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Taking on the most crowded trade


Hello everyone. Welcome to Beat the Market. 

Over the next 10 minutes we will talk about our investment strategy for the week ahead. 

Global equities were flat last week. However, rotation out of China into India continued. India was up 3% while China fell 3%.

Global bonds had a mixed week. Japan and Brazil sold off while Europe rallied.

The US dollar gained ground against most currencies. The Japanese yen was the best performer while the Norwegian koruna was the worst

It was a down week for commodities. However, wheat was up 6% after Russia attacked a Ukrainian port facilities on the Danube river.

Our trade of the week last week was to sell EUR/USD

The trade had a good week as the bellwether cross could not hang onto support level at 1.08.

In our book, we remain also long copper, short Nasdaq, and long Brent

Our absolute return portfolio had a good week with US airline stocks going up 6.5% on the week. BYD that had struggled in the previous weeks also clawed back 1.7%

The portfolio outperformed its benchmark by 24bp on the week

As for our global asset allocation portfolio, we went into last week underweight stocks and underweight US bonds

Both stocks and bonds largely unchanged on the week, we underperformed our benchmark by just 4bps.

With rates up and stocks up last week, the market traded in our growth optimism regime

As you can on this chart, the market has split its time over the past six weeks between growth optimism and liquidity easing.

It is interesting to see US small cap stocks and EM equities parting ways. It says a lot about how investors feel about the US versus China. 

Looking ahead to next week, will we return to liquidity easing, or stay in growth optimism, or move ahead of liquidity tightening?

In my view, the 3 key drivers are US rates, oil price, and Chinese response to the deepening housing crisis

I was right last week about the risk that the November US job market data would come in stronger than expected

What is interesting is that this was despite a loss of more than 30k jobs in the retail sector

This has bearing on the December job data as strong holiday shopping so far is almost for sure going to boost retail employment this month

The establishment survey numbers were strong, but it was the household survey data that really impressed. The household survey showed a net creation of 750,000 jobs that drove the unemployment rate down 3.7%

Wage growth accelerated sharply, breaking the declining streak of the past four months

I am not suggesting that the labor market remains red hot. 

The job openings to job seekers ratio is nearly back to the pre-pandemic level

Consistent with this development is the fact that the share of small businesses reporting that jobs are hard to fill is also back to 2018 levels.

What I am saying is that job market remains strong, financial conditions are too loose

As I pointed out last week, financial conditions are back to levels before the Fed hiking cycle began

This is premature in my view. This is why 2 year treasury yields back at 4.75% are closer to fair value

Much will be riding on the US inflation release next week

 I am expecting core services inflation excluding housing to accelerate after the unexpected decline in October

If I am right, expectations that the Fed will soon cut rates will push back further. 

As important as the next week’s inflation release is the immediately outlook for oi price. 

The correlations between major markets and oil price picked up further last week

This is especially true about the equity market that is increasing supported by falling oil price.

Yes, crude oil price is almost back to year lows

As a result, US retail gasoline price is poised to break the important 3 dollars per gallon floor

The S&P consumer discretionary sector rallied 1.1% while the energy sector fell 3.3% last week

I have no doubt that a further decline in oil price could extend both the equity and bond rally that are long in the tooth otherwise. 

December is never kind to counter-trend traders. 

This may be why the market didn’t care about a bigger than expected draw of US oil inventory last week

Sure gasoline inventory picked up but this is exactly what we would expect it to do at this time of the year

More important is the fact that US crude oil production declined last week

Not by much, but given it has gone up in a straight line since August, I think it warrants at least some caution.

On the same day US oil data came out, Putin made an unexpected visit to the Middle East, first to UAE and then to Saudi Arabia

I don’t know what Putin had to say to MBS in person that he could not say over the phone, but my guess is that it had something to do with oil price. My gut tells me that Putin went to Riyad and Abu Dhabi to show that there is no daylight between Russia and OPEC over the question of the commitment to support oil price. 

It wouldn’t surprise me that his Saudi trip also had something to do with his meeting with the Iranian president in Moscow the next day.

With the Iranian backed Houthis in Yemen vowing to target all Israel bound ships in the Red Sea, I think Putin needed to assure the Saudis that he would apply pressure on Iran to rein back the Houthis before things get out of control

As you can see, the Houthis are in a position to seriously disrupt all traffic, Israel bound or not, going in and out of the Red Sea

The Saudis don’t want to see a regional war in the Middle East and Putin wants MBS to know that he is doing everything in his power to prevent it.

I see Russian diplomacy as helping to strengthen the unity of OPEC+ which should be viewed as positive for oil price. As I said last week, I think the market is underestimating the impact of the 700,000 barrels per day additional cuts announced by OPEC+. 

Meanwhile, Venezuelan, following a nationwide referendum last week, has threatened to annex the oil rich Essequibo region of Guyana.

Maduro chose his timing well. This decision came less than 2 months after Biden had agreed to ease Venezuela’s oil sanctions

I think Maduro figures that Biden wants oil price to go down so badly ahead of his re-election campaign that he might just turn a blind eye to his land grab. 

Guyana has a population of less than 1 million people while Venezuela has a population of nearly 30 million people. It is no match in an armed conflict. 

But will Biden allow Venezuela to invade Guyana when Guyana produces 400,000 barrels of oil per day and Exxon and Chevron have huge stakes in its oil reserve?

I don’t know but I think geopolitical risk premium in oil price is too low given so many moving parts 

As I said, trend is your friend in December. 

But I think oil is definitely a buy on sell-off story. 

This is especially so given short oil position is probably the biggest speculative position in the market right now

Besides US inflation, oil price, I think China is at a pivotal juncture. 

I hope you had a chance to watch my video earlier in the week about the deepening Chinese housing crisis

I see the new directive from Beijing to state owned banks to provide unsecured lending to developers to complete their unfinished apartments as an important shift in policy that might finally unlock the biggest bottleneck in the Chinese economy. 

The market wants to see that this is not just more talk.

The market will want to see an increase in lending to developers before deciding that the policy is being implemented.

Next week we will get China’s monthly total aggregate financing data for November

We won’t get the detailed breakdown for developers this month but we might be able to make some inference

A strong reading would be supportive for the RMB, for base metals like copper, and EM equities

My bias for next week: 

Higher oil price and higher US super core inflation reading that drive equities lower.  the USD higher, and rates higher.

For the Unbound global asset allocation portfolio, we will maintain our UW equity and UW US bond positions.

Now let's find out what John's thinks about the absolute return portfolio.

Thanks David. US markets were little changed last week, which in particular means that there wasn't any sort of dip that we are looking for to add risk to the absolute return portfolio.

The two markets where there was some movement were oil and China. Lower oil was great news for our position in JETS, which has now rallied around 10% for us in the 2 weeks we have had the position. This has made JETS a larger share of our risk, but not to the extent that we wish to take some risk off.

With oil now trading close to its low for the year, I still think that JETS has some catching up to do. If we get another 10% rally in 2 weeks, then it'll be caught up and it'll be time to take profit.

For China the jury is still out. If we compare the price of Copper to Chinese equities, it looks like home construction has picked up and this is not reflected in the equities yet. (Chart 2) On the other hand, looking at the performance of US homebuilders, maybe all the construction is here.

Our position in BYD managed a small rally, which is bad in the context of

how far it has fallen, but good considering how bad the rest of the Chinese market was. November car sales in China were decent, and the volatility skew in various car makers still favours calls over puts. As such I still like this position.

So no changes to the portfolio this week. As always I'll give updated weights on Monday.

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I don't know but centralization is not a bad thing with banks increasing unwilling to step up during liquidity crunch.

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