2nd April 2024
March 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.
The big movers this month were the traditional inflation hedges, gold, and energy. Japan continues to do well in local currency terms. All these moves, we believe, are related to easier monetary policy as flagged at the Bank of Japan meeting on March 18th and the Federal Reserve meeting 2 days later. We discuss this below.
Hong Kong is taking a breather after a big move-up last month while India is showing a bit of internal weakness with the headline indices continuing to rise while small and mid-cap stocks fail to keep pace with the overall market.
Please see the Themes section of the website for a breakdown of our current investment themes.
Our themes performed very well this month, with our short on US markets being our only loser.
Precious metals were the standout with Gold and silver themselves up 8-10% while the higher beta miners were up anywhere from 15-25%. We have covered this sector on many occasions, and we increased our exposure at the beginning of the year as we believe that not only are they unloved and under-owned by institutional investors, but the underlying commodity is going to do very well over the next few years.
As we noted in our previous commentary:
“The chart below 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.”
Gold smashed through this level and closed the month of March at $2232 an all-time monthly and quarterly high. That is very technically significant, and this should start prompting some institutional flows into the sector. We may even get some momentum players and CTAs attracted to the sector.
Energy also did well for us as the inflationary theme continues to run and we are glad we increased the allocation at the beginning of the month. Offshore oil services and natural gas producers did very well and we believe these capital-starved sectors will continue to do so. Natural gas itself is very cheap at less than $2/barrel in the US. As LNG infrastructure gets built out and the ability to transport more gas around the world, we believe US pricing will go up and this will benefit US Natural gas producers. This is in addition to shale output shrinking over the next few years as the high grading of reserves plays out. We wrote about the offshore services theme in commentary # [X?], and continue to believe this has years to play out given the lack of capacity at shipyards to bring on new supply, the bad rap the sector has from destroying investors’ capital in the previous cycle, and the trend towards deep water exploration as traditional wells dry up.
We will add to precious metals and energy on any weakness going forward, and we highlight some additional reasons for ongoing bullishness later in this commentary.
While the US continued to rally, we do not feel comfortable taking off our shorts as the risk is extremely high despite some of the technical indicators we followed showing underlying strength. We repeat what we said last month:
“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 but from experience, this can go on for a while, and while our short US position is hurting, it enables us to take risks elsewhere.”
We will change the make-up of the shorts, removing industrials and materials as these sectors will do well in our thesis of a continued inflationary environment.
The thematic portfolio performance is detailed below, and overall, we made 5.2 % for the month.
So why are inflationary themes working now?
We have written extensively on the supply constraints facing a lot of the energy and mining world as ESG investing has deprived the sector of capital. This is not new. What is new, are the signals emanating from the major Central banks around the world.
We have had two central bank meetings this month and the outcomes have not been particularly surprising.
Firstly the Bank of Japan moved the overnight rate from -0.1% to 0 -0.1%. The signalling a change in intent is only significant if this is the start of a trend. In Governor Ueda’s post-announcement press conference, we got the real message:
“We reverted to a normal monetary policy targeting short-term interest rates, as with other central banks. We will choose the appropriate level of short-term rates in line with our economic and price outlook. But in doing so, we need to be mindful that there is some distance for inflation expectations to reach 2%. When we focus on this gap, it’s necessary to maintain accommodative monetary conditions even under a normal monetary policy framework.”
We have been guilty of thinking the BOJ would do what we think it should do rather than what it does. We anticipated that inflationary pressures in Japan (which have been above the Boj target for over a year now), combined with the lack of real wage growth for consumers for the last 22 months and the reduction in disposable income for Japan’s elderly savers would prompt this action. While it did take this small step, The Governor of the BOJ signalled it was safe to get back into the pool.
We then had the Federal Reserve meeting on the 19th/20th March.
So what did the Federal Reserve say and do? The Fed similarly gave the all-clear signal on inflation, kept rates where they were, and signalled three rate cuts this year, while continuing to project strong growth and higher PCE statistics going forward.
A few choice quotes from his Press Conference, referring to the hotter inflation and employment data recently published.
“Strong hiring in and of itself would not be a reason to hold off on rate cuts”
“I think [the strong labour reads] haven’t changed the overall story, which is that of inflation moving down gradually on a sometimes bumpy road toward 2%. We’re not going to overreact to these two months of data, nor are we going to ignore them.”
Despite inflationary pressures continuing to reverberate through the system, two major central banks are effectively saying they will either be keeping rates where they are or raising them slowly.
This for us, is the signal for the second wave of inflation to take off. We thought it would be prompted by a US recession and the subsequent easing, but the US government deficit spending and hiring of workers has postponed that recessionary outcome. Instead, we have lower real rates brought about by an increase in inflation. The Fed will be highly unlikely to raise rates over the next 6 months before the Presidential election and in fact, may face pressure to cut if there are any signs of weakness in the employment numbers.
The chart below is very significant. It shows the 2-year chart of the CRB and the one-year percentage changes. Today’s print is up 18% year over year so we can expect to see this in reported inflation figures coming soon globally.
In this scenario, the Japanese stock market will also do well as monetary conditions will remain loose. We reduced our Japanese allocation at the beginning of the year as we saw a slowdown domestically and thought the BoJ would be serious about tightening to raise real incomes.
Instead, the BoJ has shown where its priorities lie. Japan is stuck between a rock and a hard place. As a highly indebted government, it would like to inflate away its debt, and so will be slow to raise rates with the currency taking the fall.
This creates a risk of a downward spiral in the JPY unless the US cuts rates faster and deeper than currently expected. We may increase our Japanese exposure, fully hedged on the currency but we need to digest the recent moves for sector selection. We have favoured financials as rises in interest rates benefit this sector, but if the JPY continues on its path, the traditional exporters will be the place to invest.
Hong Kong/China digested their strong gains last month and we are more confident now that a bottom is in place for the market. We don’t believe this translates into a V-shaped recovery but the fact that a bottom has been reached will mean volatility should subside and that will attract more investors to the value of the market. We are still early here as we’ve only had a 10% rally off the bottom for the Hang Seng Index after a devastating bear market which has knocked 50% off the headline index and 80-90% off many non-index names.
China continues to do its incremental easing and from a narrow stock market perspective, this won’t give us quick gains but is likely better for the economy in the long term. The economy is coming out of its long winter and the market is starting to notice, while the bears focus only on the property market. Let’s look at some recent data.
Chinese data released for January and February was stronger than expected with industrial production rising 7% (expectations of 5%) and fixed asset investment rising 4.2% (3.2% expected). Retail sales grew 5.5% (expectations of 5.2%).
On the other hand property investment fell 9% y/y (vs 24% fall in December), while sales by floor area fell 21% y/y vs 23% in December.
This we believe, led to comments at a meeting of the State Council led by Premier Li Qiang
“It called for efforts to refine real estate policies further, ensure the delivery of housing projects, and ensure that real estate financing coordination mechanisms deliver tangible results.
Related support policies should be made systematically to tap into potential housing demand and increase the supply of high-quality housing, promoting the steady and healthy development of the real estate market, the meeting said.”
Source: Xinhua March 2024
We shall see what follow-up comes from this but the key will be loosening up restrictions on buying property in Tier 1 cities. These cities lead the overall market and a signal there will be key.
The developers on the whitelist (a list released by the government stating who would be leigible for support) have started receiving financing and although the inventory is large, the move to convert some housing inventory into social housing will help confidence and the overall situation.
On Sunday 31st March, China released its PMI data which again showed an improvement.
China’s March factory activity expands for first time in six months
SHENZHEN, China, March 31 (Reuters) – China’s manufacturing activity expanded for the first time in six months in March, an official factory survey showed on Sunday, offering relief to policymakers even as a crisis in the property sector remains a drag on the economy and confidence.
The official purchasing managers’ index (PMI) rose to 50.8 in March from 49.1 in February, above the 50-mark separating growth from contraction and topping a median forecast of 49.9 in a Reuters poll.
The official non-manufacturing PMI, which includes services and construction, rose to 53 from 51.4 in February, marking the highest reading since September.
We will increase the allocation to HK this month. In addition, we will change the make-up of the HK portfolio with the removal of some of the “reopening plays.” These stocks are cheap but very focused on the HK economy. The trend nowadays is for Hong Kongers to go to the Shenzhen area and spend weekends or the day there. Everything is much cheaper, and the travel infrastructure now makes it an easy journey. The earnings of these companies may not grow back to pre-Covid levels. We will add a couple of other names instead: two spinouts from Alibaba, Sun Art Retail and Ali pictures. We will aslo add some commodity focused names- beaten down sectors in a beaten down market.
The thematic portfolio for April is shown below, with changes highlighted in red as usual:
April Thematic Portfolio
Until next time,
