Market Thinking

making sense of the narrative

Drilling Down

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If we only look at the top-down numbers for Asset Classes we risk missing the underlying stories and information that is ‘out there’. Thus while April saw something of ‘A reversal of the reversal, as we discussed in the May Market Thinking, the first week of May has seen something of a re-establishment of those November to March trends. Essentially the reflation trade remains in place.

Factors and Thematics

When looking at Equity Markets beneath the surface, we traditionally use countries or sectors to examine ‘what is happening’ at the next level down. Another useful approach is to use either Equity factors or Thematic approaches for our analysis. This in fact is the approach we take with our model portfolios, which use sub asset classes. Thus, while we can see that April was a positive month for Global Equities overall, drilling down saw some meaningful dispersions. In particular, we saw a reversal of some of the recent trends we have observed in the Global Factors underlying our Core Equity Model Portfolio. This can be seen from the chart below where the Red, Value, factor is at the ‘bottom of the list’ for April (albeit still positive) having been at or near the top for the previous 5 months. Meanwhile, the blue dot – momentum – which had been near the bottom of the list for the last few months jumped back to the top.

Global Factors, performance and dispersion.

Source Market Thinking

Key: IWMO Momentum, IWVL Value, MVOL Minimum Volatility, IWQU Quality, IWSZ SIze

Sometimes the dots are very widely dispersed (eg December 2020), while at other times they are more closely crowded together, but part of our discipline for the model portfolios is to have lower exposure to factors that are persistently at the lower end through use of our risk modelling framework.

We can do a similar study for our thematic approach, as shown by the second chart. Just as we use Factors for our ‘Core Equity” model portfolio, we use thematics for our Satellite Model Portfolio. Here the most noticeable thing is the relative performance of INRG, the Clean Energy ETF, which, having been bottom last April, proceeded to dominate for the rest of the year. However, it began to fade and recede during the first quarter and has been (easily) bottom for the last three months.

Global Thematic performance and dispersion

Source Market Thinking

Key RBOT Robotics, DGTL Digital Economy, LOCK, Digital Security CEMG Emerging Market Consumer, INRG Clean Energy, HEAL, Digital Health, IGLN, Gold

We have discussed the I-Shares clean energy ETF (INRG) a number of times on this forum in recent months, in particular with reference to the high weighting of the benchmark that it tracks in a small number of relatively illiquid stocks with negative earnings. (see ‘A sustainable Bubble’ ) In particular we were concerned that one company, ‘hydrogen fuel solutions provider’ – Plug Power- seemed to represent almost 9% of the index and yet had a market cap of only $15bn. More alarming was that a year earlier it had a market cap of only $1bn! This is basically a Micro-Cap company with negative earnings and a great narrative but it’s requirement to restate its earnings, not long after announcing a deal with Korean giant SK (and not coincidentally a $2bn equity raise in early February) raised some serious red flags with many investors – the stock is now down to a market cap of $11bn. This is a problem for those looking to invest via ETFs – the risk that they actually end up without the diversification benefits they purport to offer. However, it does look like both the index maker and the ETF company have made some alterations to this recently, with Vestas the windfarm manufacturer now the largest holding. In any event our risk models have been steadily scaling back our exposure to this area and are now out. On the other hand, the other interesting ETF on this list is Gold, which has been at the higher end of our risk model spectrum since last autumn, but which now looks to be returning towards neutral. As noted on many occasions, Crypto Currencies seem to be taking the place of Gold in a number of portfolios in terms of providing perceived protection from inflation and currency depreciation as well as diversification, which is one of the reasons we named it in our ‘5Cs’ back in November (along with Convertibles, Commodities, China and Cash Flow). We suspect that some of that cash may be returning to Gold, with that ‘pocket’ now being split between Bitcoin (or more likely the GBTC ‘ETF’) and Gold.

Staying in Versus Going Out

Drilling down to the next level, we can see some interesting relative stock behaviours embedded in shorter term sub themes, such as Lockdown winners or losers. Currently year on year return figures are distorted by the extreme rallies from the lows, but it is worth remembering some of the extreme behaviour that was going on a year ago. Leaving aside the crazy situation that left Oil futures trading at negative levels last April, we also had some dramatic price spikes in what were known at the time as ‘Lockdown beneficiaries’. Foremost perhaps amongst these was Zoom, which benefited from the fact that lots of people had just ‘discovered’ their product. It fitted the ‘thematic narrative’ perfectly and the market cap promptly rose dramatically to over $100bn – for $2.5bn of sales and only $700m of cash flow. However, as the chart shows, the dramatic performance in the second quarter obscures the subsequent decline. Compare Zoom the lockdown favourite with BHP the open-up favourite since last October. BHP is up 40% while Zoom is down a similar amount.

Lockdown versus Open up

Source Bloomberg, Market Thinking

To Conclude. In our May Market Thinking we highlighted how the trend reversal that took place last October appeared to have stalled and reversed, but that we believed the new trend remained intact. Looking beneath the surface and drilling down into factors, sectors and thematics seems to confirm this – as does unravelling of a number of the hype names embraced by the stay at home day traders, especially when the only other ‘investors’ are the index tracking ETF machines. Tech stocks with no earnings are thus struggling to sustain their extended valuations and in a week when Warren Buffet made much talk about inflation we would do well to remember one of his memorable lines about stock specific risk – “When the tide goes out, you can see who is swimming naked”

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