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Time to take the other side of the market


Video Transcript:


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 higher last week. India was up nearly 3% while China fell more than 1%.

Global bonds staged another big rally last week, with sharp gains in Canada, the eurozone and the US.

The US dollar lost ground against most currencies. If there was any pattern at all it was that safe havens like the CHF and the JPY and commodity currencies like the AUD and CLP outperformed

It was another mixed week for commodities. Notable movers were nickel and wheat which were each up 5%.

Our absolute return portfolio should have had a great week. Our newly established positions in US banks and airlines did very well, with BAC up 4% on the week. Our long position in TIPS also gained more than 1%.

The trouble was that BYD took another dive and lost 10% on the week.

Apparently Charles Munger’s death was too much for BYD bulls. If you recall, Munger recently said that Elon Musk is outclassed by the CEO of BYD.

I can only pray now that nothing happens to Warren Buffet, who still owns 8% of BYD, until we make some money out of this stock.

Anyway, the portfolio outperformed Treasury bills by 3bps last week.

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

Stocks were up but the DXY was flat on the week.

We underperformed our benchmark by 15bps.

Even though we have underperformed our benchmark year to date, we are still up 8%, believe it or not.

The 60/40 portfolio has made a nice comeback in 2024.

Only a year ago some pretty smart people on Wall Street were pronouncing that 60/40 was dead.

Long live 60/40.

With rates down and stocks up last week, the market traded in our liquidity easing regime

Small caps stocks, junk bonds, EM dollar bonds, and gold all racked up hefty gains.

The market spent the past 5 weeks in either our liquidity easing regime or our growth optimism regime.

Once again, the question we ask ourselves every Sunday: what’s going to be the regime next week?


This question is especially important now given markets are at a major cross-road.

US 10 year real yields have declined from 2.5% to around 2%

Will 2% hold or give?

The MSCI world equity index, after the monster rally that it had in November, is approaching the year-high reached in July?

Will the rally keep going?

EUR/USD made an attempt last week at going for the 1.10 level that has proved to be tough to crack all year.

Will this time be different?

To a great extent, the outlook for both stocks and the USD depends on the outlook for rates, for real rates more specifically.

The correlation of EM bonds, junk bonds, stocks, and the EUR with 10-year US real yields have been rising recently

MSCI world has a -60% with 10 year real yields right now

Another important market driver is oil price.

Over the past 20 weeks, EUR/USD has been more correlated with oil price than with US rates

This chart should make clear to what extent the rally in stocks, including tech stocks, was driven by the decline in oil price since October.

So what’s in store for US real rates and for oil over the next week?

What are the balances of risks for these two pivotal markets next week?

Remember, the market has now priced in more than 5 rate cuts by the Fed next year

Given the Fed doesn’t like cutting rates in the middle of an election year, for the market to be right growth has to be more than soggy next year.

Or as I said last week, oil price will have to get into the $60 territory.

But next year is still far away. The rates market does not seem to be looking much beyond Q4 GDP growth right now

The Atlanta Fed GDPNow real GDP estimate came down hard last week to just 1%, on the back of the weaker than expected ISM manufacturing report.

All I would say is that the November ISM is probably stronger than it looks as we saw a nice tick up in the new order component.

More importantly is that following a weakish Oct retail sales release, November looks like it going to be very strong.

According to Adobe analytics, the Thanksgiving week sales hit a new record.

My own daily survey of US consumers suggests the same

Meanwhile, US container rail traffic looks heathy as we head into busiest shopping weeks of the year.

The fact that Korean export growth in November came in strong also makes me think the demand for electronics has finally turned the corner

I know it is not fashionable to mention financial conditions, but the reality is that they have loosened so much over the past month that they are now back to early 2022 level when the Fed has not even started hiking rates

I really struggle to see how the Fed can cut rates any time soon.

Of course, next week we have US nonfarm payrolls. Bond bulls will be looking for clues that could foreshadow rate cuts

Consensus is looking for 180 new jobs added and 0.3% month on month increase in average hourly earnings.

Given the massive rally in bonds over the past week, it is reasonable to assume that the market fears a strong reading more than a weak reading.

Yet, if there is anything I have learned from the last few months is that mean reversion has become the new thing in US monthly data.

If we add 30,000 auto strikers who have returned to work in November to the October payrolls, we get to 180k.

It seems to me that the risk is that the job market data come in better than expected.

If I am right, the risk is that rates will backtrack next week, possibly even before Friday.

What about oil price?

It was clear from the oil sell-off on Friday that the market was not impressed by OPEC’s announcement of new production cuts.

It was a good thing that we got out of our USO position in our absolute return portfolio before the OPEC decision, but I think the market’s reaction was premature and not thought through.

The size of the cuts was massive, even if we take into account of the fact that the contributions from Saudi Arabia and Russia were only extension of previously announced cuts

If we just look at new cuts from other OPEC members, we are talking about a combined 700,000 barrels a day to be removed from the market

This was more than I was expecting.

The market apparently did not like the fact that these are voluntary cuts.

You might argue that voluntary cuts are less enforceable, but I would argue that voluntary cuts could mean a high level of motivation to do what it takes to protect the price floor.

The market didn’t like the fact that the cuts are temporary.

But let’s look at what the OPEC statement actually says:

It says that after March 2024, in order to support market stability, these voluntary cuts will be returned gradually subject to market conditions.

My interpretation of the statement is that these cuts are so big that OPEC wanted to reassure the oil consumers that if oil price were to overshoot to the topside, they will unwind the cuts.

I believe oil price will recover next week as the market comes to its senses.

Especially if the US production stabilizes at 13.2 mln b/p as it has over the past few weeks

For whatever is worth, the high frequency data on Iranian oil exports suggest a sharp decline in November.

I can think of a good reason but I don’t want to go there right now.

Another development that makes me less bearish oil going into 2024 is the fact that Brazil, the 9th largest oil producing country in the world, is applying to join OPEC.

That should help strengthen the cartel power of OPEC.

In any event, I am expecting Brent crude to get back to $85 a barrel before the end of the year.

So I am looking for both rates and oil price to head higher next week.

If I am right, what will it mean for stocks?

The Unbound risk appetite indicator is not yet in full complacency mode but it is back to the level we saw in July just before the stock market peaked

More troubling is the fact that the magnificent 7 has not managed to catch any momentum after breaking above the consolidation flag pattern a couple of weeks ago

High quality stocks have been the best performing style factor all year

And as of last week, it appears to be running out of steam (Chart 40)

Value is catching up and I am still bullish BAC but value is not big enough to drag the entire stock market higher

Meanwhile, the Chinese stock market is looking ever more sickly

So for next week, my bias is for higher rates and higher oil, lower equities, and higher dollar.

For that reason, I am keeping my overall UW equity positions, I am moving to a neutral USD weighting, and I will move to a UW US bond position.

Now let's turn to John to find out what's on his mind:


Our new positions in BAC and JETS have done well for us, but these gains have been offset by losses in our position in BYD.


The rationale for buying BYD was that easing trade tensions between the US and China would benefit companies such as BYD which are looking to export more. We have seen a small step in that direction with the rules on imports to qualify

for EV tax credits. Certain trace minerals were exempted from the restriction, presumably exactly the ones that GM needed to qualify. It's a long way from there to BYD selling cars in the US so the market isn't getting excited about it just yet.


For most of 2023, BYD has traded sideways, while its competitors such as LI and XPEV have rallied

The recent sharp decline isn't a result of competitive pressure however, as all three stocks have declined by similar amounts. The tells us that the market is unconvinced about Chinese plans to stimulate domestic growth. Both LI and BYD are profitable companies so if the EV market takes time to grow, it should be more or a problem for XPEV. The options market doesn't seem to be too concerned about XPEV though, with puts and calls trading at about the same level.

I'm inclined to think therefore that what we're looking at is a clear out of short term positioning.


The sideways price action in BYD is in part why we thought we were getting a reasonable price. Even with the recent sharp decline, it remains in its range, and I think it will hold. BYD is actually below average risk in the portfolio, so

if anything we could add to BYD at these levels. However, it isn't sufficiently below average risk to make this worthwhile so we'll keep it as is.

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


Also this week in More Buyers or Sellers, in honour of Charlie Munger, we take a close look at the value ETFs, and see if we can find some great companies trading at fair prices.



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