5th January 2024
December 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.
December market action, in many ways was a continuation of November’s moves so we can repeat that what we wrote in Commentary #24:
“As can be seen above the biggest upside gainer for the month were US bonds, rising nearly 10%, and this reduction in interest rates pushed most markets, especially the US a lot higher. As we said in Commentary #22:
“We believe that short-term flight to safety in bonds is either beginning or starting soon and as stated above, will cause a relief rally in equity markets.”
What this means in the short-term is that the pressure on the equity markets from higher bond yields will abate for the moment and together with the sell-off in September and October, means we will likely get a rally into the year end, before economic reality hits next year as the long-awaited US recession finally comes home to roost. “
We are surprised at the extent of the bond and stock rally, but with the chasing of performance at year end and the increase in algo/momentum trading, we probably shouldn’t have been. The soft-landing scenario is now fully priced in (in our opinion). We shall discuss this “goldilocks” scenario further below.
Please see the Themes section of the website for a breakdown of our current investment themes.
In terms of themes, our US shorts predictably lost money, and as US government bonds rallied, the dollar fell against most currencies. Most of our long exposure didn’t help us as much, with the exception of India and other commodities.
India as a stock market continues to make all-time highs as both money in the Emerging market space chooses India over China and as recent state elections showed continued support for President Modi. Modi is seen by foreign investors as being the mastermind behind the economy’s upswing, despite good arguments that a lot of these structural changes would have been happening anyway, regardless of who was at the helm.
The thematic portfolio performance is detailed below, and we made 0.36% for the month bringing the full year performance to 11.1%.
In terms of themes for the year as a whole, we were wrong to have so much exposure to Hong Kong/China earlier in the year, although we brought the exposure down over the year, and US equity indices had another good year, so shorting them lost the thematic portfolio money. But from the perspective of the overall portfolio, being short those markets gave us the peace of mind to be long other areas which were successful such as Japan, precious metals, energy and India.
A reminder: our thematic portfolio is changed only once a month, and is mainly intended for informational purposes outlining our investment themes. Everyone’s risk tolerance is different and usually people scale in and out of positions rather than making changes once a month.
We discussed the soft-landing scenario in commentary #24 and, to summarise, the market is anticipating that as inflation continues to moderate, interest rates will be cut six or seven times (in 25 bps increments) over the next year beginning potentially in March 24, yet the US economy will avoid recession and so corporate earnings will grow 10-15%.
Now we don’t believe this at all, but given it is an election year, the politicians are going all out to portray that all is well.
In Commentary #23, we wrote:
“A major reason the recession has not officially started is government spending. With the government running a US$2Trillion budget deficit, it tends to keep economic activity going, useful and productive or not, but the GDP numbers will be growing.
Over the last 2 years we have had the Inflation Reduction Act, the CHIPS act and numerous smaller Federal support programs as well of course the War in Ukraine and now also the Middle East. Now, obviously war spending is a net contributor to GDP even though there is nothing productive about war and the parallels with the late 60s, early 70s are more striking given the open ended spending on the Vietnam War while running big fiscal deficits, the unrest in the Middle East leading to oil embargos, so the question is whether the US government can continue to spend like the proverbial “drunken sailor.”
As another example of government involvement, we can look at the December jobs data released last Friday, January 5th.
The good news was that the headline number showed a better-than-expected increase in Nonfarm payrolls of 216K vs an expected 175K increase and average hourly earnings increased 0.4% month over month.
The bad news included:
- The previous two months were revised down by 71K jobs.
- The household survey showed a decline of 683K jobs.
- The unemployment rate, while steady at 3.7%, was helped by both an increase in people working part time because they cannot find a full-time job and because people continued to leave the labour force, with the labour force participation rate decreasing to 62.5% (down 0.3% m/m).
- Because of these changes, the actual number of people who were unemployed in December 2023 was 6.3M vs 5.7M in December 2022.
- A large portion of the jobs increase in December (52K) came from government jobs, with an average of 56K jobs added per month in 2023, vs an average of 23K per month in 2022. This is consistent with government spending and job creation being a large part of why the US economy has not YET gone into recession.
- The number of full-time employees actually dropped by 1.5M from November to December and over the past year, the number of additional full-time jobs is 800K of which, as noted above, 672K were government jobs.
In other data releases on that same Friday, ISM services slid to 50.6 in December from 52.7 in November (compared to market estimates of 52.6).
WASHINGTON, Jan 5 (Reuters) – The U.S. services sector slowed considerably in December, with a measure of employment dropping to the lowest level in nearly 3-1/2 years, a survey showed on Friday.
The Institute for Supply Management (ISM) said that its non-manufacturing PMI fell to 50.6 last month, the lowest reading since May, from 52.7 in November. A reading above 50 indicates growth in the services industry, which accounts for more than two-thirds of the economy.
The ISM survey’s measure of services sector employment plunged to 43.3 last month, the lowest level since July 2020 when the economy was reeling from the first wave of the pandemic. The index was at 50.7 in November.
Overall, we believe this data supports our view that the US economy is weakening and entering recession, which has implications for US equity markets, which is discounting the perfect soft landing of lower interest rates, lower inflation, but ongoing robust corporate earnings growth of 10-15%.
As the recession signs become more widespread, this should put downward pressure on the US equity markets, certain commodity prices (although there has already been some weakness given the global industrial recession), and upward pressure on gold, bond proxies and the JPY. Note that we say bond proxies, not bonds as we believe as recession ensues, the standard response will be to spend and stimulate and there is reduced demand for US government bonds from foreigners for multiple reasons we have expounded on before. So, for bond proxies, we like high dividend yield stocks, with consistent payouts. These should benefit as nominal rates comes down in the US.
While we like Japan from a longer-term perspective, we are concerned in the next 3 to 6 months. Japan had the winning combination of expansionary monetary policy, a weak Yen making the country both an attractive tourist destination post Covid and helping exporters out, and nominal wage increases supporting domestic consumption. But we are becoming cautious on the Japanese equity market for at least the first half of 2024 as the economy is slowing and will continue to slow, especially as year over year comparisons become more difficult. We will reduce that exposure and remove the trading company Marubeni (due to their commodity exposure) and the index ETF, while adding a REIT focused on the hotel sector, as we like the yield in a potentially stronger currency going forward (we expect the JPY to continue to strengthen from here).
For the moment we will keep our position in Hong Kong, removing the large cap China ETF and replacing with a basket of high dividend yield stocks including utilities.
We will increase the short exposure in the US especially given the big move up over the last two months.
We will keep the other exposures the same, and will be looking to buy more precious metals, energy, and India on any material weakness.
The thematic portfolio for January is shown below, with changes highlighted in red as usual:
Until next time,
