Mean Reversion and Momentum

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January 23, 2023
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Markets have two ‘modes’ – momentum and mean reversion. Last year of course was a huge momentum year for the Macro Traders. On the negative side. They made their huge profits from a short position in Bonds, Equities, Metals and Currencies (against the $). Medium term asset allocators meanwhile took the pain in their 60:40 portfolios, something we have discussed a lot recently. There has also been some capitulation amongst retail investors, with Goldman’s estimating that US Retail has now sold all the stock it accumulated during 2019-2021.

The year has started with mean reversion, which means it has been particularly good for International equity markets, most of which are up double digits in $ terms (gaining a tailwind rather than a headwind from the currency, unlike last year), as portfolios are rebalanced and ‘underweight’ positions attract inflows (something we discussed in the latest Friday Market Thinking). Equally, overweight is now attracting outflows. The BoA survey shows that US Equity Allocation as the lowest since 2005 (chart shows % overweight).

Meanwhile a number of our year ahead themes, European Banks, Global Miners, Chinese Internet stocks etc are up a few percentage points more than that. The commentariat are still divided as to whether there will be a second leg to the bear market, but it looks to us like it will be mild, or rather much more sector specific. Also interesting to note this week has seen a mean reversion’ in the outperformance of equal weighted to market cap weighted indices on the S&P and Nasdaq.

The Fed are now paying the Banks, not the government

We prefer European Banks, not least for the fact that they haven’t paid out dividends or bought back shares, unlike their US counterparts, but that doesn’t mean some of the US Banks aren’t in a sweet position now that the Fed has flipped on rates. One thing that has been somewhat overlooked is that for a number of years, the Fed has been paying its ‘profits’ to the US Treasury at around $100bn a year, but that, thanks to rising interest rates, that Profit has now turned into a loss. This obviously is something that the Federal Budget will have to take into consideration, but it also reflects a shift in power; the Banks are now able to expand their balance sheet, borrowing cheaply off their depositors while running a nice carry trade into ‘risk free’ government paper. The flip side of this of course is that there are a record number of companies in the Russel 3000, where interest Expense is greater than EBITDA. This blog does not give stock advice (it is for information and entertainment purposes only), but it does without saying that screening these Zombies out of portfolios remains a key part of Financial Housekeeping.

Peak Davos?

As we noted last week, there is a feeling that we may have reached ‘Peak Davos’, in line with a shift in the belief system away from Macro, top down, ‘solutions’ proposed in response to Macro, top down assertions of ‘problems’ . What used to be known as the ‘throw a brick through the window, then sell them a burglar alarm’ approach. This shift of attitude has come with the growing realisation that most of the problems that have arisen have in fact emerged as the unintended consequence of other top down policy actions. We are of course thinking mostly here of our old friends the Triple Zeros, two of which, Zero Interest Rates and Zero Covid are now consigned to history, leaving the third policy error of net Zero to do all the heavy lifting at Davos.

Davos is, in essence a caricature of our Western Political system – an unlikely alliance of Centre Left European Socialists, with a French ‘dirigiste’ mindset and US style corporate lobbying. Neither side has much time for the messy issues of democracy, which is why none of the three Zeros was ever part of a democratic mandate or political manifesto. Mutual self interest brought them together and Klaus Schwab made no secret of his business model – if you are charging delegates $250k for a ticket, they had better believe that they are getting something for their (company’s) money. It used to be known as ‘a meeting where Billionaires tell an audience of millionaires what the ordinary people are thinking’ and while there were apparently still 116 billionaires attending, this year’s list felt distinctly ‘second tier’. In previous years the crowd have seen the likes of Trump and Xi, but this year there was only one G7 ‘leader’, Olaf Shulz of Germany and obviously no Putin, or Xi, but no Bill Gates, nor George Soros either. Although we did have John Kerry and Al Gore to hype up the climate change bit. In fact the most important thing to come out of the week (in our opinion) was the announcement from Saudi Arabia on accepting payment in other currencies for their oil. Something very much not in keeping with the New World Order.

We also sense a split appearing in the ranks of the Davosians, as ‘Saint Greta’ railed against the pursuit of profit, while the dreams of the true Globalists like Tony Blair and Mark Carney are extending far beyond their Net Zero agenda into multiple other areas. Look at this year’s agenda, which was dominated by one phrase:

  • High inflation, low growth, high debt economy in the context of a new system for investment, trade and infrastructure.
  • The current geopolitical risks in the context of a new system for dialogue and cooperation in a multipolar world.
  • The current energy and food crises in the context of a new system for energy and climate
  • The industry headwinds in the context of a new system for harnessing frontier technologies for private sector innovation and resilience.
  • The  current social vulnerabilities in the context of the new systems for work, skills and health-care.

Of course, each of these ‘New Systems’ is one designed by Klaus and his friends and is basically one of tax and subsidy. With them in charge. As the FT wryly pointed out, the leaders of the EU countries would probably have preferred to hear Ursula Van de Leyen’s plans for yet more Green Subsidies (to compete with Joe Biden’s) before she told them to 600 odd CEOs that had paid Klaus $250k for the privilege. To date, these CEOs have largely been on board with the Green Agenda as it has been profitable to do so, but they are very unlikely to think the same about this further power grab. Building new systems involves throwing out old ones and that harms a lot of vested interests.

Meanwhile, just as Davosian inspired ESG is getting push back in investing circles, so it looks to have hit resistance in the upper echelons of Banking. It was interesting to see that Fed Chairman Jerome Powell caused something of a stir last week with his speech in Greta’s native Sweden, where he repeated his standpoint that the Fed’s independence means it is not going to be a policy maker on climate (something the hugely powerful climate lobby has been demanding).

We are not, and will not be, a “climate policymaker.”
JEROME POWELL, JANUARY 2023

Meanwhile, the Federal Reserve Banks themselves are increasingly vocal about ESG, most notably the Capo Di Capo, Jamie Dimon ,in contrast to WEF stalwart Larry Fink of Blackrock, who might also be wondering about how one part of his business – the one that borrowed at floating rates to buy up swathes of housing – might be faring as the other side of the trade of rising short rates that Jamie Dimon and his fellow bankers are now benefitting from.

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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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