Wave riders....
What are these waves? They're coming over me It must be my destiny - Blancmange
Paul recently spoke with Bloomberg’s Haidi Stroud-Watts and Shery Ahn on Daybreak Asia,[1] explaining that the extraordinary scale of current cross asset volatility and market churn is telling us that something major could happen and that a major factor driving this volatility is the bull whip effect stemming from the consequences of a hard shutdown and an equally severe re-opening, adding
““This created all the supply chain problems.
Which in turn caused resultant inflation issues.
This therefore resulted in the various policy responses to that.
But it has evolved into a series of waves, very much a bull whip effect or perhaps more like an oscilloscope, and these waves really feed through to the markets.
Last month we put out a note warning not to do victory laps too soon because there seemed a high chance to us that all the promise of January would quickly fade into an ugly February. Similarly, now that February has redirected the narrative in a pretty negative way for the rest of the year, we wouldn’t be surprised to see short-term pessimism peak – it seems plausible that we’re likely to experience a year of fits and starts and continued waves on the oscilloscope because of this underlying bull whip effect and the policy responses that engenders.
The fact that the scale is so extreme is creating extraordinary cross asset volatility which for us is a warning sign that something very significant could be about to happen at some point during the year that will end up breaking this cycle. Whether that break is to the upside or the downside is very difficult to know.”
Haidi and Shery asked Paul whether MBMG’s advice was to remain fully invested, especially with attractive yields available on cash while balanced or 60:40 investors have suffered significant losses, or whether those factors had led to a “massive perspective adjustment”?[2]
Paul once again referred back to the need to respond to prevailing volatility, explaining “we did an awful lot of profit taking at the end of January. And at that point we had the highest cash holdings we’ve had for quite a while. But right now, we're redeploying that and we're getting closer to being fully invested, we’ at about 95% invested across the board at the moment. Again, it's just about riding the waves. We are looking at certain trigger levels on certain assets. We think, whatever the volatility shakedown ends up telling us, that there are some assets that we think are going to be okay. That primarily means buying long treasuries again now and buying gold miners again at the moment because we don't know whether the volatility shakedown will be negative or not in terms of economic activity. If it is, that's going to be brutal for equity exposures, so, we wouldn't want to be caught holding the equity bag, whereas we’re much more comfortable holding the treasury bag. That said, if we have another price rally in treasuries from here, then, playing into the, the bull whip thesis, the oscilloscope thesis, we'll sell down into that.”
Shery and Haidi then asked what the liquidity picture is like right now, and what that means for risk assets?
Paul confirmed that liquidity metrics were currently supportive of risk assets, noting that in terms of excess reserves, ample cash was floating around waiting to enter markets, which also reinforces MBMG’s view that the sharp market lurch from positive to negative might be a knee-jerk overreaction, although risk exposure needs to be balanced by the idea that at some point a major market event could be looming, explaining that “we're approaching risk assets primarily with some degree of protection in there - we'd rather have long/ short or we'd rather have some options protection. We think that there could be money to be made on risk assets in this month or next month or the month after, but you really want to be caught holding the bag. So, the liquidity picture is supportive but you want to have some protection against the fundamental picture.”
Shery and Haidi picked up on this, noting the regional dispersion, with Asia lagging in some respects and asked where we might see opportunities in the region if inflation remains subdued.
Paul answered that this is the same story that we've anticipated for a few months now, with domestically focused Chinese companies the best way to exploit China re-opening –
“Chinese smaller companies are probably the best way to play that. We’ve also had exposures to Chinese tech but pretty much sold all those at the end of January, which was fortuitous. The smaller company, the domestic focus company, story is much clearer than the tech story. Tech could be a very big opportunity in China, but the sector is dominated by a lot of non-technology companies, more consumer discretionary companies, at valuations that we still find a bit worrying. Therefore, it’s clearer to us that smaller companies are a better focus to play Chinese reopening, but once again, we’re going to see that bull whip driving the path of that.”
Paul explained this by highlighting the need to active manage exposures, noting that this is not a time to just ‘buy and hold’ because of the unpredictability and volatility stemming from the actions of policymakers in response to problems of their own making, having unleashed the bull whip with the shut down and reopening policies that they deployed, concluding that portfolio management today requires a “more active approach than I've ever seen before in my career in order to respond these impulses.”
[1] https://www.bloomberg.com/news/videos/2023-02-28/mbmg-group-s-gambles-on-global-markets-video
[2] Cash yields have reached highest levels since 2001, with 6 month treasury bills yielding in excess of 5% for the first time since 2001. 60:40 portfolios refer to the archetypal diversified portfolio that invests 60% in equities and 40% in government treasury bonds. Such portfolios incurred major losses in all major currencies in 2022. MBMG IA has long taken the view that diversification requires a much broader range of asset classes, including property, commodities, cash, precious metals and derivatives as well as methodological, style and manager diversification.
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About the Author:
Paul Gambles is licensed by the SEC as both a Securities Fundamental Investment Analyst and an Investment planner.
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