Putting (Some) Chips Back on the Table

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January 13, 2023
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Macro Traders had their best year in decades in 2022, benefitting from clear negative trends in Bonds, Equities, commodities and currencies (against the $), but they largely cashed out after Thanksgiving, leading to some squeezed short positions creating a slightly more positive year end for the beleaguered 60:40 funds, who had correspondingly had one of their worst years in decades. As we start the new Calendar year, the traders are back, flushed with funds, but are being cautious, running relatively low-volatility trades and placing only a few ‘chips’ on the proverbial table, hoping and waiting for more clarity. Generally, we seem them sticking to their preferred hunting grounds of Commodities and FX, which helps explain why, for all the noise and bluster ahead of the CPI print this week, nothing really happened in equity markets. Interestingly, it looks like most of the early positioning has been the inverse of last year’s big directional trades, suggesting at the very least that traders see those markets as having overshot (thanks to their own efforts). Meanwhile, medium term asset allocators and long-term investors remain largely on the sidelines grappling with the question of whether the bear market is over, or does it have a second leg?

Traders spreading their bets

In 2022, it was all on red, all of the time. In early 2023, bets are smaller and being spread around more.

Short Term Uncertainties

After a blow out year in 2022, the CTA macro funds are being careful how they place their chips for 2023 and while some are trying to push equities and bonds lower, continuing last year’s winning trades, more focus is currently on their more traditional ‘noise markets’ of FX and Commodities, where if anything most of the trades being put on are now the opposite of last year! However, this is evidently harder work than last year, when it was ‘easy’ to create forced buyers and distressed sellers. Thus, after being long energy in 2022, with early commentary emphasis on a big slowdown in GDP, the traders tried to flip and push Oil lower from the top of its trading band (around $85 on Brent). However, they quickly encountered some resistance such that even a massive US inventory build this week (normally a sell signal) was shrugged off. Copper meanwhile , which was held short last year, was more successful as a reverse trade and has bounced aggressively from the bottom of its band to break out, as the notion of China opening up (one of our key themes for 2023) began to gain more traction. Gold (another short) also gathered momentum, although we would put this into the FX rather than commodity basket, trading as it has as a form of cross currency rate, now up almost 15% from the September low. For what is clear is that the big reverse trade we are seeing in early 2023 is now to be Short Dollars (particularly against the Euro).

Overall we doubt that 2023 will see the type of powerful directional trades that were so profitable in 2022, indeed, the start of the year has seen the traders start to put on almost entirely the reverse set of trades.

As we noted from examining the spectrum of year ahead commentary, there is a disproportionate emphasis (in our view) on the minutiae of the Federal Reserve, when there are in fact much bigger forces at play (notably the West v The Rest theme). However, the traders are currently the main market ‘players’ and typical of this macro trader ‘noise trading’ has been the fuss this week around ‘The CPI Print’ (use of the term ‘print’ is always a reliable indicator that the comment is from a short term trader) which took on all the standard ‘sports betting’ characteristics we usually associate with other noise trading events supposed to influence the Fed, such as the Non Farm Payrolls. This week we saw a lot of drama and excitable punditry, (apparently 2/3rds of survey respondents expected it to come in lower) then…nothing.

The best that can happen from a weak CPI is that the Fed stop raising rates earlier.

To the extent to which the noise traders are looking for a Fed Pivot and a resumption of rate cuts, and thus’ bad news is good news’ , we think they will be disappointed and to the extent to which speculation has picked up in stocks that would benefit from an early return of Cheap Money, we suspect that there is likely to be a sell-off in those areas. Of all the year-ahead forecasts outlined in the Bloomberg link above, the idea from UBS (but notably not UBS Asset Management) that the Fed would be back at 1.24% by this time next year looks to us to be the biggest outlier and a classic example of what the analyst would do if it was up to them. Except it isn’t. Importantly it implies a conscious decision to repeat the errors of ultra low interest rate policy, which in our view is like a repeat of Zero Covid; just because the authorities won’t admit to the previous policy being wrong, it doesn’t mean that they will repeat it.

For us, any shift in Fed strategy is going to be about when they stop, rather than if they pivot and, following the de-rating of long duration assets last year, the impact now of 25bp here or there on Fed funds on bonds and equities is likely to be modest, leaving the main impact to be on the currency, which is now likely the most reliable indicator of expectations on relative interest rates. This of course has been weakening since q4 and technically the trade weighted DXY seems to have broken down, particularly against the Euro, which is up more than 9% since the end of Q3 – although the pound and the Yen are almost as strong, as the relative interest rates argument turns against the $ (as well as the deleveraging story ending). More interesting – as we said in our year ahead piece – are the cross rates against the Chinese, Singapore, Korean and now even the Australian currency. This in turn is the Asia and China re-opening story and just as the DXY is about interest rates, so the Asian Cross rates are an indicator of expectations on trade and growth. Gold, meanwhile sits somewhere in the middle.

Gold continues to trade like a currency and thus up against the $

Within Equities, the dominance of ‘Top Down’ last year was emphasised by the fact that single stock option trading volume halved during 2022, while index options surged by more than a third. In part this was an unwind from the huge, Tesla related, meme stock, option-driven, ‘squeeze rallies’ in 2021, but also the retreat of retail from stock trading, a roller coaster ride brilliantly summed up in this clip of ‘superstar’ day trader Dave Pourtnoy (NB some of the language as the markets melt down is not for the delicate constitution!) Also, the mega-trend shift of ETFs rather than single stocks was illustrated by the fact that ETFs pulled in around $745bn during 2022, which while less than the $1,2tn in 2021 is symptomatic of some large structural shifts. Indeed, in our own Model Portfolios, we are diversifying away from single stocks into Smart Beta Global ETFs that allow us to capture exposure to themes and factors in an efficient and effective manner, enabling us to add value through our portfolio construction and asset allocation. Generally though, most ETFs being sold are still the simple index ones; According to Reuters, of the growth Vanguard and Blackrock took almost 60% of that between them, largely in index trackers. However, it is not just in equities, but a lot also in Bonds, which emerged as a New Year favourite for investors using ETFs signifying a shift there too.

Having said that, this year, we would expect things to be more bottom up again in equities and certainly there has been little top-down directional trade at the market level so far, with activity concentrated on ‘events’. With this in mind, we suspect that the upcoming rash of earnings reports are likely to generate a fair amount of activity at the single stock level, while we would also note that with China re-opening the Asian IPO and capital markets have also burst into life. The levels of uncertainty around stocks are nevertheless such that both momentum, (buy last year’s winners) and dogs of the Dow (buy last year’s losers) are attracting attention, with notable early January spikes in a number of (devastated) meme stocks like Bed Bath and Beyond, AMC and Gamestop, as well as our old friend THG in the UK, while on the other hand the strong running themes from Q4 such as European Banks and Chinese Internet stocks have seen strong follow through buying into 2023. We would expect the former to fade and the latter to endure.

Medium Term Risks

In contrast to the CTA traders who had their best year in decades, the 60:40 funds had their worst and, while most are trusting to mean reversion (the last time 60:40 had two down years was 1931), they are largely sitting on the sidelines in early January (although the Q4 turn in the $ has had some dipping their toes into Emerging Markets as a 2023 asset allocation). As we detailed in our year ahead piece, while the consensus seems broadly in agreement on the economic outlook – both growth and inflation to fall – it is divided on the extent to which it is already in prices, particularly for equities. (For a really exhaustive analysis of the year ahead forecast, Bloomberg ran a large study, you can click here to see it). For us, the key is whether, after the first, de-rating and deleveraging leg of the bear market in 2022, there is a second, credit cycle, leg, led by collapsing earnings. The more conventional analysts say yes, citing risks from over-tightening by central banks and historical precedent (you never buy when the Fed are still raising etc), while a few appear to support our own view that this is not so much tightening to a level to cause a recession as normalising rates to a level where ‘normal’ companies can still make ‘normal’ profits. We believe that this, rather than anything the WEF can come up with, is actually ‘The New Normal’.

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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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