Irregular Roundup, 10th June 2024

We begin today’s Irregular Roundup with rate cuts.

No rate cuts

John Authers reported on investors giving up on their 2024 rate-cut bets.

While inflation is back below 3%, it remains higher than at any time in the two decades before the post-pandemic inflation spike.

There’s room for 10-year yields to track further up.

Since the fed funds futures contract for this year’s December meeting was initiated in June 2023, the 10-year yield has shadowed it very closely. That has begun to shift this year, with the 10-year yield not picking up as much as might have been predicted.

Real rates are increasing as inflation falls, and are now at their highest since 2007 – and at levels which have previously triggered recessions.

It’s the monetary easing of 2021 that looks to be the extreme outlier. The Fed’s decision to hold off rate hikes until 2022 begins to look like a historic mistake. It cannot be undone, however, and its officers will be understandably anxious to err on the side of higher rates this time around.

John also looked at what this “higher for longer” world might mean for investments.

When rates are high because the economy is strong, we can expect stocks to beat bonds. Equity outperformance has persisted ever since stocks hit bottom amid the panicked atmosphere of the first pandemic lockdown.

But of course, high rates (especially high real rates) will eventually slow down the economy, and then the outperformance of stocks should end.

One theory for the outperformance – that low rates would help “long-duration” growth stocks with lots of earnings far out into the future – has already come under pressure.

The Magnificent Seven tech giants massively outperformed the rest of the S&P 500 from the first wave of the pandemic until the Fed began to tighten in early 2022. Then they underperformed as rates rose. But since the beginning of 2023, the Magnificents have enjoyed more huge outperformance.

The explanation is the launch of ChatGPT in Nov 2022 and the resulting wave of AI optimism focused on Nvidia.

• But this makes stocks vulnerable to AI under-delivery.

When ChatGPT launched, the Santa Clara-based chipmaker was worth more than $2 trillion less than Apple. Now, only 18 months later, ithas almost closed that gap.

Whilst the Mag7 has recovered, real estate remains crushed by high rates.

Real estate stocks pay a regular yield thanks to their rental income. The higher the yield on bonds, the less appealing real estate will be and vice versa.

Covid lockdowns and working from home didn’t help, either.

• So if you expect early rate cuts (I don’t), then real estate might be a good bet.

Short term reversals

Joachim Klement looked at whether the short-term reversal effect is dead.

• Although asset prices show momentum over six months to eighteen months (before reverting to the mead over three to five years), the first month after strong price momentum (say over a year) usually also shows reversion (weak returns).

Hence momentum strategies traditionally use a 12-1 approach.

• The returns from the most recent month are subtracted from the 12-month returns to calculate the MOM signal.

The most intuitive [theory is that] investors overreact to recent news. Positive news leads to more people buying the shares, pushing the price up. But after a couple of days or weeks this buying pressure declines, and the share price drops as investors correct their overly optimistic beliefs.

But the effect has been missing since the 1990s.

• The chart shows US data but the same thing has happened in Europe (though not in the Pacific region).

So we can just use the 12-month momentum, without correcting for the most recent month.

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Jochaim also looks at a recent paper which says that some stocks are more salient to investors than others.

Stocks that have particularly strong deviations from recent price trends are more salient than others.

This ties back to the short-term reversal when we compare two stocks with 11% gains over months T-12 to T-1.

Then, in the previous month, one stock rises another 1% while the other stock drops by 1%. The stock that rose another 1% last month after rising pretty much 1% per month for the previous 11 months will be less salient to investors than the stock that first rose 11% and then suddenly dropped 1%. 

This should lead to selling pressure for that stock, but:

If the most recent drop was just a fluke and the company continues to provide positive fundamental news, the stock that sold off in the short term should rally more in the coming month than the stock that just moved higher in an orderly and rather boring fashion. The bigger the zig, the more aggressive the zag.

This implies no short-term reversal should not occur.

A long-short strategy using salience (gains, then losses) vs. negative salience (losses, then gains) worked in most countries from 1991 to 2019 (before costs).

• Joachim would like to see this effect investigated further.

AI and earnings calls

A second article from Joachim looked at the use of AI tools like chatGP to summarise company information from earnings calls.

Let an app transcribe the call and then use AI to summarise the contents. That can reduce the time spent on earnings calls dramatically. 

A new study has found that earnings calls and management discussion and analysis (MD&A) sections in annual reports can be reduced by upwards of 70% without any loss of information.

Once you remove the clutter, the sentiment and information content becomes not only clearer but more pronounced. Good news gets amplified while bad news does too. 

It makes sense for companies to try to hide bad news in a long report or on a long call, but why are they hiding good news?

The outperformance effect from positive and negative news in MD&A statements was particularly strong.

And the effect was also decent from earnings calls.

Labour watch

There were two bits of news this week:

1. Labour plans to keep the British ISA, and
2. there won’t be a summer budget.

Labour has previously said that it would simplify the ISA system (the UK version makes seven options), but the British ISA appears to be exempt. A spokesperson said:

Labour has no plans to drop the British ISA. Labour wants to make it as easy as possible for people to feel the benefits of saving and investing their money, including through increased utilisation of stocks and shares ISAs.

I see why the government wants more investment in UK firms, and the extra £5K of allowance is welcome, but it still feels like a drop in the ocean to me.

• Investors who are happy with their current asset allocation are likely to reduce their UK exposure in other accounts correspondingly.

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Rachel Reeves has ruled out a quick Summer Budget because she won’t hold a fiscal event without a forecast from the Office for Budget Responsibility (OBR).

• That’s seen as one of the mistakes made by Truss and Kwarteng, though for me, the real issue was not cutting services to fund tax reductions.

Reeves said:

The OBR requires 10 weeks’ notice to provide an independent forecast ahead of a Budge and I’ve been really clear that I wouldnot deliver a fiscal event without an OBR forecast.

That means the earliest possible le date for a Labour budget is mid-September.

Reeves also ruled out tax rises beyond what’s been announced already (a windfall tax on oil and gas firms, adding VAT to private school fees, closing non-dom loopholes, and removing private equity carried interest rules).

• No changes to income tax, NICs, VAT or corporation tax – and no wealth tax – sounds pretty good.

But of course, frozen allowances will act as tax rises assuming inflation stays higher than in recent years.

• Still, the more Labour bangs on about the increased tax burden under the Tories, the less able they will be to get away with increasing it further (despite the wishes of their core supporters).

Reeves also claimed that Labour is the natural party of business, which feels like a stretch.

Forestry

Foresight Sustainable Forestry (FSF) – a diversifying fund that I track but am not currently invested in – looks like it will disappear after Averon Park (AP) made a bid at 33% above the closing price.

• This is just below the 100p float level from three years ago and 5% below the current NAV.

AP is advised by the fund’s manager, Foresight Group (FSG) which sounds like a conflict of interest.

• But investors will probably be glad to exit, given that the shares were at 60p only six months ago.

They are also being offered the opportunity to roll their holdings into a new unlisted fund, but that sounds unattractive to me.

Alternative investment trusts have been having a bad time in recent years (the song royalty firms come to mind).

Crypto

The first crypto ETNs have been listed on the LSE, following the decision by the FCA in March to allow professional investor access.

• Retail investors are still banned from buying them, with the FCA describing them as “ill-suited”.

Only BTC and ETH ETNs are approved and they must be “physically”-backed and non-leveraged.

The first new products come from 21Shares, who I haven’t come across before:

• BTC (ABTC)
• ETH Staking (AETH)
• BTC Core (CBTC)
• ETF Core (ETHC)

I’m not sure what the difference between the two sets is, but the first two cost 1.49% pa and the last two only 0.21% pa.

• There are dollar and sterling versions of all the ETNs.

WisdomTree also launched ETNs this month.

Quick Links

I don’t have any for you this week.

• Until next time.