4th March 2024
February Performance Review
Dear Investor,
As usual, we will start the month by having a quick look at what the markets did in the previous month, our themes, and then the thematic portfolio performance.
Stock markets continued their strength in February, with Hong Kong leading the pack (for once) in the main markets we follow.
US indices continued to rally despite the pullback in US government bonds which impacted both gold and the USD index.
Please see the Themes section of the website for a breakdown of our current investment themes.
The two biggest thematic losers were Precious Metals and short US equities.
While gold itself was only slightly down, the miners and higher beta silver and silver miners fared extremely poorly as hotter US data pushed back expectations of interest rate cuts and pushed rates up.
We have covered the investment case for gold miners in various commentaries and although the US recession and lower interest rates may be pushed back in time, this sector is poised for a dramatic move up once gold moves to an all-time high.
The chart above shows Gold on Friday 1st March closed at an all-time daily and weekly high and all you can hear are crickets. Economic confidence is so high right now that no one cares that the metal is at all-time highs and the miners (white line below) are languishing as the chart below shows with the miners having retraced fully their Q4 2023 rally. A monthly close above $2062, will be highly significant.
What people are noticing, and where all the noise is, are US equities, which continue to move up with speculative juices running high. NVIDIA had blowout earnings, Amazon got added to the DJIA, and all is well in the land of US technology. One major difference we see today is that some of the bearish non-confirmations we noted previously are no longer diverging, with most significantly, the Advance-Decline Ratio for the Nasdaq moving to new high territory with the indices, and finally some strength in the Russell 2000 index.
Having a value bent has not helped in this melt-up but chasing performance rarely works over the long term. We feel the same way today as we did in 1999/2000 and there are signs of excess everywhere. That said, from experience, this can go on for a while, and while our short US position is hurting, it enables us to take risks elsewhere.
The thematic portfolio performance is detailed below, and overall, we lost 1.3 % for the month.
As we discussed last month, we said that Hong Kong/China had what we felt was a capitulation moment, hence we increased the allocation to this market at the end of January, and indeed there have been continued government support measures announced since we last discussed them in the January performance review.
After Chinese New Year, we had Premier Li Qiang calling for “pragmatic and forceful action”
Li Qiang tells cabinet meeting he wants real achievements
Slow economic recovery has led to recent slide by stocks
Li used a meeting of the State Council, China’s cabinet, on Sunday to urge officials to “do more things that are conductive to boosting confidence and expectations, and ensure policymaking and execution are consistent and stable,” the official Xinhua News Agency reported.
Various departments should focus on solving practical problems faced by individuals and companies as the Lunar New Year holiday ends, Li said, adding that they need to “win the trust of the people with real work and achievement.”
Source: Bloomberg Feb 19th
The next day, Chinese banks cut their five-year lending rate which is used for mortgage pricing. A move that surprised markets as President XI famously said “housing is for living in, not speculation”. The heat must be on…
With the annual Two Sessions held in Beijing over the next week or so, there is a risk that expectations have become high for massive stimulus or reform, which may disappoint given the incremental nature of the Chinese leadership. However, it is clear to us that the leadership is now highly focused on the stock market and stopping the rout. Steps will continue to be taken to put a floor under the market and if there is a floor, that will give people more confidence to invest.
Last month we said we would increase the weighting in red chips and SOEs and we did so. We have been asked, why this sector? Our answer is that whether as a trade or a long-term investment, it appears that investments in SOEs fit the current Zeitgeist.
Now why are Hong Kong listed SOEs the place to be? Several things are going for them. The valuation gap to A shares is at historic levels so you have the prospect of mainlanders closing that gap. In addition, from a cyclical perspective, resources, construction, and financials are coming into favour, and these are all SOEs. There is a perception, justified or not, that Beijing isn’t supporting the private sector, so there is more upside from a narrative perspective to exposure to China via SOEs. And, beyond this they have to date been favourite short targets for hedge funds, setting up a bullish unwind if sentiment changes. Beyond this, they are very lowly valued both relative to their history and in absolute terms, though valuations haven’t mattered for a while here.
Now for investors who have no interest in the state-owned banks and construction companies due to continued worries about the property sector, another place to find ideas is the red-chip index (Hang Seng China-Affiliated Corporations). The 5-year chart below shows an interesting positive divergence whereby this index bottomed above its October 2022 low with a higher RSI.
This is a mainly forgotten area of the stock market as the focus was on different sectors for the last few years, but there are many solid businesses here. The top 2 constituents are stocks we already like CNOOC and China Mobile.
If you take out the property and construction stocks, we would look at Citic (267 HK), China Resources Beer 291 HK), (both are also in the main Hang Seng Index), China Unicom (762 HK), Beijing Enterprises (392 HK), and China Taiping (966 HK).
In the HK allocation of our Thematic Portfolio, we will change the makeup of the red chip basket portion to:
Citic Pacific, Tai Ping Insurance, and China Resources Beer.
We will also change the dividend part of the HK allocation by removing the HK utilities, which are heavily tied to US interest rates, and replace them with a coal stock, China Coal (1898 HK)
The other themes in the portfolio didn’t have much of an impact, as a mix of winners and losers in each theme largely cancelled each other out.
The Japanese stock market continues to perform, and we are not benefiting so much having reduced the allocation there this year. While we are bullish medium-term, we remain cautious in the short-term. That said, having ridden the Japanese market up for quite a while, we may be underestimating the onging impact of lagged decision-making by large institutional investors. With a sustained move out of deflation, it makes sense for Japanese institutional investors to continue to allocate out of bonds into equities. We thought,however, that this would take time and be overwhelmed in the short term as faster foreign exited as the economy weakened.
The translated article from the Nikkei shows that foreign asset managers do indeed seem to be selling, but the detailed picture is more complex, as it may be that brokers may be buying in their own name on behalf of other foreign buyers, but while being categorized as domestic flows.
Stocks, securities companies net buy 500 billion yen. Are the real buyers overseas?
The buying and selling trends by investment sector announced by the Tokyo Stock Exchange on the 29th are attracting the attention of market participants. The third week of February (19th to 22nd), when the Nikkei Stock Average reached its highest level in 34 years, was due to unexpected net selling by major investors such as overseas investors and individuals. The proprietary trading departments of securities companies have net bought about 500 billion yen, making it difficult to see who is driving the new record high.
When an investor buys or sells stocks, he or she submits the purchase or sale to a securities company that is a transaction participant.
Source: Nikkei 29th Feb
Is this real institutional money-buying and trying to disguise it? Buying via derivative products to hedge the JPY exposure? Prop desks going all in? We don’t know yet, but will be an important signal depending on the type of investor.
The broad Indian market continues to move ahead as Modi’s popularity, the strong economy, and the widening culture to buy stocks all combine for a potent combination. One of the stocks we like, Fairfax India corrected this month and we will be reviewing that position closely. The parent company has been targeted by short-seller Muddy Waters and this will be impacting the position.
In energy, we were happy to exit Uranium stocks as we wrote last month
“Uranium has continued to move higher and the stocks rallied another 15% this month. While we have liked the theme for a while, we sense some exuberance in the sector so we will remove those also.”
However, we will increase our overall energy allocation this month as valuations remain compelling while major economies start to come out of the worst of recession and the US continues to defy the odds.
We had also previously removed our successful Cannabis ETF, MSOS, after it moved up. But following it’s recent sharp correction, we have added it back this month.
The thematic portfolio for March is shown below, with changes highlighted in red as usual:
February Thematic Portfolio
Until next time,
