Market Thinking

making sense of the narrative

Friday Market Thinking

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One Regime, Two Parties

The Vice Presidential Debate this week was an overwhelming victory for Kamala Harris. Or Mike Pence. It rather depended on which side you asked. For the small number of pro Trump media outlets, Harris was exposed according to all their talking points, while to the Democrat leaning Media (ie almost all of it) Pence and Trump were exposed to, well all the things that they talk about. In other words, as with the first debate, the commentary is all coming from ‘the base’ on either side and confirmation bias is all around. Meanwhile it is interesting to see that President Trump has refused to take part in a virtual debate, suggesting Trump thought Pence did OK. The only other (possible) insight we might have is that by not obviously alienating the Democrat base, Kamala Harris has increased the likelihood of Joe Biden stepping down sooner rather than later.

The reality for investors though is that the difference in actual policies, both at home and (especially) abroad, probably won’t alter course very much. Presidents and governments come and go but institutions such as the Council of Foreign Relations endure. In a studied remark contained in a wide ranging interview that, at the very least offers a different, indeed insider, perspective on the almost decade that he has been “fighting terrorists”, President Assad of Syria recently observed that the President of the US is best thought of as a CEO and they do what the board instructs them to (questions 9 and 10 in the interview). The board, as he puts it, are the lobby groups and vested corporate interests that donate to (and thus own) the US political system. As such, he doesn’t expect any change of US policy in the Middle East, even if there is a change of ‘CEO’. Assad is not alone in regarding the West in this fashion and while this is an interesting interview in itself it also serves to remind investors of the increasing polarity emerging in international relations as we finally move beyond Covid.

Elsewhere, in a year of dramatic price movements, it has nevertheless been fascinating in the UK this week to watch the share price of blue chip Rolls Royce (which along with Tate and Lyle, GKN and Imperial Tobacco is one of only 4 companies remaining from the original FT 30 index of 1935), which moved to double in four days – although of course this follows an 82% drop from the start of the year, itself a quite extra-ordinary move. However, it does have echoes of the immediate post era. Back then, large corporates that had overstretched themselves in the Telecom area (France Telecom is a particular example) found traders simultaneously going long the bonds at, say, 70 cents on the Euro and short the equity, driving prices down in a friendless market until the inevitable deep discounted rights issue arrived, at which point they would step in and ‘help’ pick up the new stock and thus close out their position without a rush to cover. To complete the strategy they would buy some out of the money call options, confident that when their and other shorts start closing, there will indeed be a big squeeze, so you can then play the gamma squeeze trade – similar to the one that the Softbank Hedge fund was running in Tech names in July and August – to juice your returns a bit more. For the icing on the cake, the bonds naturally go back towards par, which you could also play through the Credit Default Swap (CDS) market.

Looking at activity in Rolls Royce around its emergency rights issue in terms of shorts, short covering and the CDS and options markets it looks like exactly this sort of activity was taking place in Rolls Royce this week, which is an important reminder that even as we focus on the macro, the market mechanics can still drive individual share prices. In this case quite dramatically. Elsewhere we should also be attuned to the fact that while on the one hand there are a lot of companies that have hugely overstretched their balance sheets and are really struggling to meet their financing obligations at the moment, on the other hand there is an enormous amount of corporate cash, especially available to private equity firms and the latest Wall Street wheeze, the Special Purpose Acquisition Company or SPAC.

While the amateur day traders chase noise and narrative in liquid markets, the professionals are playing a different game; companies are being taken private and restructured in some areas and being pre-packed and floated in others. Meanwhile sophisticated multi asset trading strategises using derivatives and access to alternative capital sources put the ‘pros’ still further ahead of the rest.

Reviewing Model Portfolios

Since the month end was also quarter end, we thought it worth looking at the Model Portfolios to see how they are performing, and what, if anything they can tell us about the markets more generally.

Global Bonds

Starting with Bonds, the Global Bond Model was down slightly, at -0.13%, while the Global Aggregate Bond Index we use as the benchmark was up 0.02%. Within the five bond ETFs we use as components, the worst performer last month was the US Long Bond, which sold off 0.53%. Year to date however, our model portfolio has returned 10.36%, versus 5.72% for the benchmark, largely reflecting the higher risk stance we took via our dynamic asset allocation process after the Fed intervened back in March. However, currently we have no exposure to High Yield Bonds, mostly focussed in TIPS and Global Aggregates, with modest exposure in Long Bonds and Investment Grade bonds.

All date Bloomberg
  • It is worth noting that the very high volatility in Q1 was down to the dramatic single day spike in investment grade bonds right before the Fed intervened.

Global Equity Factors

For our Core Global Equity Model Portfolio, we outperformed the MSCI World Index, which was down 3.45% for the month, but nevertheless still recorded a loss for the month, of 1.7%. This should not have been too much of a surprise however given the very strong performances in July and August, both for our model and for the benchmark. Year to date, the Global Equity Model portfolio is up over 8% against the benchmark at 1.7% and importantly for many investors with around half the volatility. The biggest loss factor was value, which dropped around 7.9% during September, while the best performer was Size (small cap), which ‘only’ fell 1.86%. The fact that our overall portfolio fell less than any individual factor was testemant to the Dynamic Asset Allocation which enabled us to capture some upsides and avoid the worst of the downsides during the course of the month. Currently our risk scores are such that we have no holdings in either the Value or the Minimum Volatility factors.

All date Bloomberg

Balanced Fund 70:30

Consistent with the underlying Bond and Equity portfolios, the balanced fund 70:30 posted a loss for the month of September of 1.31%, around half that of the underlying balanced benchmark which dropped 2.57%. Year to date the return sits at 9.1%, over double the benchmark’s +4.13%

All date Bloomberg

Global Thematic Equities

For the Thematic portfolios, the loss was only 0.13% in September which is impressive given the tech/growth bias – Nasdaq was off over 7% in September by comparison. Year to date it is currently +23.15% against the 1.7% MSCI world benchmark. The resilience during September reflected the dynamic asset allocation as the risk metrics reduced exposure to Gold – which had peaked in August as well as EM Consumer and Digital Security and started to increase holdings in Robotics, digitalisation, clean energy and healthcare innovation.

All date Bloomberg

For more data, Graphics and portfolio measurement please contact us at mark.tinker@market-thinking,com

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