Try to remember the kind of September

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September 13, 2023
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...the kind of September when stocks had doubled, or halved. When interest rates were negative, or had just gone up by 30x. As we look aead to Q4 2023, it is perhaps useful to reflect on the wild ride of the last few Q4s for context.

Recency bias is a classic cognitive bias and a key part of behavioural finance, meaning we tend to focus only on what just happened, ignoring what came before and, often, missing the context of what is likely to happen next. Sometimes it is worth ‘Zooming Out’ to put things into context a little more. Five years ago, we had never heard of Zoom, or AI, or working from home. We knew nothing about viruses and most people wouldn’t have been able to identify Ukraine on a map. Nobody outside of China had heard of Tik Tok, or indeed Huawei and the Gilet Jaunes, Hong Kong protests and BLM were all yet to come. Meanwhile, anyone talking about Bitcoin was wishing they had bought it at 4000 and sold it at 18,000 rather than the other way around.

Instead, we talked of driverless cars, stopping Trump and Brexit and the final season of Game of Thrones, but otherwise assumed everything would now calm down after a hectic decade. Obviously we were wrong (!), largely because we all suffer from something termed The End of History Illusion, a title taken from a study in Science Magazine in 2013, where a large sample of people of all ages essentially all agreed that they had finally reached a stable period - even though they hadn’t. And in 5 years time will look back and agree that in fact it was the last 5 years that was the hectic period. And so on. Given that they are made up of people, markets are of course no different and predictions of stability should thus be seen as no more than a baseline.

The End of History Illusion - we all suffer from it

A Five-Year look-back

Context is everything. Looking at the behaviour of two of the biggest stocks in the US market - and indeed the world - over the last few years is to view a whole variety of different apparent realities. Five years ago, Facebook (as it was then known) fell 20% in a day and went on to fall 40% during Q4. It recovered, but this time last year, the now renamed Meta had fallen by over 60% to around $150, on its way to an eventual low of $90. Now it is back to $300, albeit still well shy of its near $400 high in the late summer of 2021. Telsa meanwhile has had an even more ridiculous ride - a ‘ten bagger’ between summer 2019 and 2020, it then almost tripled again by late Q4 2021 before dropping all the way back to the 2020 levels again by the end of last year. This year it has risen from $100 to almost $300 again as the Magnificent Seven mega cap tech stocks have dominated returns. But clearly, whether you were made rich or poor by these two stocks - or indeed Bitcoin, which enjoyed a similar ride, albeit not in institutional portfolios for the large part - depended on when you joined the ride. And when you got off.

The real start to the wild ride in tech stocks was the monetary pivot in early 2019

Central to this has been the dramatic turn in the US Monetary regime, obviously since Covid, but really since the late 2018 panic as, what were correctly deemed economically necessary, higher interest rates appeared to be causing a crisis in Money Markets and this was then spilling over into all asset markets. This is a period which many commentators appear to have already forgotten about. Libor, which had risen from 1.3% to 2.3% in the 12 months to September 2018, went on to touch 2.8% by year end before the Fed started cutting to ease pressure, such that by 2019 Libor was back below 2% and the long duration tech stocks were off to the races once more.

Over this period, the Fed was essentially managing market stability and those looking at economic and inflation based metrics like the Taylor Rule as a guide to what the Fed might do, were once again blindsided by the fact that it is rarely about economics. The huge injection of fiscal stimulus and the resort to near zero interest rates in the wake of Covid obviously gave a further boost to these areas, before the belated return to normality led to the collapse in those speculative positions during q4 2022, dragging wider markets with them and destroying the new ‘certainty’. With the Fed aggressively inverting the yield curve on a new-found zeal to counter inflation, bonds joined the rout, making for the worst year in decades for 60:40 funds - and the best for short selling macro traders. We obviously remember that bit due to our recency bias, but not always the correct context of what came before.

So much has gone on in the last few years that it is worth reminding ourselves of some of the bigger shifts we have seen, not just in rates and stocks, but across all aspects of macro.

One Year ago it was a cost of living crisis; Oil had gone above $100 a barrel and UK Natural Gas Futures hit $75mmBtu in the wake of sanctions on Russia. (Now at $11). Potash and other fertiliser prices have followed a similar pattern. The US CPI was over 8% and the Fed was reining in liquidity such that US tech stocks were collapsing on their way to a low in October. At this point nobody had (really) heard of AI - at least in terms of an investment opportunity., but perhaps even more important, nobody had considered that Saudi and Iran would strike a peace deal and both join BRICS+. The UK’s saw an end of an era with the passing of HM the Queen and 3 Prime Ministers in as many months as a brief attempt to break from the European tax and spend consensus under a new Prime Minister had led to the, already- in-process unwind of the rally in Sterling from $1.25 to $1.40 to extend to a short term speculative crash - with many ‘experts’ predicting parity. Needless to say it is back to $1.25 a year later. Meanwhile Hong Kong was in the process of scrapping Hotel Quarantine, to all intents and purposes signalling the final chapter of Covid. Bitcoin hit a new two year low - 75% off the top, while Zoom dropped an equally impressive 86%.

And yet, it was only two Years ago, that the West were steadily easing back on Covid restrictions, but in Hong Kong travellers were still forced to Quarantine at their own expense in hotels for up to three weeks, their only contact with the outside world being Zoom, which was still $400 (it’s now $70). Bitcoin meanwhile rose 50% in q4, as the world embraced fintech (or at least appeared to). In August, the US had pulled out of Afghanistan after 20 years and Xi had reminded the west that Common Prosperity meant that the western plans to financialise the Chinese economy would never happen. At this point nobody had heard of the so-called Special Military Operation that was to come in Ukraine, or of the impacts this would have on commodities, currencies and geo-politics generally.

Three years ago Tesla’s share price had risen 60% during August alone, while Zoom, which had begun the year at $100, went almost to $600 as day traders went crazy with their stimulus checks (sic). Meanwhile, in a world of peak QE, Austria issued a tranche of its 100 year bond for 0.85% yield, its original having peaked at a price of 225 at the end of 2021 - for a bond that redeems at 100. At this point nobody was thinking about inflation or normal levels of interest rates. Except (as usual) Warren Buffet, who celebrated his 90th birthday by raising capital in Yen at 0.44% and buying $6bn worth of Japanese Trading houses that were yielding 10x that - still one of our favourite trades. Amid widespread Covid restrictions, the US elections resulted in a win for the Democrats and Joe Biden. Bitcoin rose from 15,000 to over 60,000 in q4.

Four years ago, Teresa May stepped down as UK Prime Minister and Boris Johnson took over with a mandate to ‘get Brexit done’, winning a large majority at a snap q4 election. At this point, nobody had ever heard about Covid. Donald Trump was aggressively pursuing trade wars with China, while being (falsely) accused of colluding with the Russians. In Hong Kong the street protests had closed down much of the activity in the city and attracted headlines worldwide. Meanwhile, the yield on the 10 year Japanese Bond was -0.295% - today it is 70bp.

Five years ago, the tightening of monetary conditions in the US had precipitated a 25% drop in the S&P in q4 and the worst hit to Emerging markets since 2008. Italy was apparently in crisis and Italian Bank shares fell by over 50% in Q3/Q4. , the Venezuelan Peso had crashed 50%, as had the Turkish Lira. China, meanwhile, saw the Shanghai Composite drop 25% in q4 2018. At this point, nobody had heard of Greta Thunberg. Of course, since then, the Italian stock market is up 65%, while China is up 30%, having been up as much as 50%. The US Equiyt Market of course, has basically doubled from the lows (as was the intention from the Fed we would suggest) and Climate change is now effectively the only thing the World Economic Forum talks about every year and is essentially forced into every conversation about anything by almost every politician. The Turkish and Argentinian economies have not really recovered however, and both have continued to weaken as have their currencies, more than offsetting any nominal gains in markets.

What to conclude?

The things that dominate Market Thinking today involve much that was not even discussed a year ago, let alone five, while much that was deemed important back then appears much less so with hindsight. To avoid the end of History Illusion mentioned above, we would acknowledge that it has been an extra-ordinary five summers and much has, genuinely, changed, but that is not to say that we see it settling into a new, stable world. Indeed, the changes we have seen will undoubtedly presage more change, but equally a lot of that deemed vital and important today, may turn out not to be so when looked back upon.

"Life can only be understood backwards; but it must be lived forwards".

Soren Kierkegaard

From a markets’ point of view, we see the end of QE as having been the key driver to the recent volatility, but this has also, we believe, put us onto a new paradigm of a new New-Normal and a return to some of the things that were previously dismissed as no longer relevant, like sound balance sheets and cash flow. Much of the ‘alternative’ investment space is now seriously challenged in a world where liquidity is more highly priced. Covid was important for some cultural shifts and working from home, but we would suggest that the geo-political shifts and the end of the Petro $ coming from the sanctions on Russia and the emergence of BRICS+ are going to be much more significant. As is, we believe, the emergence of Japan from a 30 year (self) induced coma.

Equally, we think inflation is now in a 2-4% band rather than a 0-2% band, but it is not the threat that some central bankers believe and that, aside from further taxes, the cost of living crisis is now easing. Nor, dare we say it, do we believe that Climate Change is a crisis (other than official policies in response are part of the cost of living crisis). In this of course we are in contrast to the WEF, whose Global Risk report has environmental risks as five of the top 10 risks on a 2 year basis and six of the top 10 on a 10 year basis, with only one (cost of living crisis) being economic.

The one we would agree with is Cyber security, not least with AI, which genuinely has come on to be a potential game changer for service industries in particular. Importantly, markets will adapt and returns will be generated from the bottom up innovation, rather than by top down dirigiste policies (although from the other direction these can easily wreck returns). Recognising at least a shift in the path can help us look to the past for some suitable paradigms that might once again start to work, while acknowledging that history rhymes rather than repeats.

As ever, these remarks are for information and hopefully entertainment purposes only and should not be considered investment advice. Please contact your finanacial advisor before investing.

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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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