A Few Basket Cases…

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May 24, 2022
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A quieter end to the month as oversold conditions are at least stabilising if not obviously (yet) reversing. This has been a steady slide, rather than a crash per se, but markets remain fragile. With the Fed still sucking liquidity out of markets a ‘risk on’ rally by leveraged traders looks highly unlikely, but some rebalancing by asset allocators may be enough to lift a number of stocks. In particularly the rebalancing of momentum baskets may lead to a further flow out of tech and into energy and commodity stocks.

The recently strength of the Dollar has tended to coincide with weaker markets generally, consistent we think with a short squeeze as widespread deleveraging takes place. As such, we are not alone in watching the $ trade weighted index, the DXY, which over the last few days has dropped to a one month low, albeit still over 100.

Dollar Basket rolling over suggests end of deleveraging short squeeze

Source; Bloomberg, Market Thinking

One important Caveat however, is that while actually trading the DXY on technicals is possible through CFDs and other derivatives, in reality it is an aggregation of the underlying pairs and the volume is set by the Euro, Yen and Sterling crosses. Of course they all tell a similar story, but the lesson about baskets is that they aren’t always what you think they are.

On a related note. we have an update on the SDR basket that we discussed in the context of the HK$ peg. The 5 year rebalancing of the SDR has just taken place and , no surprise, the Yuan and the $ have increased in weight versus the Euro, Yen and Pound.

SDR Basket Changes.

We continue to believe that the SDR is the most likely vehicle for China to challenge the dominance of the US $. As well as perhaps pegging the HK$ to the SDR basket, China could move to create a parallel monetary system based around the SDR. Rather than demand a full switch to the Yuan, a halving of $ influence would be an acceptable first step to the rest of the world, not only in using the SDR as a form of Bancor (see is it time for the Bancor?), but also in providing an alternative platform for sovereign and supra-national borrowing/lending. Instead of lending to US consumers in $s, the current account surplus countries could instead ‘lend’ in SDRs to the emerging markets.

ESG Baskets and Momentum Baskets

The spat last week with Elon Musk and S&P over the inclusion (or otherwise) in its ESG index is a reminder of how important the passive buying and selling of stocks going in and out of an index can be. There is nothing a trader likes more than a distressed seller or a forced buyer and index tracking funds can be both of those around the time of rebalancing. Generally speaking this is more about a shift in weightings and of little import to most people, but when big stocks are moved in and out of smaller benchmarks, the impact on prices can be meaningful.

At the end of this week, i.e. at the end of the month, we will see the semi-annual rebalancing of the MSCI Momentum baskets US, Global etc, (for those interested in the calculations, they can be found here.) Unlike other factor baskets, these can change markedly when there has been significant factor rotation in price and this will undoubtedly apply this time as the biggest weightings are stocks like Apple, Microsoft and, yes, Tesla, all of which have underperformed this year, while others – essentially oil and gas and mining stocks have done much better.

One way to look at is is through the lens of the Global Factors ETFs that track these indices and where we can see that while Value is down around 8% year to date, Momentum is down almost 23%. The chart represents momentum beating value (upward slope) and then reversing, demonstrating the strong relative performance of value in the last month in particular. Of course it could be that it is this very re-balancing that is being anticipated.

Value outperforming Momentum (for now)

However, the point is that most of the Value stocks are also now about to become momentum stocks! Such is the vagary of baskets.

Another angle is to look at the Goldman Sachs VIP basket, which is available in an ETF and is essentially their ‘reflection’ of the most popular long holdings among hedge funds. As can be seen, it hasn’t been quite what most of them would have hoped for, nor of course anybody that was seeking to ’emulate’ them (!)

Hedge Fund Hotel Stocks had a torrid start to the year

Note, however, the stabilisation over the last week or so. Does this signal a bottom for the stocks they have – presumably a lot of long duration tech names? Well, yes and no. For while other thematic baskets that we look at do seem to be showing signs of stabilisation over the last two weeks, a look at the breakdown of the Goldman VIP basket tells you that the Hedge Fund Caravan has moved on. Now they appear to be long stocks like Cheniere Energy and Berkshire Hathaway.

Overall, this is yet another reminder that a lot of the moves in markets have more to do with technicalities than with so called fundamentals. This is not to say fundamentals are not important, indeed over the next six months we think they are about to become even more so. For while at the moment we are concentrating on the investors left stranded as the liquidity tide goes out, the same will apply to companies. Non GAAP earnings, inflated receivables, vendor financing and unrealistic sales projections were all characteristics of previous earnings recessions. Make no mistake, they are coming this time too….

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Political Cicadas - no change in the product, just the sales team

The habit of spending long periods underground before re-emerging is not limited to the Cicada, for while this year sees the coincidence of the 13 year year Cicada cycle and the 17 year one, something that last happened 221 years ago, it is also 17 years sine Tony Blair was last in power and 13 since Francois Holland (likely PM in the French Hung Parliament) was. Both now look to be re-emerging to ensure continuity of policies that never really went away. The key sources of protest across Europe - crippling expensive wars against Russia and Climate change as well as uncontrolled immigration have only been addressed in the doubling down - the first thing UK PM Starmer did was fly to Washington to offer more money to NATO, while his Chancellor promised more money for Net Zero. Meanwhile, the left alliance put together to thwart Le Pen is even more pro immigrant than Macron. For markets, there is no prospect of lower spending and every prospect of higher taxes - the only 'Change' visible but not the one promised. The Technocrats and Globalists expecting this 'democracy' means that the populous will go quietly will be disappointed, especially with the arrival in the Autumn (once the Cicadas have gone) of the great populist, anti open border, anti net zero and anti war populist Donald Trump.

Market Thinking July 2024

The scorecard for the first half puts Equities, commodities and Gold in the top half of the table, with cash and fixed income in the lower half. This is consistent with the steady but uninspiring macro backdrop and positioning ahead of a tricky H2 from a political perspective. The anomaly of the Market Cap weighted SPX out-performing the equal weighted SPW by over 10% points tells us both that the SPX is no longer telling us anything about the US economy and that this excess return is for taking (considerable) concentration risk. Meanwhile, with Bond analysts 'pivoting from the Pivot' the fixed income markets have calmed down a little and leaving The Donald' rather thna 'The Fed' as likely the biggest policy influence on Markets over the next 12 months. In particular, we would look out for a 'Trump Plaza Acord" early next year, 40 years after the last one- something the FX markets aren't talking about, but the asset allocators seem to be (at least subconsciously) pricing in.

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