To date Huddlestock* is up +7.96% versus -0.35% for the HFRX Equity Hedge Index**, +0.80% for the MSCI All Country World Index*** and +1.75% for the NASDAQ 100****. Huddlestock was down -2.53% in March.
* 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.
Performance in March was dominated by US trade war rhetoric, Fed hawkishness, a data privacy scandal at Facebook, a Trump Twitter storm against Amazon and a general flight to safety. With an overbought, momentum-driven market, especially in the US, being subjected to near daily political interference, investing this month largely entailed cautiously anticipating and avoiding areas of uncertainty. There have now been nearly as many days with moves that exceed 2% over the last 3 months as happened in 2016 and 2017 combined. Volatility is back.
Fundamentally, we continue to believe that equity markets will rise despite shifting, headline-driven, investor sentiment. Corporate credit markets, which we regard as important to track at this stage of the economic cycle, are still supportive of this view.
Having said that, if trade war rhetoric escalates into action we will clearly need to re-evaluate our position given its potential impact on the global economic picture. At this juncture, we believe that the Trump administration is simply positioning itself for negotiations with China to deal with a legitimate structural US-China trade imbalance, greater access to the Chinese market for American companies and the protection of US intellectual property rights. The threat of tariffs alone will likely result in more capital expenditures by US companies in the US than would otherwise have been the case.
As evinced by the structural shift upwards in volatility and the breakdown of momentum over the past few months, investing in simple themes like ‘AI’ or ‘Higher Oil Prices’ is steadily being replaced by a need to dig deeper into the individual merits of each investment. This change in environment, from simple to complex, harbours opportunities for those willing to put in the effort to separate the wheat from the chaff.
Specifically, and at the risk of coming across as being overly confident in our view of future developments, we believe that the macro investment story could unfold as follows:
The tax reform bill that was passed in December will lead corporations in the US to make strategic acquisitions, invest in new technologies and buyback their own stocks to boost their return on equity (we are already seeing evidence of this).
Currently, debt at American non-financial companies is at an all-time high relative to GDP, and is set to continue to rise. This suggests that if interest rates rise materially, a point that could be reached more quickly than most expect, abnormally many companies are susceptible to defaulting on their debt. One threat that could lead to higher interest rates comes from China, which has the option of purchasing fewer Treasuries going forward.
An upward shift in expectations related to corporate defaults will very likely undermine the current bull market. For this reason, we are closely monitoring high-yield corporate bond markets for signs of stress.
As the risk of corporate defaults rises heavily indebted companies, and companies that need external funding for survival, are going to fall out of favour with investors and there is an elevated risk that the massive indiscriminant inflows that we’ve seen into passive ETFs over the past few years will reverse and turn into indiscriminant outflows.
At that time, these ETFs will be selling overbought, leveraged stocks exactly when liquidity in individual stocks reaches multi-year lows. If these hypothesised developments materialise we’d expect a deep, fast stock market crash.
Importantly, the timing and severity of this potential sequence of events is highly dependent on how and when Central Banks across the world react to these challenges. One thing seems certain, as investors we need to understand the sensitivity of our investments to unanticipated changes in interest rates. For now, we continue to believe in our melt-up hypothesis until we see evidence to the contrary. Please consider the scenario described above as useful for contingency planning rather than an outright prediction.
What does this mean for an investor?
We’ve been highlighting the need to keep both corporate credit markets (a potential solvency event) and a reversal in ETF flows (a potential liquidity event) at top of mind in past Investor Briefs. At this point, we believe the former is likely to precede the latter. We will continue to monitor both credit and ETF markets for signs of stress. From an overall strategy perspective, we’d want to derisk (and possibly go net short) if we see evidence that these developments are playing out.
At Huddlestock we value different perspectives. This month, NOVU Invest provides some colour on developments in the Energy Markets
The headlines that got most attention in March, were filled with “trade-war” between the US and China. However, no one comes out as a winner in a trade war. We can’t say that we are heading towards a trade war, but certainly a period of escalating trade tensions. And a lot of reasons to be concerned.
We encourage everyone to take a deep breath in these uncertain times,
Fundamentals control the market; the market doesn’t control fundamentals.
Markets seldomly move purely based on fundamentals, hence the existence of euphoria and depression at market tops and bottoms. The key is to understand when the turning points in these cycles will occur.
Energy stocks finished up and the S&P 500 down in March. The worst quarter for the sector in 3 years.
There has been a dislocation between supply/demand fundamentals and the oil price since 2017. Global oil storage reflected an ever-increasing deficit which culminated in the “largest oil storage drawdown in history”. Despite mounting evidence of an undersupply, investors didn’t appreciate its significance until October 2017, when the oil price finally broke above the $55/bbl resistance level.
Energy stock prices continue to lag despite what has been termed as a “new oil price period”. The March IEA Oil market report, might be the wake-up call for the market, as we exit a seasonally rough first quarter with a lack of OECD storage build. The disconnect between energy companies and the oil price has led more companies to shift their capex focus from growth at any cost to return maximization, and investors have started to reward the ones that have done so.
April will be the peak maintenance month for global refineries, and from May to August, scheduled refinery maintenance will materially decline versus last year. Along with expected higher refinery throughput, we believe that global oil demand will rise substantially in Q2 driven by the economic expansion we’re seeing around the world.
The recent rise of populism is widely attributed to electorates that have become dissatisfied with the distribution of the benefits of globalisation. It should therefore not come as a surprise when a populist leader like Donald Trump, who seems particularly in tune with his electoral base, plays to the crowd by standing up to China by threatening a trade war.
After raising tariffs on solar panels and washing machines in January and then steel and aluminium this month, the Chinese retaliated by announcing tariffs of their own on Soybeans and threatening further tariffs on 106 US products. At this point, the products involved are clearly focused on causing maximum political harm in the US by targeting pro-Trump states before the mid-term elections in November.
The Department of Labour Statistics has shown the extent to which potential tariffs will impact corporate earnings in different industries in the US. As we have been anticipating for a few months, technology and finance are the areas that are least likely to be affected while industrials, energy and consumer cyclicals are most affected. Indeed, it’s been estimated that the negative effect of tariffs could completely offset the positive effect of US tax reform.
A legitimate motivation for starting the trade war with China is the desire for greater protection of intellectual property rights. We don’t expect much to change on this front until the Chinese have concluded that they’ve closed the gap or bypassed the US technologically. The lack of IP protection, and the relatively lax stance on user privacy in a protected market has given China’s technology companies an enormous comparative advantage. In some areas, Chinese companies are ahead of their US counterparts.
The two questions that remain relate to whether things will escalate or subside and whether a potential bilateral trade war will spill over and meaningfully involve other countries. At this point, we consider a full-blown trade war a low probability, high impact scenario. A fair conclusion at this stage, is that the sheer complexity of understanding the effects of a trade war including higher prices, lower productivity and ultimately lower output on specific companies will likely lead to deleveraging (and not rotation) until the dust settles.
Here too, the response of central banks will prove critical in determining whether the shock of a trade war manifests itself through higher prices or through weaker economic activity and employment. Clearly, an escalating trade war, especially in the context of the developments discussed above, is unambiguously negative for stock markets.
What does this mean for Investors?
Our base scenario continues to be one of strong growth and contained inflation. While an all-out trade war would be very negative for global stock markets, at this stage we believe that the chances of that happening are very low. Real evidence of escalation would lead us to derisk while fading rhetoric would indicate that there are investment opportunities in affected sectors.
Pro tip: The Beauty of Blacklisting
Every month we’ll be focusing on delivering an insight that will help you get the most out of Huddlestock
This month we would like to discuss how and why it may make sense to blacklist companies / instruments that you don’t want to invest in.
Since we don’t tell you specifically which companies are involved in each idea before you make an investment, the option of not receiving investment ideas in the companies that you blacklist is an important one. The reason why we don’t tell you which companies are involved in an idea before an investment is made is due to ‘frontrunning’. This occurs when people try to trade around our investment i.e. they will try to buy before we buy or sell before we sell, hoping to benefit from our market impact. Being frontrun will invariably have a negative effect on performance and we are particularly careful if we’re investing in less liquid instruments.
There are any number of reasons for blacklisting a company. It might be that you’re the CEO of a company that is contractually restricted from trading in certain companies, or work with sensitive information at a bank and are restricted via personal account restrictions, or alternatively, it might be that you simply don’t want any of your money invested in a specific company for ethical reasons.
We intend to expand the functionality of the blacklist to give you more control and give us insight into the types of companies that you do/don’t want to invest in. At scale, it would be nice to have a ‘positive’ impact on the decision making at companies, where you decide what ‘positive’ means. Ethical, Impact, Religious, Sustainable or Green investing is just a blacklist away.
You can find the ‘Blacklist’ tab in Settings.
For any feedback, please email us at firstname.lastname@example.org.
Michel van Tol, PhD
Chief Investment Officer
Download this brief as a PDF file here.