Huddlestock Investor Brief – April 2018 – Huddlestock

Huddlestock Investor Brief – April 2018

Huddlestock Investor Brief – April 2018

To date Huddlestock* is up +6.62% versus -0.26% for the HFRX Equity Hedge Index**, +1.20% for the MSCI All Country World Index*** and +2.13% for the NASDAQ 100****. Huddlestock was down -1.23% in April and is recovering strongly in early May.

* Estimated actual performance of all strategies/themes on the Huddlestock  platform on an unleveraged basis.
** The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies.*** The MSCI ACWI Index is designed to represent the performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 24 emerging markets. It covers approximately 85% of the free float-adjusted market capitalization in each market.
**** The NASDAQ 100 is a stock market index made up of 107 equity securities issued by 100 of the largest non-financial companies listed on the NASDAQ. It is a modified capitalization-weighted index.

April’s performance narrative included:

– The ongoing potential for an escalation of the tariff tiff into a trade war. Beyond rhetoric and positioning for the upcoming negotiations we haven’t yet seen any real escalation. Given the negative response of the stock markets to these developments and taking the upcoming mid-term elections in November into account, we believe that these negotiations will be drawn out and the mainstream media will likely interpret this as positive progress which could push investor sentiment higher. There is a very reasonable chance that the end result of this dispute could be more, not less, global trade if China takes a step towards opening its economy, integrating into the global system and protecting intellectual property.
– A slight softening of economic data in the US and Europe is complicating central bank normalisation and the path towards raising interest rates. There is a real risk that central banks won’t be able to reposition themselves in time to help combat the next recession. The main problem is that inflation hasn’t taken hold despite a growing global economy that’s at roughly full employment. It seems clear to us that this is at least partly explained by technology’s effect on every industry. Technology is somewhat uniquely governed by two laws: Moore’s law and Metcalfe’s law. Moore’s law describes the diffusion of ever more powerful and cheaper technologies and Metcalfe’s law describes the power of network effects. These laws could be explaining why productivity gains in a constrained environment haven’t yet led to wage increases and inflation. An additional complication in the US specifically, is that a very high proportion of 401k retirement plans are heavily invested in stocks which, combined with a peak number of retiring baby boomers, may mean that when a recession does arrive it may take substantially longer for the economy to bounce back than it did after 2008. The Fed is undoubtedly aware of this so a market shakeout at this stage makes sense from that perspective. We need to be aware that a V-shaped recovery may not happen next time.

– The 10-year US Treasury yield broke through the psychologically (and heuristically) important 3% level leading automated sellers to generate volatility and noise. The sensitivity of the stock market to changes in interest rates, especially given the recent flattening of the yield curve, has also led the Fed to become more cautious on the potential impact of a policy mistake. The latest FOMC meeting notes indicated a shift from a 2% inflation target to a target symmetrically-centred on 2%.

– Other events in April included: Sanctions being imposed on Rusal in Russia and ZTE in China on national security grounds, the Facebook/Cambridge Analytica data scandal and Trump’s tweet attacks against Amazon both of which rocked the technology industry as a whole, unexpected positive progress of the peace process in Korea, rapidly escalating interest rates in Argentina as it tries to defend the Peso (this is likely due to the recent strengthening of the US dollar which is also having a marked negative effect on European exporters), the threat that the US could pull out of the Iran Nuclear Deal which would impact the supply of oil and the start of the renegotiation of the NAFTA agreement in May.

Unsurprisingly, given these geopolitical and macroeconomic vacillations we’ve witnessed a bit of a switch from a ‘buy the dip’ to a ‘sell the rally’ mentality. We believe that the elevated level of volatility this year is feeding into this switch since many large institutional investors are mandated to deleverage if market volatility rises above a certain level. The fundamental economic backdrop continues to look broadly solid however and while there are clearly risks that require navigating we continue to believe that, all in all, stock markets will rise. If they do, and February’s volatility spike becomes a distant memory, we believe a re-risking by these same institutional investors is likely which should power the markets higher, especially given the strength of corporate earnings and the materialisation of secondary effects related to December’s tax cuts in the US.

What does this mean for an investor?
It is difficult to understand the spell of indecisiveness that has come to dominate the financial markets of late. Are investors really concerned about a 3% 10-year US Treasury yield when expectations of S&P 500 earnings have risen from 12% to 20% in 2018? It seems to us that an environment of robust operating leverage, corporate pricing power and more normal interest rates is a healthy backdrop for holding stocks. While Europe isn’t doing as well as the US, and there has been some softening of economic data (possibly purely due to seasonal factors), the ECB has signalled that it is prepared to continue to support the recovery.
It seems that politics is causing a degree of uncertainty which the markets have decided to fully price into risk assets, like stocks. If progress is made and China opens its economy, integrates more closely with the global system, starts protecting intellectual property and assuages US national security concerns there is a realistic chance that we’ll see far more global trade. These developments would be very positive for stocks.

Vendor Perspectives

At Huddlestock we value different perspectives. This month, NOVU Invest provides some colour on developments in the Energy Markets
The Asian Tigers are back in the spotlight

There are times in history when three months feels like an eon, and other periods when the last twelve months feel like no time whatsoever, as shown by the last eighteen months since Donald Trump secured the US Presidency.

With the constant blast of market moving news emanating from the President’s Twitter account, it’s hard to stay on top of the geo-political landscape that often now changes by the week, if not the day!
This week’s dial moving event sees the spotlight focus on the impending meeting in Singapore where North Korea’s idiosyncratic leader Kim Jong-Un will discuss nuclear disarmament with Trump. Seemingly out of the blue, the Asian Tiger economies, Taiwan, Thailand, Singapore, South Korea, Malaysia, Vietnam, Philippines and Indonesia are well and truly back in the news.

It has been over 20 years since JP Morgan’s foray into Thailand’s burgeoning Credit Default Swap Market resulted in significant losses for all concerned, and in many ways set back the reputation of the region. However, from many of the metrics that matter today, relating to the likes of ‘Nu Tech’ and other aspects of modernization, the overall prospect for investors looks promising.

For some time now, the ETF industry offers a suite of index trackers that provide exposure to all those countries’ mainstream equity markets, and for those fortunate to have engaged in some tactical asset picks of late, the rewards have been noteworthy. For example, the Xtrackers FTSE Vietnam UCITS ETF has returned 10% (in USD) since the start of the year.

We anticipate that the spotlight that the nuclear disarmament talks will bring to Singapore will rub off positively on the markets. From a technical perspective the 50 day vs. the 200 day moving average for the Xtrackers MSCI Singapore IM Index UCITS ETF looks encouraging and for this reason we feel exposure to this ETF is worth considering in more detail.

Dr. Allan Lane and Dr. Irene Bauer

The Hedge Fund Trick
We’ve been sending you investment ideas that relate to an individual company’s stock or an ETF. Going forward, we intend to facilitate ideas involving more than one instrument which will allow us to better exploit investment opportunities.

Investments in single stock ideas are required to be absolute, meaning that by buying a stock its price must go up for you to make money. By introducing ideas based on more than one stock we can pursue relative investments, an example being to go long one stock while shorting another. In this case, we can target the relative outperformance of the long over the short. Structuring ideas of this type intelligently means that we can make outsized returns while possibly taking less risk. Variants of a classical hedge fund strategy called ‘pairs trading’ play into this. Examples include ideas around dual-listed stocks, share class arbitrage, statistical arbitrage, mean-reversion strategies and risk or merger arbitrage strategies. Importantly, the simplicity of investing in an idea won’t change for you, it’s just that we are working our way towards sending you higher quality ideas with bigger payoffs for the same level of risk.

So, what’s the hedge fund trick? The trick lies in the use of leverage while explicitly controlling risk (risk is defined as measurable uncertainty). If an idea is structured in the right way, then by combining several instruments you can massively reduce risk (via hedging) while holding onto (most of) the payoff. You then have the option of using leverage to push the risk back up and, most importantly, leveraging the payoff. Here’s a simplified example of the trick:

Scenario A :: Buy shares in Microsoft: expected return = 10, risk = 5;
Scenario B :: Buy shares in Microsoft, sell short Shares in Google: expected return = 6, risk = 2;

To compare them more directly we leverage Scenario B 2.5 times. Then for the same level of risk (i.e. 5) the payoff would be 10 under Scenario A and 2.5 x 6 = 15 under Scenario B. Applying the ‘trick’ means that for the same level of risk we’re able to make a 50% higher return. Note that leverage is optional, you could simply go for a lower risk portfolio. We used this heavily simplified example (properly understanding risk measurement, dynamic hedging and idea construction is a field unto itself) to illustrate the usefulness of being able to attenuate risk in order to generate better performance.
If the above example sailed right over your head just know that we’re actively working towards sending you better, smarter investment ideas every day.

For any feedback, please email us at

Michel van Tol, PhD
Chief Investment Officer
Huddlestock Capital

Download this brief as a PDF file here.