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Insight - Making Sense of the Narrative


Recency Bias makes us focus on what just happened and ignore even recent history, while the end of history illusion makes us think that there will be less change in the next five years than in the last five. A quick recap on the last 5 Q4 periods reminds us of the dramatic changes we have seen, and while the next 5 years may not be as dramatic, we would see these changes as pressaging further changes on paths now revealed, be it BRICS+ disrupting the financial system, AI and working from home disrupting the service sector globally or just the retsoration of the proper price of money and liquidity through the end of QE.

Two steps forward, one (or two) step(s) back. After a strong July, when markets seemed to broaden out from the narrow concentration on mega cap tech stocks, investors were once again frustrated to see most stocks and markets give everything back in August, leaving many sectors, stocks and themes once again flat for the year. We believe that the proximate cause of the weakness in August was the late July bond sell off from Japan that spilled across to trigger trading stop losses in equity markets at a time when many were closing books for the holidays. Meanwhile, the high returns available on risk free $ cash are helping the dollar while continuing to impose something of a liquidity drought across other markets, including further out on the bond curve and many medium term risk managers are happy to delay the decision on searching for real returns in equities. China has dominated the narrative in August, but the long term investors need to start to think of the implications of the new BRICS 11 grouping, not least on account of the dominance of resource rich nations and the Sovereign Wealth funds they support...and how they are going to spend that money going forward.

July saw markets broadening as recognition that the second leg of a bear market is unlikely to appear became more widespread and fears of a recession receded. Shorter duration areas such as energy, mining and financials began to catch up with the megacap tech stocks. While retail may be too bullish, institutional investors are heavily short equities and long cash, a position that is not sustainable in the long run. The wobble in bond markets in early August may have more to do with 'the beginning of the end' of yield curve control in Japan than any US fundamentals, but will doubtless keep cash as a crowded trade in bond markets for the time being. Meanwhile, politically inspired narratives against China should not fool investors that they can ignore the impact of China on economies as well as markets; martial threats may be exaggerated, but competitive ones are very real.

This week, the BoJ finally moved on yield curve control. While the details are not exactly clear, in the manner of FX management in the past, the direction of travel is and the last man standing is now normalising rates. While it will be slow, more in the manner of Powell pre rather than post Covid, unwinding the policies of his predecessors will be a delicate task for BoJ Governor Yueda. As Japan is a major provider of global risk capital and liquidity we need to hope that he succeeds without too much disruption.

As we get to half year we see narratives shifting - the negativity on equities is fading after a strong recovery which is feeding into more positive views on economics, although this is only consistent with the new New Normal view that we had in January. The narrow breadth of the rally however has led to AI as a new narrative that we feel is over-done. Equally, while geo-politics has died down as an issue, the Geo-political related weakness in China equities is being 'explained' by an economic narrative that also doesn't really add up. Bonds meanwhile are caught between long term buyers looking to lock in a real return in a 2-4% inflation world and traders who have flipped from Pivot to tighten and who are focusing once again on high frequency data. Q3 is generally lower volume, but potentially higher volatility