Market Thinking

making sense of the narrative

Pulling to the sidelines

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Sterling dropped, Tech dropped, Oil prices dropped. It all feels like some de-leveraging going on.

As the west goes back to work and school (or at least tries to), there is a feeling of money coming off the table. The rally in sterling against the $ has unwound, as has some of the summer strength in the long bond. The Nasdaq of course is having its own correction as the options driven leverage comes out and the whole ‘gamma squeeze’ story flips around. The narratives are reasonably clear – the Softbank engineered squeeze in tech has helped make sense of a lot of unusual activity – while the long bond is reflecting worries over the Fed’s stance on inflation, which is also given as the reason for the general weakness of the $ in the last month. Meanwhile, the sterling weakness is attributed to ‘concerns’ over Brexit. Of the three narratives, the options one is the strongest, the others look like relative ‘noise trading’ to us.

One thing that has also caught our eye is the recent weakness in the Oil price. It seems a long time ago that we had the extra-ordinary moves in the Oil Futures markets that gave us negative oil prices (it was only April), but after a steady climb up from the distorted $20 levels, we have seen a lurch down since the start of September. Time was when a 15% drop in oil prices would be capturing all the headlines. No longer it seems.

Sharp drop in Oil prices

The default explanation for weak oil prices is usually ‘weak demand’ but actually more often than not really means excess supply. Certainly the latter is more consistent with other economic indicators, for while the GDP data is far from great, other indications of economic activity such as industrial metals prices remain strong. Particularly anything to do with China. After back to back weekly losses, commodities traders are doubtless trying to make this a pandemic story, but with copper inventories low and oil inventories high, we suspect it is more to do with earlier expectation. Likely that when Chinese refiners sucked in a lot of cheap imports earlier this year, traders drew a straight line up and tried to supply accordingly.

The drop in Sterling at the end of last week was widely attributed to the latest ‘concerns’ about a Brexit deal and certainly the move was biggest against the Euro. However in the context of the post Brexit vote period it just looks like the pound has followed something of a seasonal pattern and has just dropped to the bottom of the 1.08 to 1.20 range it has traded in.

Sterling Euro at bottom of range

Source Bloomberg

It should also be remembered that there is a weak dollar story playing out in the background that has seen the trade weighted index drop sharply in recent months, around 10% against the Euro and perhaps more significantly over 5% against the Chinese Yuan. Indeed, from a technical point of view it’s difficult to see any support for the $/Yuan. It may well be (as we continue to suspect) that this is actually, quietly, official policy from the US.

Of course, part of the drop in the $ could reflect views about US inflation, as apparently also demonstrated by the sell of in the US long bond, but we suspect that there is actually something of an international buyer’s strike for US assets ahead of the election. As previously discussed, a Biden Presidency would be something akin to ‘the blue pill’, a return back to the previous establishment globalist ‘normal’, but a Trump Presidency is, quite simply, way too unpredictable for many investors. Moreover, with an expected pause in the Tech rally the imperative to buy any US assets has gone.

Tech Options

The drop in the price of Tesla was to be expected in the wake of the revelations about Softbank’s fun and games in the options markets, but we probably have to wait to see the option expiry/roll on September 18th to see how it fully plays out. The biggest volume is in the September 370 calls, which are currently just in the money, having gone underwater briefly as the stock price bounced in a textbook fashion off its 50 day moving average this last week to close at 372. (It was also very close to a neat 38.2% Fibannacci retracement of the rally from the March lows for those that follow those sort of trading systems). Similarly for Zoom, where the biggest volume is in the 380 September calls and the price is just above that. There is also large size in the 380 puts, so the tussle between those two camps will be interesting to watch.

The value of those Tesla calls is off around 90% from their end month highs. Similarly, Apple September 115 calls have lost 90% of their value so far this month.

We discussed previously how the summer rally in US Tech felt a bit like the May 2015 moves in the Shanghai Composite and it is worth noting that, back then, the narrative for buying into the Shanghai Composite was that it would be included in the MSCI World index and that the index trackers would have to buy it. They, day traders were assured, would be the bigger fool to enable you to get out at the top. Except it didn’t happen and the day traders lost all their money. Interesting therefore to notice that part of the rally in Tesla was based on a similar notion about the stock going into the S&P500 index and thus the famous ‘tracker funds’ would be forced buyers. That didn’t happen either.

Finally, one company clearly not relying on tracker funds is The Hut Group, or THG as it calls itself trying to sound more tech focussed. Currently one of the largest private companies in the UK, THG is planning an IPO, which in true Venture Capital fashion comes with an eye watering valuation based on it being some super tech growth stock. In fact, less than 10% of its revenues comes from the division being touted as the growth engine, the rest comes from selling beauty products and vitamin supplements online. Moreover, the company doesn’t actually make a profit. The IPO is going for a ‘standard’ listing, which means lower levels of corporate governance and no eligibility for tracker funds. Just as well perhaps on the basis that, while the VCs are getting out at a 4.5x sales multiple, the CEO is retaining a blocking founder’s share, awarding himself an extra-ordinary incentive scheme and seemingly being given the company’s portfolio of physical properties (with a GBP20m annual revenue stream), a portfolio that this ‘tech’ company has spent several hundred million acquiring in the last few years. Brought to you by a laundry list of almost every major bank – most of whom also picked up a nice fat debt financing fee only last year – the Corporate PR machines have been working overtime this last week. Still in a year when nobody appears to be paying much attention to detail and facts, perhaps the spin merchants who have seemingly perfected the art of making people fearful can convince them to be greedy instead.

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