2nd May 2024
April 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 move this month was the continued sell-off in US government bonds which impacted the USD and finally started to impact US stock markets.
The purported reason for the bond sell-off is the hotter-than-expected economic numbers coming out of the US and the delay in any future Federal Reserve cuts. We will discuss that below
For us, as important, is what didn’t go down with an increase in nominal rates: the Hong Kong stock market, Gold and Commodities.
As we have noted previously, it is clear to us that as the world comes out of its industrial recession and inflation rises, while at the same time central banks are not in tightening mode, real rates are going more negative, and this is supporting the price of gold and commodities.
Please see the Themes section of the website for a breakdown of our current investment themes.
Our themes performed very well again this month, with energy positions being our biggest loser.
While Japan also lost money, we now have a very small allocation to that market as we believe the risk is high. As we wrote last month:
“In Japan, a loose monetary policy could help the stock market in the short term. 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, we may look elsewhere.”
Hong Kong continued its move up after a breather in March and while bottoming is a process, we have much more certainty now that both Hong Kong and China markets have indeed turned. We continue to believe that the Hong Kong market offers an extremely good risk reward here and both Hong Kong and Chinese markets will provide an uncorrelated return to US equities within a global portfolio, reducing risk AND providing absolute returns.
Precious metals and miners continued their stellar performance this month, and we have written about this sector numerous times this year. We have expected a correction down to around $2100 in gold and the related equities, but as an ex-colleague of mine pointed out, on a percentage basis, it really doesn’t matter unless you are highly leveraged, and the fundamental and technical trend is pointing higher.
We will increase our allocation to this sector if we do get that correction.
The thematic portfolio performance is detailed below, and overall, we made 4 % for the month.
So why have US bonds been selling off?
We had another “blowout” US employment report for March:
Strong US labor market underpins economy in first quarter
- Nonfarm payrolls increase 303,000 in March
- Unemployment rate falls to 3.8% from 3.9%
- Average hourly earnings rise 0.3%; up 4.1% year-on-year
- Average workweek rebounds to 34.4 hours from 34.3 hours
Economists polled by Reuters had forecast 200,000 new jobs in March, with estimates ranging from 150,000 to 250,000.
This caused an initial sell-off in US bonds, the US stock market and gold, but this was reversed throughout the day, apart from bond prices remaining weak.
Our take on this is that the employment numbers are superficially strong, but that under the hood there are real issues.
We once again had a lot of government hiring.
“In March, employment in government increased by 71,000, higher than the average monthly gain of 54,000 over the prior 12 months.”
Source: BLS
The number of people in full-time employment has declined by nearly 4 Million since June 2023 and nearly 2 Million this year:
Source: St Louis Fed
The number of people working part-time has gone up by a similar amount in the same time frame:
Source: St Louis Fed
The number of people working multiple jobs is at a 5-year high:
Source: St Louis Fed
The other big economic number out of the US last month was March CPI data.
US CPI grew 3.5% y/y UP from February’s 3.2% and the biggest increase for the last 6 months.
It also grew 0.4% month on month. Expectations were for an annual rise of 3.4% and a m/m rise of 0.3%.
Not such a big deal really, but the trend is increasingly clear especially as “core” inflation (taking out energy and food prices) is rising 4.5% on a rolling three-month basis.
Unlike the employment data, the CPI release moved interest rate expectations materially.
Expectations for a cut in June moved down to 27% from 50% the prior week.
Source: CME
Expectations for another cut in July moved from 22% to 11% and from 40 to 25% in September. Overall, the market is now predicting two 25 bps cuts this year down from three a month ago and seven in December 2023!
While there was an initial sell-off in Gold and US equity futures, both recovered and ended up for that day. What didn’t recover was our old friend the JPY, which is continuing to struggle:
There was some intervention by the Japanese authorities last week as the JPY breached 160 but they are fighting a losing battle, we think and the JPY volatility will be a risk for the stock market going forward.
Going back to the thematic portfolio, in Hong Kong our overall thematic return was similar to the overall index but this masked a weaker-than-expected performance from some of our red chip plays which was more than made up for by our HK commodity exposure. We discussed those stocks last time and they fit the profile of a beaten-up sector in a beaten-up stock market.
We will increase the exposure to Hong Kong/China again this month with the biggest risks being a short-term impact from a bigger global market sell-off and the continued chatter about a RMB devaluation. This is not our base case but the shenanigans in Japan and the JPY’s relentless downturn make it a non-zero probability.
Source: Refinitiv Workspace
The chart above shows the relative performance of the CNY, the JPY and the KRW over the last 3 years. The CNY is a strong currency in this light and despite our thinking that it doesn’t benefit the Chinese economy in the long-term to devalue, it doesn’t mean it won’t happen.
The other part of the narrative around RMB depreciation is recent news articles in establishment periodicals, which have brought up again the idea of China doing QE. First up we had the PBOC talking about the central bank buying bonds in the secondary market as a liquidity management tool:
PBOC may up bond trading
China’s central bank will likely increase the trading of government bonds as a liquidity management tool, yet such a move should not be misunderstood as quantitative easing, officials and experts said.
It is appropriate for China to maintain the stability of monetary policy given the remaining scope of interest rate cuts, experts said, citing the likelihood for China to slightly cut policy benchmarks of interest rates in the second half of the year.
Financial News, a newspaper backed by the People’s Bank of China, the country’s central bank, reported on Tuesday that the trading of treasury bonds in the secondary market can be used as a liquidity management method and a reserve of monetary policy tools.
But the official drew a clear distinction between such an operation from QE, in response to speculation that China could resort to QE to bolster the economy.
Source: People’s Daily Online April 25th
The Chinese language version of the story issued on the 22nd was from the Ministry of Finance’s viewpoint and said the PBOC would be directly buying Treasury Bonds which would increase the money supply.
Now by law, the PBOC cannot buy bonds in the primary market (direct funding of the government), but they can buy in the secondary market and if the government simply issues more bonds and the PBOC buys them in the secondary market, it still increases the money supply. There is now more talk around QE a la US:
Zhang Monan, deputy director of the Institute of American and European Studies at the China Centre for International Economic Exchanges, is among the advisers proposing less orthodox ways to handle the situation.
She said China could adopt certain practices used by the US to weather economic crises throughout history, the coronavirus pandemic most recently.
“The so-called dirty talk about debt can now have a new and different perspective.”
“This [coordination] is a relatively mature experience in many countries in the three years since the pandemic,” said Zhang, who used to work with the National Development and Reform Commission, China’s top economic planner. “[It avoids] deleveraging in the private sector and the residential sector, with more leverage taken by central banks and government departments. It is worthy of discussion.”
Source: SCMP 25th April 2024
Now in the first article, we think the official doth protest too much about this not being QE and the second one is at least floating the idea which the Chinese have been loathe to do. Now actually for the long-term health of the economy, central bank monetization of government debt is not a good thing, but in the situation that China is in, it may be a good short-term move. The problem, as Western governments have found out, is that QE is like a drug and the market/overleveraged economies are like junkies which need ever-increasing fixes.
It is becoming increasingly clear that the Chinese are focused on the economy and the stock markets, and this is another sign that the HK/China markets have bottomed
The argument against this is that Xi is trying to internationalise the use of the RMB and indeed some of China’s trading partners are using the RMB (another unintended consequence of the seizing of Russian assets which makes many countries unwilling to continue to accumulate US government debt). So, any depreciation would be a setback for this goal. Two other points against this are that it could precipitate further capital flight and less international investment into China going forward as well as the positive impact on commodities. China doesn’t want commodities and food prices to go up as this potentially creates unrest.
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.
Our “Other commodities” positions helped this month with MSOS rallying 10% after rallying 16% last month. We discussed this sector in a previous commentary and one of the catalysts we first thought would come through is about to happen:
US poised to ease restrictions on marijuana in historic shift, but it’ll remain controlled substance
WASHINGTON (AP) — The U.S. Drug Enforcement Administration will move to reclassify marijuana as a less dangerous drug, The Associated Press has learned, a historic shift to generations of American drug policy that could have wide ripple effects across the country.
The proposal, which still must be reviewed by the White House Office of Management and Budget, would recognize the medical uses of cannabis and acknowledge it has less potential for abuse than some of the nation’s most dangerous drugs. However, it would not legalize marijuana outright for recreational use.
We will also increase the allocation to this theme as we believe the fertiliser sector will start to perform again after its own long winter post-Ukraine/Russia spike. As we believe Natural gas has bottomed and food prices are moving up, this will be a sector to watch. A five-year chart of Mosaic is below:
To reflect the risk in global markets, we will also increase the overall short position in the US.
The thematic portfolio for May is shown below, with changes highlighted in red as usual:
May Thematic Portfolio
Until next time,
