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Seasonal Tailwinds

Video Transcript

Hello everyone and welcome to beat the market. In the next ten minutes or so I'm going to talk about our investment strategy for the week, with my views on the sectors, and the stocks that will be in our systematic global large cap portfolio.

Last week equities rallied while bonds sold off.

This was our growth optimism regime and for once the picture was quite clear. After a blockbuster payrolls report, the market needed some time to come to terms

with stronger growth. The only asset that went against growth optimism was copper.

This is now 3 out of 4 weeks in growth optimism, and in light of the strong data, this is clearly now the dominant regime.

The only question we need to consider then is whether all the good news on growth is now priced in, and the market will shift into a liquidity tightening regime.

So what's going on?

Well first we note that Chinese equities tried to rally again.

The catalyst for this was a meeting of Xi with the securities regulator, and his decision to appoint a new head. The market liked the fact that Xi is getting

involved personally, because he presumably doesn't want his efforts to fail. However, the fact that he decided to fire the man whose efforts to date have failed makes it look like he is trying to find a scapegoat. I think this is why a lot of Chinese companies gave back their initial gains, with BABA being the most notable.

The fall in copper suggests to me that Chinese efforts remain focused on propping up the financial economy rather than the real economy. Of course, if we compare Copper to Chinese equities, it looks like Copper was due for a fall.

However I think this gap is more to do with lack of supply.

Further evidence of the weakness in the real economy came from the shipping company MAERSK, which put out a pessimistic forecast for the year.

The economy continues to struggle against deflation, as evidenced by the latest weak CPI print in China. On a structural basis, deflation is generally caused by a population that is declining - indeed if you look at the numbers for Japan,

deflation started exactly when their working age population began to shrink. China too shrank last year, due to a collapse in fertility rates. That's not something that is easy to fix. The US is "fixing" their demographic problem by keeping the border open. By contrast, China loses about 350,000 people each year from net migration according to the UN.

So I still don't see any reason to get excited about China. However, this week their markets are closed for the New Year holiday so we aren't going to get any further bad news either. I looked at what the China ETF FXI does during the New year week, and the answer is generally not too much, but it drifts lower if anything,

while US markets drift higher at the same time.

Turning to the US, there was strong demand for treasuries at the 10y and 30y auctions last week. In part this was because yields were higher than the prior month, but I suspect that the CPI miss in China may have created some demand, as indirect bidders were particularly strong in both auctions. Either way, I think this reduces the probability of a disorderly sell off in treasuries that kills the equity rally.

The equity rally was partly a short squeeze, as evidenced by small caps leading large caps despite rates being higher on the week. However, there was still strong demand for everything AI, with ARM and PLTR seeing huge gains on earnings, and NVDA making another new high. It also wasn't a total capitulation from shorts, with bank stocks for example being lower on the week. However, even bank stocks were not that bad, with NYCB up 17% on Friday for example. The market evidently is not too concerned about a banking crisis any more.

Next week we get CPI and then retail sales. If we get soft inflation to renew hopes of aggressive Fed cuts then clearly the market will rally. If inflation comes in hot then we'll get a dip, and retail sales will matter. I think that the market will want to see a strong number to reassure them that inflation is high for the right reasons of demand as opposed to the wrong reasons of disruption in shipping. Our prediction is that retail sales will be reasonably strong, so I think that a CPI induced dip in equities will be one to buy.

Last week in the sectors I was looking for financials to underperform on lingering concerns about regional banks, while I wanted to trade momentum by being long industrials.

We didn't get a big sell off in financials in light of the banks not collapsing, but they did lag industrials, giving us another positive week. Let's see if we can continue

Financials are still looking vulnerable, but there's a seasonality reason why I don't want to be short this week.

We're in the period when the average rate at which stock bonuses are issued is determined, which tends to cause bank stocks to rally until that date before selling off afterwards.

Instead I'll sell materials, which are trading badly due to their sensitivity to China, and in general are quite correlated to financials.

Against materials I like staples this week. XLP corrected back towards the botton of its bull trend channel last week, and with our view that retail sales will be solid, I think they'll recover.

At the industry level last week I was looking for bank stocks to go lower.

They did, but they weren't among the laggards.

What we saw last week instead was a reversal of trends in the energy sector, with a short squeeze in solar and lithium, and some profit taking in Uranium, presumably all triggered by the rally in Chinese stocks.

The spot price of Uranium reached 100 at the end of January.

The long term price is similarly climbing rapidly. At some point presumably

it will reverse sharply, but we don't seem to have reached that point yet, so I'd expect the dip in URA to be bought.

The other laggards were in the metals and mining sector, in particular gold and copper miners. There is now a large disconnect between the price of gold and the value of gold miners.

This is partly a result of central banks adding large quantities of gold to their reserves. We had the latest update from China this week, and in January again they

bought relatively little due to the elevated price. Central banks aren't going to be selling, but the stock of CAT has been on a bit of a tear recently, which suggests that miners are trying to increase production. This could depress prices in the long run

so I still favour selling gold here.

The VIX sold off last week, although it did tick higher on Friday as everyone got the S&P 5000 hats on.

I still see evidence of demand for calls in the volatility skew, particularly on the Nasdaq, so I still see volatility as being supportive of equities.

Okay next let's talk about our systematic global large cap portfolio.

Last week our portfolio was up 3.1% compared to 1.2% for the benchmark. We're now up 8.1% on the year compared to 5.9% for the benchmark, which is the MSCI World Large Cap index.

The main contributions on the week came from the stocks which had earnings - BN, FTNT and MPWR, with the latter in particular seeing a big gain as it broke out of its range.

Detracting from returns were CCL and FCX. CCL was hit both by rising oil prices and weak results from Expedia, while FCX continued to suffer as copper sold off.

This week we are staying long the market. We are taking profit in MPWR as that is now looking a bit stretched, and stopping out of our position in FCX as the bears are now in control. We are also exiting FTNT, which only entered the portfolio as a result of other positions such as MELI becoming stretched.

MELI has now been through a little correction, so we are rebuying it. We are also buying ALGN and PLTR.

I mentioned that PLTR looked cheap last week, and obviously it isn't ideal that it has rallied so much. Given that the market has little idea how to value companies these days though, I don't see why it can't continue higher.

It's actually quite interesting that even though the market can't value any individual company, the VIX is low because its partially a zero sum game. In other words, META does well because they get lots of advertising dollars, but SNAP

does poorly because they lost advertisers to META, and it roughly cancels out.

ALGN is the company that makes invisalign orthodontics. These are partly medical devices and partly cosmetic, so ALGN is more correlated to the general market than your typical medical device company.

In fact over the last year, the sector with the highest correlation to ALGN was consumer discretionary, while healthcare was only sixth highest.

Orthodontics tends to be a once in a lifetime procedure, with only occasional recurring revenue from retainers getting worn out, so in the long-long term demographics should be a problem for this business. However, for now I think it is in

a good place. There was some significant pull-forward of demand during the pandemic, presumably due both to increased disposable income, and because it is more convenient to manage liners at home than at work. This created a hangover, but unlike their competitor in SDC, ALGN had a strong balance sheet, are are now back to growing earnings. SDC on the other hand went bankrupt and shut down in December.

ALGN has a great moat in their technology, so with the main competitor gone, they should do well as long as people have money to spend.

In our portfolio, ABNB reports earnings this week. I touched upon this in the forum on Friday after Expedia reported weak earnings. The bottom line is that I think there's a good chance that ABNB is capturing market share from Vrbo, so

I'm hopeful that we get a good report.

Okay so to summarize, we're long the market this week, with positions in ABNB, TEAM, URI, CCL, NUE, AXON, BN, MELI ALGN and PLTR.

In the sectors I like selling XLB to fund XLP. I think banks are going higher this week before selling off next week, and I like selling gold.

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