Double entendre
“Man's most valuable trait is a judicious sense of what not to believe.” – Euripides
Looking with interest the unfolding “everything rally”, in an effect an early Santa Claus rally, which we anticipated while watching BitCoin as a proxy liquidity indicator, when it came to selecting our title analogy given our fondness for multiple referencing we decided to go for “Double entendre”.
A “Double entendre” is a figure of speech that is devised to have a double meaning, of which one is typically obvious whereas the other often conveys a message that could be perceived as suggestive or even offensive in some instances. “Double entendre” generally rely on multiple meanings of words or different interpretations of the same primary meaning. The phrase has not been used in French for centuries and would be ungrammatical in modern French. No exact equivalent exists in French we must confide. Our signature style of using title analogies can indeed be akin to “Double entendre” but definitely not doublespeak, which deliberately obscures, disguises, distorts or reveres meaning of words. We use “Double entendre” while politicians and central bankers use “doublespeak”. Doublespeak is language used to deceive usually through concealment or misrepresentation of truth. We often joked that we were immune to these “jedi tricks”.
In this conversation we want to look at the epic rally we saw during the month of November and what it entails as we move towards 2024 from an asset allocation perspective.
Synopsis:
Santa Claus rally came early
What’s for 2024?
· Santa Claus rally came early
Thanks to the continuation in the fall in US yields, we have seen a significant bounce in the “high beta” space like in US High Yield (1 month chart) with CCCs leading the race:
- Graph source Macronomics - KOYFIN
Most spectacular move during the course of November was in the long end of US Investment Grade. The performance has been spectacular to say the least and particularly the long end, no real surprise there given the fall in yields in the long end of the US Yield curve (1 month):
- Graph source Macronomics – KOYFIN
In relation to US Investment Grade, the volatility as been significant as displayed in the below YTD chart:
- Graph source Macronomics – KOYFIN
In one month the performance of US Investment Grade ETF LQD versus US High Yield ETF HYG:
- Macronomics – TradingView
Bond volatility in the long end has created huge volatility and as such, US Investment Grade performance relative to US High Yield has been plagued by “convexity” as shown in the below 6 months chart:
- Graph source Macronomics - TradingView
Credit risk wise 5 years CDS spreads have significantly receded (YTD chart). Since our last conversation US High Yield CDS gauge is tighter by around 80 bps (359 bps now vs 443 bps). European High Yield as well is improving:
- Graph source Macronomics – Datagrapple.com
But, if indeed there are signs of the US economy weakening, then we think that credit spreads are therefore too tight in US High Yield and we would think that 2024 should see an outperformance of US Investment Grade relative to US High Yield and default rates should start in that instance to creep higher. US Chapter 11 Bankruptcy fillings are rising according to Variant Perception:
- Graph source Variant Perception – X/Twitter
Since the Fed started raising rates in March 2022, default rates have gone from 1% to 5%+. US High yield and leveraged loans will continue to see rising default rates as the Fed holds rates higher for longer in that context:
- Graph source Appollo, Slok – X/Twitter
We think US High Yield will widen in 2024 more relative to US Investment Grade following yet another stellar performance in 2023. But, bond volatility could make a significant return still and “convexity” exposed Investment Grade could be impacted as well given current US fiscal deficits trajectory and issuance.
According to Bank of America, in the US Investment Grade space, November 5.6% total return was the strongest month in 38 years. The 30yr UST delivered a sweet 10% gain.
November saw the largest easing in US financial conditions of any single month in the past forty years hence the early Santa Claus rally:
- Graph source Bloomberg
As well ETF ARKK aka the beta play, saw its best month versus the Nasdaq 100 ever:
- Graph source Bloomberg – X/Twitter
Overall the month of November has been a month for the record books:
- Graph source Bloomberg – X/Twitter
The S&P500 finished November with a gain of 8.9%, the second best November since 1980:
- Graph source Bloomberg – X/Twitter
As you know by now, we have been tracking the Japanese yen depreciation in synch with the rise in US Treasury 10 year yields (6 months chart):
- Graph source Macronomics – TradingView
As such we indicated that a strengthening of the Japanese yen was on the cards. We believe that we will see further strengthening of the Japanese currency in 2024. The big elephant in the global markets room as we keep repeating ourselves and there is no “double entendre” there is the Bank of Japan monetary policy. The Bank of Japan racked up the most unrealized losses on its bond holdings on record in the latest six-month period to the tune of $71.2 billion. This illustrates the growing challenge facing Governor Kazuo Ueda if he moves toward normalizing policy after years of “easy policy”. With inflation cooling to the slowest pace in over a year, it supports the current cautious stance of the Bank of Japan:
- Graph source Bloomberg – X/Twitter
The Bank of Japan is currently discussing the end of Zero Interest Rate Policy (ZIRP) as such there are been a significant strengthening of the Japanese yes as we type this musing:
- Graph source Bloomberg – X/Twitter
We therefore think it is paramount to watch what the Bank of Japan is going to end or not its ZIRP policy in the near term as it will have significant implications in terms of global asset allocation and carry trades. Is the Bank of Japan going to “break” global markets in general and fixed income in particular?
· What’s for 2024?
When looking at 2024, we do think China we are already seeing supportive measures to the economy being set up as reported by China Daily:
“China Daily: "Some provinces and municipalities in China are stepping up policy support for the consumption sector, with many giving out vouchers to boost sales of automobiles and home appliances."
As well China Dalian Iron Ore futures have surged 65% since May 2023, regardless of the Lehman narrative relating to Chinese real estate woes. Bear in mind that in just 5 years China increased its oil consumption from 13 millions barrels per day to 17 millions barrels per day as per the below Goldman Sachs chart (H/T Michael A. Arouet):
- Graph source Michael A. Arouet – Goldman Sachs – X/Twitter
In various musings we highlighted our fondness for the luxury sector driven by Asian demand in general and Chinese demand in particular. As such we continue to favor Hermès over LVMH for 2024, the year of the Dragon.
Hermès vs LVMH – one month chart:
- Graph source Macronomics – TradingView
On an interesting note, ETF consumers discretionary between US and Europe are completely distorted by “TECH” given the US ETF comprises 23.82% of Amazon, Tesla represents a weight of 17.77% whereas ETF STR the European version is strongly geared towards “LUXURY” with LVMH weighting 19.58%, Richemont 6.18%, Hermes International 6.12%. Textiles Apparels & Luxuryry Goods represent 42.25% of the European Consumer Discretionary ETF STR wheareas the US ETF XLY is made up of 24.40% of Broadline Retail and 23.55% of Hotels, Restaurants and Leisure. No wonder there is a huge performance gap YTD:
- Graph source Macronomics – TradingView
As such US sectors wise no wonder US ETF XLY consumer discretionary is slightly trailing US XLK (TECH) YTD:
- Graph source Macronomics – KOYFIN
On a one month horizon ETF JETS has been flying above the rest thanks to 2.9 million US airlines travelers on November 26, the busiest day for air travel in history:
- Graph source Macronomics - KOYFIN
On the TECH side, we already confided we kind of like the Chinese battered TECH sector and as such we have been adding exposure to ALIBABA.
On the Alibaba story we recommend you follow the take on “valuation” from our business partner Geoffrey Fouvry from GraphFinancials.
Here are some couple of points made by Geoffrey on what we think is a compelling “contrarian” take on the subject of Alibaba:
“A lot of investors today have started their career in an environment where credit conditions were loose or extra-loose, they have not seen 2002-2003 or 2009-2011 for many quarters. They have just seen a brief 2020 blip where the name of the game was to “Buy! Buy! Buy!” fast as the money was flowing. Post 2014 what has mattered is not the protection on the downside but the momentum that continuous money printing has favored. To the point where “margin of safety” has disappeared from the Lexicon of investors. In a tight monetary environment (China) you look at the downside FIRST, SECOND and THIRD. You don’t get too excited about projections but by the value.
Alibaba has grown its sales and earnings significantly, but that’s not what is getting us excited. What is exciting is the nature of the business of AliPay with massive margins and revenues per employee at 1.2 million USD (yes not YUAN but with YUAN salaries), its has expanded by 500 million users since 2020. Granted the Fintech part at Ant Group is probably suffering a bit post ebullience but not the payment business.
The real excitement is the margin of safety/asymmetry. To make money you need not lose it first, because it’s mutually exclusive hence the focus on the margin of safety in valuation and a hard-to-replicate business. Try to replicate a 1.5 billion people payment network. Play the augmented web presentation here link.”
By now you know we like to buy what is “cheap” such as our recommendation to buy BTU and ARLP aka coal plays in December 2020. We also have to confide we have been riding the Uranium play via ETF URNM and via Kazatomprom stock. For us Uranium is a long-term play.
In continuation to our previous conversation relating to the gold spread between New-York and Shanghai, we continue to see a lot of central banks adding the “barbaric relic” to their reserves, a sign of the ongoing transformation of the monetary system in a growing multipolar world:
- Graph source Bank of America – X/Twitter
Falling real yields and deceleration of US economic growth in true Gibson paradox fashion should continue to support gold prices in 2024:
- Graph source Bloomberg – X/Twitter
As Ray Dalio put it recently:
“Watch the value of your money (e.g. dollars) in relation to the prices of other currencies, gold, and goods and services to understand what is really going on with the value of your money and what it buys. If you don't do that, you might fall under the illusion that the things measured in that money (e.g., stocks and bonds) are going up, when the truth is the value of your money is going down.” – Ray Dalio
The money illusion posits that people have a tendency to view their wealth and income in nominal dollar terms, rather than recognize their real value, adjusted for inflation. Irving Fisher reminded us about this concept in his must read 1928 book before it was popularized by John Maynard Keynes but we ramble again…
With Geoffrey’s help, we endeavor to touch more on various subjects through GRAPHFINANCIALS. Should you have any question, don’t hesitate to reach out to us.
“Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold.” - Leo Tolstoy
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Martin - Excellent as always.
great comprehensive take, thank you!