You may have missed this amid all the talk of heat and drought and the cost of living crisis, but equity markets in Europe and the US have enjoyed a remarkable summer bounce.
Having plummeted for much of the first half of the year, Wall Street’s S&P 500 has climbed 12 per cent in a month, Europe’s Stoxx 600 has risen 4 per cent over the same period and the MSCI All-Country World Index is up by just under a tenth. After a dismal start to 2022, technology stocks are once again performing well. As Harvest Volatility’s Mike Zigmont, says: “Bulls like to party.”
But recent investor optimism rests on shaky foundations. Russia’s invasion of Ukraine looks set to trigger recessions in countries heavily dependent on the aggressor’s oil and gas. Meanwhile, consumer sentiment is dire despite low rates of unemployment, and across much of the west inflation is as hot as it’s been in 40-odd years.
The US Federal Reserve and other central banks are talking tough as a result. Bond markets — in the US at least — have turned decidedly dovish, with prices rising and yields dropping again. Some investors clearly think tighter monetary policy is set to trigger economic downturns, which will eventually pave the way for lower rates.
Elsewhere, the cryptocurrency market is in disarray, China’s economy is slowing and a strengthening dollar has left lower-income countries facing soaring debt obligations. The spectre of stagflation looms large across the board.
So where to put your money? A particularly tricky question for British investors, with the government in disarray pending the end of the Tories’ leadership election.
Going out on a limb with investment advice in the illiquid dog days of August is risky business. “The one thing that we can say with some confidence is that market volatility is likely to rise again as we move into late summer and the fall,” says UBS Global Wealth Management’s Jason Draho.
In the meantime, all eyes will be on the agenda-setting Fed, which makes its next interest rate decision in late September. “The medium-term outlook should be a little clearer after that,” Draho says, “whether it’s good, bad, or somewhere in between.”
FT Alphaville broadly agrees that right now the only certainty is further uncertainty. The Vix volatility index may be at its lowest point since April, but for most investors risk management remains the only game to play.
Having said that, we’re prepared to share a few tips. We’ve selected five recent Alphaville articles — covering everything from star hedge fund manager Daniel Loeb’s prognostications to the outlook for coal. We hope these might be of help for anyone still desperate to dabble. Naturally, those in search of bona fide investment advice should look elsewhere.
Market regime change
Third Point’s Loeb penned an interesting letter to his hedge fund’s investors summing up the mood back in May. We think his words are still worth pondering.
His inspiration was the 1982 film Koyaanisqatsi, which takes its name from the Hopi word meaning roughly ‘life out of balance’. Loeb thought it had a timely message. “The prescient film juxtaposes striking images of nature with urban scenes depicting the imbalances created by modern technology, set to a haunting soundtrack by Philip Glass,” he wrote. “Forty years later, this film and soundtrack make an apt backdrop for today’s investment environment. Koyaanisqatsi neatly captures current market conditions which are, in many ways, a reaction to imbalances.”
FT Alphaville’s Robin Wigglesworth noted that all hedge fund managers love pseudo-philosophical metaphors and references, especially if they are a little recondite.
But the truth is that there were then signs everywhere that a pretty profound market regime change was upon us, and that people were only starting to grapple with the implications.
The US Nasdaq tech stock index had by this point given up all of its 2021 gains, with the most vulnerable groups being still-profitless companies that needed the support of their equity or debt investors to stay alive. Loeb hinted that many of the more speculative companies that relied on stock options to attract talent might already be entering a death loop as the value of their equity withered.
Goldman Sachs’s index of unprofitable tech stocks was in freefall, but it was clear that the rot was affecting bigger names too. That prompted the US bank’s chief global equity strategist Peter Oppenheimer to publish a report on the dawn of what he called the “postmodern cycle”.
For most of financial history, market cycles were generally short and turbulent, but during the past four decades they have been longer and smoother — characterised by falling inflation, independent central banking, globalisation, generally lower volatility, and higher corporate profits. Oppenheimer calls this the “modern cycle”.
However, the coming postmodern market era is likely to be characterised by faster inflation, higher bond yields — both nominal and real — greater regionalisation rather than globalisation, pricier labour and commodity costs, and more activist governments, the Goldman strategist argues.
Will the new era actually look that much different? It’s always tempting but often wrong to over-extrapolate current conditions into the very long term. Yet the sense of “Koyaanisqatsi” is unmistakable. As Loeb says:
“Since I started Third Point 27 years ago, I have seen many investors (including myself) stumble after years of success because they did not adapt their models and frameworks quickly enough as conditions shifted. I have said before that they don’t ring a bell when the rules of the game are changing, but if you listen closely, you can hear a dog whistle. This seems to be such a time to listen for that high-pitched sound.”
Who are we, at Alphaville, to disagree?
Of all the sectors and stocks to have suffered during the first half of the year, cryptocurrencies imploded perhaps most spectacularly. Alphaville’s Alexandra Scaggs wrote recently about how crypto’s performance was increasingly correlated with that of the S&P 500 — undermining hopes digital currency assets might serve as a diversifier in equity-based portfolios.
Why? A pair of academics — Luciano Somoza and Antoine Didisheim of the University of Lausanne — analysed data from a random sample of customers of Swissquote, one of the few regulated banks that also offers crypto-trading services. Of the 77,364 active accounts they studied, about 21 per cent traded cryptocurrency.
In short, they argue that cryptocurrency and stock prices have been highly correlated because risk-hungry retail punters have been trading stocks and cryptocurrencies together.
The academics find that the trend started “suddenly” in the early days of the pandemic in 2020, when the correlation between bitcoin and the S&P 500 jumped from zero to nearly 60 per cent.
Somoza and Didisheim attribute this to retail traders using US government Covid support payments — though Alphaville couldn’t help but notice that the jump in retail trading happened at a time when many gamblers’ usual arenas were limited, with casinos closed and most sporting events cancelled.
No matter the reason, the crypto traders captured by the survey do appear to be the gambling sort. The report says: “Looking at the stocks favoured by agents who hold cryptocurrencies, we observe a strong preference for growth stocks and speculative assets. When agents open a cryptocurrency wallet, their overall portfolio becomes riskier.”
The academics also find that the stocks most favoured by crypto traders tend to be the most highly correlated with crypto prices. These investors are either buying both crypto and speculative stocks at once, or selling both at once.
Of course, if we assume that frequent trading is bad for an individual investor’s performance and that people who crave financial risk are more likely to open a cryptocurrency account, that outcome makes sense. If investors get their volatility fix from crypto, there’s less need to make wild leveraged bets on meme stocks such as GameStop.
Alphaville’s hunch is that particularly in frothy markets, the more people hope to use crypto as a portfolio diversifier, the less of one it will become.
People tend to drink more when they’re stressed. But what they drink depends on how flush they are feeling. As RBC Capital Markets has noted, Americans buying liquor moved a bit upmarket at the height of the pandemic, when they had more money in their pockets because there were fewer alternatives for their leisure spending. But in recent months the rising cost of fuel and food is driving US shoppers to switch back to cheaper drinks.
The pandemic sweet spot in the spirits market was $30-$74 a bottle, which is Cîroc vodka and Hennessy VSOP territory, Alphaville’s Bryce Elder wrote in July.
Stimulus cheques and lockdown boredom combined to push mid-market brands share up by about 2.5 percentage points, which came mostly at the expense of the cheapest stuff.
That trend reversed in early 2021 and has been strengthening since March 2022 as inflation has chewed into incomes.
The shifts are clearest among poorer people, who appear to have increased their alcohol intake more than the rich at the height of the pandemic only to cut back more later. Citing Numerator Insights data, RBC says that for lower income households (defined as on $40,000 a year or less), consumption peaked during the apocalyptic days of March 2020. Repeat purchases of beer and wine have since been declining.
Spirits stayed stronger for longer in these poorer households, possibly because shoppers buy strong alcohol less often, but such purchases have been hit by the recent inflation surge.
Meanwhile, high-income households — with yearly incomes above $125,000 — have continued to make merry.
It seems that liquor companies have been right to keep extolling the defensive qualities of premium branding — and the high-priced deals it has generated, such as Diageo’s $610mn acquisition in 2020 of Aviation American Gin (priced at about $30 a bottle). Much of Diageo’s recent growth has come from higher-end tequila brands Casamigos (around $50 a bottle) and Don Julio (around $85), which together account for nearly 10 per cent of group sales.
So let’s not call an end quite yet to up-trading. NABCA Spirits data for May (which covers 17 states, so gives a sales snapshot of nearly a quarter of the US market) showed Diageo’s tequila brands up 39.5 per cent by volume, well ahead of the 5.5 per cent average gain in their market category.
King Coal’s comeback
Much of this year’s market downturn is of course attributable to Vladimir Putin’s invasion of Ukraine. Economies previously reliant on Russian oil and gas are now, sadly, turning to old king coal, though prices for the black stuff were on the rise long before the conflict broke out.
Demand for coal last year ended up surpassing 2019 levels by 6 per cent, according to BP’s latest Statistical Review of World Energy. China and India — the world’s two biggest producers and consumers — accounted for more than 70 per cent of the extra appetite. Coal-fired power plants still fuel more than a third of global electricity production.
Prices for Newcastle coal are at just over $400 a tonne. Anticipating Putin’s recent move to slash supplies of eye-wateringly expensive natural gas to countries including France, Italy and Slovakia, and ahead of a ban on Russian coal that came into effect in August, Brussels in May gave the EU the all clear to fire up its own mothballed coal plants.
Austria, Germany, Italy and the Netherlands say they have no other choice. Imports from the US, South Africa, Australia and Colombia are likely to rise as a result, and the European Commission now expects the EU will use 5 per cent more coal than previously expected over the next five to 10 years.
Russia, for its part, is unlikely to feel much of a hit from the EU’s ban given how many other countries still want what it’s selling. China, for one, imported 54Mtpa of coal from Russia in April, “representing a near doubling of March levels and the highest level on record,” BMO says.
Europe and coal-dependent emerging markets, on the other hand, could well suffer. Perhaps it’s time to think twice about investing on the continent. Some investors may even be tempted to tiptoe back into coal — though we’re not going to advocate investing in such a highly polluting fuel.
The tuber trade
As inflation hedges go, root vegetables aren’t the most obvious candidate.
But after a year that can fairly be described as an omnishambles, US hedge fund manager Chase Coleman is desperately trying to mitigate the tech stock losses of his Tiger Global portfolio and limit the heavy losses in his flagship fund this year.
The latest 13F regulatory filing, covering the second quarter, reveal his plan: out went Robinhood, Zoom and DocuSign, and in came, er, potatoes.
Coleman added a $12.8mn position in a small company called Lamb Weston. Eagle, Idaho-based Lamb Weston is one of the world’s biggest producers of frozen potato products, such as the french fries you can find in your local American supermarket. It used to be owned by ConAgra, until it was spun out and listed in 2016, and is now valued at almost $12bn. Trivia fans might appreciate that Lamb Weston invented the water-gun knife technique that revolutionised the industrial production of fries since the 1960s.
Despite a professed dedication to what the company calls “Potatovation”, Lamb Weston might seem like a weird investment for a big hedge fund overwhelmingly focused on fancy tech bets. We scoured the website for any mention of machine learning, leveraging the blockchain, quantum computing or big data, but it really does seem dedicated to just shipping gargantuan amounts of frozen fries (80mn portions a day on average, apparently).
Alphaville suspects it is simply just a small but potentially canny inflation hedge for Tiger, something that might help counter some of the pain elsewhere if inflation continues to pummel its portfolio. Readers interested in investing in staples should take note.