India was one of the first countries to form the “Non-Aligned” movement , which according to Wikipedia:
The Non-Aligned Movement (NAM) is a forum of 120 countries that are not formally aligned with or against any major power bloc. After the United Nations, it is the largest grouping of states worldwide.
The movement originated in the aftermath of the Korean War, as an effort by some countries to counterbalance the rapid bi-polarization of the world during the Cold War, whereby two major powers formed blocs and embarked on a policy to pull the rest of the world into their orbits. In 1961, drawing on the principles agreed at the Bandung Conference of 1955, the Non-Aligned Movement was formally established in Belgrade, Yugoslavia, through an initiative of Yugoslav President Josip Broz Tito, Indian Prime Minister Jawaharlal Nehru, Egyptian President Gamal Abdel Nasser, Ghanaian President Kwame Nkrumah, and Indonesian President Sukarno.
Now, unfortunately, it looks like we are once again coalescing into two blocs so this movement may need to be revamped for the current environment. As we have noted, while India is legally buying Russian oil, refining it and selling product to Europe, it is also a beneficiary of the US’s antagonism towards China. I can imagine many more headlines like the below, with increased FDI (Foreign Direct Investment) flowing to India from the US.
Bloomberg June 22, 2023
Biden and Modi Announce Defense, Chips Deals at White House
- Countries ink agreements involving GE, Micron, General Atomics
- India seeking to increase its engagement on the global stage
US President Joe Biden and Indian Prime Minister Narendra Modi announced a series of defense and commercial deals designed to improve military and economic ties between their nations during Thursday’s state visit at the White House.
General Electric Co. plans to jointly manufacture F414 engines with state-owned Indian firm Hindustan Aeronautics Ltd. for the Tejas light-combat aircraft, as part of an effort to improve defense- and technology-sharing as China becomes more assertive in the Indo-Pacific.
Micron Technology Inc. is investing more than $800 million toward a $2.75 billion semiconductor assembly and testing facility in India, while Applied Materials Inc. will announce a new semiconductor center for commercialization and innovation. Chip manufacturer Lam Research is announcing a training program in India for up to 60,000 engineers.
As we noted previously, it will take a long time for India to supplant China as a manufacturer, due to the infrastructure China has built up over the last 30 years, and part of this infrastructure is skillset. Just as the Chinese did before them, they will be hiring engineers to learn from them.
Vedanta Deepens Tech Push With $4 Billion India Display Factory
- Billionaire Agarwal’s metals group is expanding in electronics
- Display business is separate from Vedanta’s chip ambitions
The newly appointed chief executive officer of Vedanta Resources Ltd.’s untried display business is seeking to hire global talent to build and run a $4 billion factory in western India.
YJ Chen, who previously worked at Chinese display maker HKC Corp., said the display venture will soon begin recruiting from South Korea, Taiwan, Japan and other regions to set up a liquid crystal display panel fabrication unit in India. The factory will create as many as 3,500 direct jobs, he said.
“We need a lot of technicians, very talented people,” Chen, who has 23 years of experience in the display industry, said in an interview in India’s financial hub of Mumbai. “That’s the biggest challenge — people.”
Gold continues to consolidate lower as rates stay high. Gold could go as low as the mid-1850s and still be in an uptrend. We believe it is and will increase our allocation if it does so.
The comments we made in previous commentaries, still stand:
“gold continues to do well, in fact close to going to new nominal highs. We repeat: Buy more if there is a correction to USD1900-1930 and you do not have your required weighting.”
You have had the correction and now is an opportunity, if necessary, we will reach our full weighting on any spike down to the $1850 area.
Oil and other Energy stocks continue to meander along. Natural gas had a big move up from depressed levels and to us the evidence is that it has bottomed for this cycle. We will be adding some NG producers to the thematic portfolio this month (see Commentary #8 for our original discussion of Natural gas). We will not increase the total allocation to energy yet and repeat our previous comments below from Commentary #13
“We are still not ready to increase the allocation to energy at this time as we are waiting for a bigger sell-off and the final shoe to drop, of it being crystal clear that global demand is falling. As a reminder, global oil demand dropped only 2% in 2008, the biggest financial and economic crisis of most people’s lifetimes. The supply situation is very different this time around -there is very little spare capacity on the supply side and very little investment in new production over the last 8 or 9 years – which is why we have maintained a core position.”
“Other Commodities” including the fertiliser stocks rebounded strongly and as we said last time:
“These stocks now trade on 5-6X earnings and are on long-term support (for those of you with a technical bent), so we will stay the course and increase slightly taking advantage of the sale.”
We don’t expect these stocks to go up in a straight line and could easily fall to retest the low, but we are very positive on their longer-term outlook. We will discuss food and agriculture generally in a future commentary.
The US market continues to perform, but he below news report tells you all you need to know.
Money.Com June 14th
As of last week, nearly 18% of the S&P 500’s 11% gains for the year at the time were driven by a single company: Apple, which hit a fresh high on Monday. In fact, all five of the index’s top contributors last week were mega cap tech stocks, according to data from S&P Dow Jones Indices. Closely behind Apple was Microsoft, which was responsible for 16.5% of the S&P 500 gains. Up next were Nvidia (14.8%), Amazon (8.8%) and Meta (8.4%).
Without the 20 top contributors in the index, the other 480 companies in the S&P 500 would have collectively been in the red for the year, according to the firm’s data from last week.
The majority of stocks are actually down for the year, but the overall index has been propped up by 6 or 7 stocks. The AI mania we noted last time has pulled a rabbit out of the hat for this bear market. Will this continue? Maybe. Do we have to be involved? No. While we may miss out on short-term gains, we are confident we will continue to make money through the full cycle. Remember anyone who tells you that they made 30% on out tech stocks this year, most likely held them while they went down over 35% last year and so are still below water.
There is also the issue faced by institutional money managers who need to match benchmarks over short term periods, or they risk losing their jobs. So, a big move up in a few stocks, means many people will be chasing those stocks higher even if they don’t believe in them or think they are expensive. This creates a momentum of its own until it falls under its own weight.
We have also discussed the phenomenon of 0DTE, zero days to expiration options. This is where people gamble invest on the close of a stock price at the end of the day. In March JP Morgan estimated that this volume was 45% of all options trading and at approximately $1 TRILLION notional value a day. It has only gone up since then. This won’t end well, but the game could continue for a while as certain people are making a LOT of money out of it.
It must be noted that the US economy continues to perform ok, not yet falling into recession even though time tested predictors of recession are flashing red. These include an inverted yield curve, ISM New orders and business confidence readings.
On the positive side of the ledger we have strong residential real estate (due to the fact that very few people are moving houses as to do so, would require giving up their 3% mortgage rate for a 7% mortgage, so there is not much supply on the market), and a stronger than expected service economy, with lower wage earners getting an uplift in income and so an increase in spending. As we have often stated, unemployment is a lagging indicator and can be stable even as the recession starts. The high-profile job losses have been in the higher-paid tech area and banking area which over-hired in 2021/22. These people have a lower propensity to consume their marginal dollar and so this hasn’t impacted general consumption so much. What we believe is happening in the US is firstly, an extremely low participation rate as lots of people left the workforce a trend starting in the year 2000 and accelerating during covid, as can be seen in the chart below.
Secondly, we have labour hoarding as companies which found it hard to fill spots after Covid are reluctant to let workers go due to this memory.
On top of this, we have had a large reduction in the price of oil which automatically puts more money into people’s pockets. The weight of evidence suggests that this will not last much longer, with much being defined by us as 6 months,
In terms of portfolio changes, we are going to increase the exposure to India, add some natural gas stocks names and replace XLY consumer discretionary ETF short (which has Amazon and Tesla at 40% of the ETF) with the Russell 2000. Changes are highlighted in red below:
July Thematic Portfolio
Until next time,
