Sovereign Wealth Partners and InvestSense Pty Ltd
When we look behind the enormous volume of column inches dedicated to AMC, GameStop and other stocks being discussed on Reddit (fascinating as the commentary has been) it really didn’t affect portfolio returns throughout the month.
So, what was the market trying to tell us about the investments we do own through the month? The most significant move was in the VIX, a measure of expected risk, jumping from 23 to 33 in the last week of the month. This tells us that traders estimate that there is now a one in three chance that the market will be 33 % above or below where it is now in 12 months. When this measure increases it usually points more to the downside risks than the imminent likelihood of 33 % upside. While the risk measure dissipates again, more often than not, it is worth keeping an eye on and so far, it has only been associated with the 3-4% fall in markets we saw in the last week of the month.
At a sector level this looked like a sell-off driven by concerns surrounding the global economic impact of further lock downs with energy and material suffering the most and consumer staples stocks holding their ground both here and abroad. Another small oddity in the local market was that a number of local consumer discretionary stocks appear to have benefited from the heat that Reddit users had put upon US short sellers. Many of these stocks had been widely shorted because they are sensitive to deteriorating trade relations with China and local short sellers also became nervous (when short sellers reduce their positions, they have to buy the stock to cover their position).
Looking at the month as a whole, we had all the seasons of the economic cycle with the prospect of global recovery lifting cyclical industrials, consumer discretionary and energy stocks early in the month. As the COVID data worsened and expected interest rates fell in the 3rd week, tech stocks again assumed a supposedly defensive role in the eyes of investors and kept the market afloat. The last week had a more, end of cycle, stagflation feel as the market appeared to contemplate the reality of expensive markets with potentially less respite from lower rates. Tech and more value biased indices ended up in roughly the same place with the former exhibiting a great deal more volatility. Commodity markets by and large saw the bright side of life and were mostly up between 5% and 10 % for the month. During the month bond markets were remarkably quiet with modest losses from slightly higher inflation expectations for government bonds and high-grade credit.
When we mentioned recently that we should probably keep an eye on the cashed-up day trader phenomenon as well as a particularly noisy and unpredictable upcoming US earnings season we had little idea that both themes would come to prominence so quickly in January. While it is difficult to discern a coherent narrative from all the current noise, we believe we are at least getting a sense of what we should be looking out for and when might be a good time to make conviction decisions based on fundamentals. With melt-up and melt-down scenarios almost equally plausible, now is not the time for conviction calls on manager selection. However, we are having some quite specific conversations with fund managers about what stock valuations based on ‘normalised’ earnings numbers, say two years from now, look like. As the outlook firms up a little in the next few months you may seem asset allocation and manager changes that reflect a more reflationary or defensive bias. With bond managers it is about squeezing some value out of defensive bond investments without taking on too much risk or being hostage to an uncertain future.
In the meantime, we will keep monitoring stress indicators like the US Dollar, long term bond rates, VIX and credit spreads as well as the myriad of economic indicators that have been put out of kilter by the peculiar nature of the COVID crisis. The VIX index, for example, has hit current levels 3 times this year and each time the market recovered after a 7% or so fall. The time before that was the last week of February 2020, just before the COVID crisis hit markets in earnest.