•2023, a year to remember. Was this time different?

•Recession still on the table and what if it already started?

•Markets are pricing the best of all world.

•Political shenanigans are, again, to be expected in 2024. Be reactive!

•Inflation, a last cyclical hiccup?

•Don’t exclude a deflation scare during the coming downturn. Longer-term this is another story.

•Investors positioning is now max long.

•Invest outside of the US stock market, favor cash generating small caps!

•One should be short vol/long carry in the belly and long vol/short carry in the wing. Investors are doing the reverse now. Nasty accidents waiting to happen.

Macro – 2023

2023 was a challenging year in many respects.

Not only did the market rose with very little participation (at least until early November) but, while the jury is still out, the recession we expected for Q3 or Q4 2023 failed to materialize (the jury is still out but…)

Our models could not anticipate the level of fiscal shenanigans and largess the current administration would come up with. We need more imagination!

Macro – Looking ahead

What the markets are anticipating?

Both politics and central bank policies will determine if we achieve the soft/no landing by kicking the can down the road or, as we still expect, the US enters (or continue the current) recession.

Macro – Looking ahead – Fiscal Policy

MMT on steroid… what counts here is the second derivative, not the absolute level but the momentum.

The various infrastructure/reshoring investment programs are likely to continue unabated or even accelerate slightly.

Students loan borrowers won’t face any penalties for missed payment until later this year. Election quand tu nous tiens!

Others might need some “help” too.

Macro – Looking ahead – the Fed

As much as it wants to pretend it is immune to political bias, the Fed is not. Ask J. Yellen and L. Brainard.  The huge range of SEP forecast for 2024 is just a reflection of this.

Some are saying that J. Powell surprising dovish (or market wanting to perceive him as dovish) in December was triggered by a sudden realization that J. Biden could loose to D. Trump this fall. We do not doubt that some members would do whatever they can to support the incumbent President, we do not think this is the case of J. Powell or C. Waller.

Indeed…

What about the balance sheet? L. Logan talked about it and we now know, thanks to the minutes, that it was a subject during the last Fed meeting. While reserves seem plentiful on aggregate, the devil is in the details. Many small domestic banks are probably under-reserved now…

And we are not talking about this…

Or unintended consequences…

Macro – Looking ahead – the Fed and others

CB liquidity and M2 diverging with risky assets. First graph is Fed liquidity: Fed held securities –(TGA+RRP) + BTFP. The second graph is global CBs balance sheets + M2. The third graph is global CBs balance sheets.

The recession call is important because…

And the curve un-inversion might not be as different as before previous recessions

Macro – Macro – Leading Indicators

Small businesses are worried about higher prices and expecting lower sales. Our rolling recession framework (metastasizing slowly from the weaker, households and corporate, to the stronger) in all its splendor.

And the curve un-inversion might not be as different as before previous recessions.

Soft surveys seem to have lost some of their luster (reflexivity in a world where adjustments can almost be made in real-time?) but we would not dismiss them completely yet and …

…Philadelphia Fed States Coincident diffusion index not looking great either…

Macro – Macro – Inflation

Our long-term inflation expectation has been clear for some time. It will be much higher than expected as it is the only way out for both the government and those who will hold the key to their election. Asset-rich boomers won’t be  able to decide election anymore.

On a shorter-term basis, our scenario was that inflation would be stickier than expected with a potential misleading rebound but that the Fed would remain too restrictive for too long leading to fears of deflation reemerging.

For now, market-based inflation expectations (Inflation Swap Forward 5Y) have risen to more than 2.61% from less than 2.5 at the start of the year.

This could lead the Fed to remain tighter for longer.

This could also lead the Fed to remain tighter for longer...

… but on the other side…

Macro – Macro – Employment

The continued apparent strength of the employment market has been puzzling lately. Even if we take it at face value, one can see that all is not good under the hood...

… and revisions are following the pattern of previous pre/early recession episodes.

Market – Liquidity

Passive, value agnostic flows to the market have been talked about ad nauseam on those pages. Employment is crucial for the pension passive related flows especially now that boomers are slowly but surely cashing out…

Will those flows be less supportive going forward? We think so (note we said less supportive, not unsupportive!)

On a short-term basis we see sign of reversing exuberance in nonsystematic passive flows and retail which have been historically followed by corrections

Asset Managers, leveraged funds and other value agnostic systematic funds are also extremely long and are going to be heavy sellers should a correction start and are not going to be heavy buyers before one start to materialize.

GS expects that corporations (buybacks) will represent, as it has in the past 15 years, most of the net demand for equities. We have explained why we think buybacks might not be as plentiful in the near-future in previous MashUps.

Here is a picture of the S&P 500 net buyback yield and…

… remember the best combination is buybacks and insiders buying and not money transfer from shareholders to managers with little or no skin in the game.

Market – Breadth

Divergences between the Nasdaq 100 and the Nasdaq Composite up volume-down volume cumulative line is not a positive. Neither is the Bullish % Index moving down from a high level.

The lack of participation of Small Caps in the rebound is a hallmark of a bear market rally, not a new cyclical bull market

Market – Sentiment

The SPY short interest is continuing to fall while we saw a large surge in AUM. This type of panic buying/short covering is not a good sign.

At the same time most risk appetite indicators are reaching their upper bound and insiders are heavily sellers (take it with a pinch of salt as it could be partially explained by tax considerations).

Market – Graph

We like when technical indicators give similar signals using different data granularity (and it aligns with what the rest of our work suggests).

We have a nice setup using T. deMark’s work…

Market – Valuation

Before we move to valuation as such, let’s have a look at the current risks to earnings… We will start with 2 graphs of F. Kronawitter.

Two more observations…

For those hoping for a repeat of the past decade US equity real absolute and relative performance, we have some bad news (a continuation of what was said in previous MashUps but it is so important that we will continue to write about it again and again).

There are more opportunities elsewhere… We have written a lot about Japan (favor Japan domestic oriented companies now to avoid the backlash exporters should experience when the Yen reverses to fair value).

What about Germany?

And while sales growth has been slower outside of the US, margin growth has been much higher (and there is still a lot of catch up, catch down or meat in the middle do do). The valuation mean reversion will support markets outside the US on a relative basis.

We would favor small cap companies everywhere on a relative basis and outside of the US small caps are likely to generate decent returns in the next 7-10 years but…

…in small cap land we would avoid loss making companies. There are a lot of Zombies wandering around there. Even when there were not that many, investing in profitable small caps has greatly outperformed the overall small cap indices (that’s why if you should invest in a tracker we much prefer the S&P 600 than the Russell 2000 in the US for example). Dimensional Funds understood it more than 40 years ago…

Once again, do not confuse great companies with great investments…

Japan’s future…

Market – Tail Risk

We expect an accident in the volatility space soon.

Now there are huge inflows into strategy selling both upside and downside volatility.

We also see rapidly rising in option volume at the expense of stock volume. Interactive Brokers just published some numbers confirming it. Investors (can we call them like this) are searching for lottery tickets!

As implied volatility is decreasing rapidly, investors need to increase their leverage when selling options to get the same income. If this is not an accident waiting to happen, we do not know what it is…

One can also see that investors are using lots of leverage on calls on the “Fantastic 15” while, when looking at all stocks and ETFs, they are using much more leverage in puts. Our guess is that the markets is financing upside volatility in the “Fantastic 15” by selling downside volatility everywhere…

The AUM in short volatility ETFs has increased rapidly recently and it is not just a function or rising price. The second graph is a crude way to look at non-price related flows and one can clearly see the recent gain in popularity (previous spikes occurred after vol shocks).

Market – Fixed Income

The boom in private credit probably dampened the number of public bonds defaults but the longer the Fed maintains its restrictive policy, the less defaults will occur beyond public scrutiny with all the psychological effect it might have.

Let’s also see how private credit fare during their first real default cycle…

Others

One should stop wondering why western societies in general and the US in particular are getting more polarized. If you add declining real purchasing power, borrowing costs rising much more for those who need the most (not to make money but to survive) and crumbling social fabrics, the opportunity cost to revolt against the system has not been this low in modern history.

Think again about the buyback and insiders' shareholding graphs showed earlier…

• A short squeeze to remember
• Recession still on the table and what if it already started!
• Markets tend to anticipate recessions but the brunt of the decline still occurs in the middle of them
• A less strong job market than what it seems
• Don’t exclude a deflation scare during the coming downturn. Longer-term this is another story
• Investors positioning is now worrying
• The quality factor might not offer the protection I has offered in previous downturn
• Japan, what not to like about it
• Don’t count on too many QRAs positive surprise going forward

Macro – What a Month!

What a difference a month can make! The markets needed an excuse to squeeze the extended short equities and treasuries positions and it found plenty. The marginally lower coupon issuance announced in the November 1st Treasury Quarterly Refunding Announcement, followed the same day by a perceived less hawkish J. Powell ignited the up moves. Disappointing macro data, a miserable less than 10 bps miss in the October core inflation number put gas on the fire.

The results:

•From 2 rates cut priced in late October to more than 5 now, despite J. Powell attempt to sound rather hawkish (the market has priced cuts multiple times during the past 18 months despite the Fed hawkish guidance).

•The biggest monthly loosening of financial conditions since the early 80’s.

•Everything up and up a lot (if you were not a CTA or oil investor).

Macro – And Now…

Mikael Sarwe thinks that markets could soon start to take bad news as bad news again…

Let’s first start by inspecting some macro recession leading indicators before we tackle what we see as the key for 2024, the employment market.

But how could we have (or already be in) a recession given the last GDP growth numbers? Well…

Furthermore, we have alluded to the large divergence between GDP and GDI in the past.

Excess savings are gone for a large cohort of the population (the one with the highest propensity to consume), while credit is harder to get by (except if you can borrow from the private credit fund mania).

Man interpretation of the disconnect between lending conditions and real GDP is similar…

Looking at who is expecting a recession, it seems that there is a cliff between Main Street (where we would include CEO’s) and Wall Street.

One thing to remember is that while the markets tend to anticipate recessions, a large part of the decline materializes during recessions…

… and the equity markets, contrarily to the rates market, are not expecting a recession (not totally true as small cap US stocks were anticipating one not so long ago ironically when rates were not anticipating one). It shows that the recent moves have more to do with flows than fundamentals.

Macro – Inflation

We will now focus on inflation and the employment markets.

We remain in the same camp as F. Trahan that during the coming downturn, markets will be spooked by deflation rather than inflation (longer-term it might well be another story).

Some analysts are still expecting a short-term rebound in inflation which is possible but really depends on how quickly the employment market unravels and how commodities move (2024 being a Presidential one should be open to anything though!).

Regarding commodities influence on inflation and inflation expectations, don’t forget this…

And as much as inflation has cooled down, it remains too high for the Fed to aggressively lowering rates, especially given the lagging nature of employment cost.

Macro – Employment

The employment market is weaker than it appears but the recent high inflation/high profit margin episode and the success of unions to get large salaries and benefits increase is likely to make employment cost stickier this time around (and it is likely to be very sticky for government workers in 24!)

Non growing US population should not help either and, down the road, this will contribute to push companies margins lower (and we are not even talking about higher interest costs, higher raw material and probably higher tax rates…).

Here below are some datapoints showing that the employment market is weaker than what it seems (we showed this in previous MashUp’s editions).

Workers unemployed for more than 27 weeks.

The “Sahm Rule” and its implication… Note that it has yet to trigger and that Claudia Sahm, the economists behind it, is on the record that she does not expect a recession if it triggers this time.

Macro – Housing

For those who think that shrinkflation only affects staples…

Market – Intermarkets

Falling bond yields are not all created equal…

Corporate bonds are offering a worthy alternative to equities for many today despite their low spreads to Treasuries. Spreads are not going to stay there if the macro picture deteriorates meaningfully.

Market – Factors

Another brilliant graph from J. Timmer. If you agree with us that inflation won’t be as benign and well behaved as is has in the past 40 years, you now know how to position yourself after the coming deflation scare… And guess what, this is exactly what serious relative valuation analysis suggest too…

Market – Liquidity

And now for what we see as the main drivers of November moves i.e. liquidity and flows.

Both US and global CBs liquidity were supportive enabling the short squeeze to materialize.

Looking at Goldman Sachs one month rolling CTAs net global equity futures flows, more than USD 225bn were bought. That’s more than USD 10bn per trading day.

US futures saw more than USD 8bn a day of buying in 2 weeks mid November…

We have now the opposite situation we described in our last MashUp. Lots of net selling if the markets decline and some net selling even if the markets rise strongly.

Looking at the CTA benchmark Kurtosis one can only see that the whole market has started to move on the same signal. We are all CTAs today and thanks to the bourgeoning Pods shops chasing short-term trends, the whole edifice is becoming less stable.

But fortunately Pods are not using too much leverage and are not all in the same positions (...), something which could be slightly problematic in case of a discontinuous market…

Discontinuous markets which could also be a problem for the short volatility crowd which is as big as it has ever been. Everybody is an expert volatility short seller nowadays…

And given the performance every short vol strategy has produced this year they are comforted in getting larger and larger exposure (adding to the fact that the strategies have to use more leverage now that the implied volatility is so low to get the return the new adept are looking for).

We had a graph in a previous MashUp on how deep out of the money puts performed during COVID (which we wouldn’t classify as a discontinued market). Suffice to say that even a 1% short exposure would have ended many careers.

Nation Tail and Skew indices are showing how little risk is priced in the markets…

Large divergences between the Vix index and the CBOE Skew Index have historically resolved through rising volatility.

Buybacks were also much higher than what we had expected for November. In fact, it was the highest
4 weeks moving average for BoA clients since they started collecting the data.

It would imply more than USD 5bn buybacks a day in November. So just adding futures flows, it is between USD 10-15bn a day of value agnostic buying in a not so liquid market!

There was also almost USD 50bn flowing into equity funds…

Yet equity hedge funds were not net buyers in November…

Market – Breadth

Breadth has improved in November but we need this improvement to persist to act on it.

But the market remains awfully concentrated…

With very few stocks outperforming the S&P 500…

Do you smell an opportunity?

Market – Sentiment

Goldman Sachs Panic Index is not showing much fear here…

And while corporations are busy buying stocks, insiders are selling… Are corporations only managed to the profit of their managers? As long as shareholders sleep at the wheel (and we do not see any reasons why the Blackrock’s of the world would wake up as being asleep is to their advantage).

Market – Valuation

Let’s start the valuation section with a question from Man…

In the meantime, as crazy as it may seems…

Those who know us for a long-time know that we have been strong supporters of the quality factor. Well, we think it is now expensive on a relative basis and is not going to offer the hedge it historically had in bear markets.

And most of the Magnificent 7’s are dominating the quality factor… (and don’t get us wrong they are superbly managed companies with incredible (challenged when/if regulators wake up) moats).

Time to stop looking at the global benchmark allocation and be bold! Try to be benchmark and career risk-free.

And as we have been pounding the table, consider Japan. The Yen is grossly undervalued and small and mid caps are cheap. Favor companies with a domestic market vs exporters given the impact a rising Yen will have on the latter.

And contrarily to the US where small caps quality has decreased (especially for new entrants) the reverse has been true for the Japanese market.

Market – Japan Catalysts

Some other reasons to like Japan…

And who would have guessed…

Market – Treasuries

A few graphs on Treasuries supply-demand and why we won’t always have positively surprising QRAs…

Corporations better hope that rates will plunge quickly. The first graph shows the current aggregated corporate yield minus the coupon they are currently paying on their debt. YTM would have to fall by 2% for interest cash outflow not to increase.

Others

A bit of humor…

In Memoriam

• Farmer’s wisdom
• Recession in sight
• Households growing despair
• Corporations, same dynamic
• Private Equity: don’t fall for it, please!
• Housing, expect non-linearity
• Europe’s “chant du cygne”
• China, could it be worse than feared?
• Intermarket canaries
• Is the Treasury looking toward next November when managing the TGA?
• Buybacks rolldown
• Unfriendly valuation
• Cheap Yen

Macro – Why?

Sometimes analysts over complicate…

We like what we call «le bon sens paysan» (farmer’s wisdom) in French.

Tom Barkin of Richmond Fed seems to agree…

And those fiscal largesses also explain why PMI's and capex trackers have not work up to now…

Macro – Recession

Money illusion in all its splendor…

…but the days of reckoning are approaching very fast!

Macro – Households

Another indication that the employment  picture might not be as rosy as it seems..…

…and consumer confidence has been showing it for some time too

Our “rising the income ladder stress” is playing out as expected.

As subprime borrowers stress is slowly getting of the charts…

Macro – Corporates

Same is true for corporations…

…as postponing refinancing or rising new debt becomes harder and harder the longer rates remain high.

Macro – Mark to Market

We have long argued that the Private Equity industry was where the asset liability mismatch was the most glaring in this cycle (as the banks were in 2007-2008). They are “ingenuous” but…

Macro – Housing

New buyers are slowly being priced out the markets… wait for employment to break down decisively and…

Visual Capitalist, as always, has a beautiful way to show it!

… explaining the rapid increase of pending home sales falling out of contract….

Given the coming surplus of rental properties to hit the market in the coming months, buying instead or renting will become increasingly irrational.

What if…

Macro – Outside of the US - Europe

Having lived 13 years in Sweden and experienced the relentless rise in the housing markets and leverage in all of its forms, I would not be surprised if it becomes one of the biggest victim of the current cycle.

The German real estate market (the whole economy to be honest) is not looking good either…

Macro – Outside of the US - China

We have shown similar graphs some weeks ago… the Chinese government is trying to avoid a further decline in the CNY as much as it  can.

Bob Elliott sees the current developments closely resembling a BoP style crisis…

Market – Intermarket

Real yields are starting to be interesting. The corollary is that real rates are high given the macro growth which is not a positive for risky assets…

As the distribution of returns shifts downward with a fatter downside tail when rates move quickly up.

Other canaries in the coalmine…

Market – Liquidity

Could the Treasury increase TGA now to be able to spend without having to borrow during the few months preceding next years presidential election?

It has been our contention in previous MashUps that buybacks would decline. This seems to be happening now…

…and not only in the US.

Now an excellent thread on why it would even be rational for some of the strong balance sheet buyback gluttons, to lower the number of stocks they buy back (taking the example of Apple).

Market – Breadth

Uniformity in risk taking is absent…

…while everyone is on the Magnificient 7 bandwagon… AAPL better not disappoint this week…

Market – Valuation

The lack of uniformity can also be seen in the large valuation discrepancy (some of which is probably warranted given the quality of the balance sheet of some of the largest index weights) between a handful of large stocks and the rest of the market.

Note that even the Fed does not think equity markets are cheap…

… same is true for other assets… Will it take responsibility one day?

The combination of overvaluation and rate pressure is unprecedented.

Market – Japan

Beside valuation and a more shareholder friendly environment, another reason why we think investing in Japan is a no brainer is the Yen...

While we have rarely complained about the wealth accumulated by companies' founders with significant skin in the game, we have often looked with contempt to the CEOs making millions with little skin in the game and absolutely no consideration for the long-term prospect of the company they “manage”.

Japan is a refreshing exception in this context!

Others

• On stable instability
• No convexity is not a dirty word
• Households growing despair
• Housing, crack appearing
• Credit divergences
• Breadth is outright ugly
• A valuation journey
• Many Japanese companies are underfollowed

Macro – Instability

We have dedicated our MashUp’s to the quest of the red spots, Mark Buchanan describes here below. There are too many to be ignored!

Sometimes it is better to be out of the markets wishing to be in, rather than in the market wishing to be out, especially when you are paid >5% for your patience.

Macro – Bonds Convexity

Before we start the Macro section in earnest, we wanted to make sure that anyone would see the following graphs/tables on the current convexity of the fixed income markets. For investors who only have been in the markets for less than 15 years it is only an academic experience…

For the current situation we first start with this beautiful illustration courtesy of Rick Falk Wallace.

The second illustration is from BoA. We would wait before committing any capital to their most aggressive example…

The third and last illustration is how convexity for the 7-10 yr Treasury Index has evolved since 1997…

Macro – Households

Our scenario is slowly developing with consumer confidence taking another leg down.

The lower income households must spend more on food, gas and utilities while higher income households are just starting to adjust to their loss excess savings and hence are starting to substitute what they put in their “necessity spending” (lower income households did it months ago and their spending is now evolving with inflation)

Macro – Households - Employment

We are also seeing the tense situation of many households with the rapid increase in 401K hardship withdrawal.

One of the rare employment indicator with a good historical record at business inflections which has yet to confirm our “job market weaker than it seems” thesis are the “Initial claims” numbers.

Warn notices seem to indicate that this will change soon.

Before we close this “Employment“ section, we want to put again a graph illustrating the potential change in dynamics of labor activism in the US. This might have (our view is that it will) profound implications on the future profitability of corporations in the future.

Macro – Housing

We have argued that there are too many houses being built in the US given current mortgage rates and macro prospects. If we add the incoming supply of “short rentals”, which were primarily financed with adjustable-rates mortgages, inventories are likely to surprise to the upside in the next 12 months.

In the meantime…

The current situation is of course much worse in countries where mortgages have shorter-duration on average and are harder to refinance…

Macro – Corporate - Credit

Credit is harder to get as confirmed by both hard and soft data…

… at the same time the % of bonds maturing in the next 2 years is reaching GFC level (back then it was because companies could not borrow, today some can not but most choose not to, hoping that the Fed will soon lower rates…)

Not all companies are in the same situation though…

This can also be seen here…

The market has taken notice!

Macro – Corporate - Cyclicality

Even the highest quality companies experience some cyclicality in downturns as the market seems to be forgetting time and time again.

Market – Bonds

Last week we presented J. Hussman Bond valuation model which indicates that US Govies were reaching fair value. Today we present Fidelity’s J. Timmer and Man Financial ones. Same conclusion.

Man also compares stock and bond valuations. Their conclusion is that the 10 years US Treasuries will have a Sharpe ratio 0.5 higher than stocks.

Given the current positive correlation of stocks to bonds which we expect to turn negative at least during the initial phase of the recession, we would recommend to explore option based relative-value strategies.

The recent rapid increase in real yields will weight on growth for at least the next 15-18 months…

Two graphs to finish this section.

First the debate on the relationship between debt issuance and change in yields is not yet settled. Man thinks if there is a relationship it is the inverse of the expected one…

The second one is on the spread between private and bank loans... Is too much capital flowing to private debt just when it could be tested for the first time in a conventional recession?

Market – Liquidity

Buybacks, the major fuel of the past 15 years US market valuation expansion, are not expanding anymore. Our contention is that even the magnificent 7 will have to lower the amount of money they plow into the markets to buyback their own shares in the months to come.

Valuation-agnostic strategies have been selling.

Market – Breadth

Breadth continues to indicate that the move which started a year ago is a bear market rally and not a new cyclical bull market.

Another way to look at it. There is no uniformity in markets actions.

And now even earning revisions breadth for the S&P 500 is reversing…

Market – Valuation

The first part of the valuation section will be based on the excellent work of N. Keimling from Taunus Trust.

Looking at today’s global market valuation, he estimates that only 15% of the global market cap is undervalued and 73% overvalued. This is a time to take big contrarian relative-bet and have the courage to sit through short-term volatility.

To compare here is how the markets were valued in 2007 pre-GFC. Not many places to hide.

Early 2009, to paraphrase W. Buffett one would have felt “like an oversexed man in a harem”.

Here below you will find where various markets stand according to his methodology.

While we are not fans of the Russell 2000 inclusion methodology (we much prefer the S&P 500), one can see that the current forward PE distribution of the index is starting to resemble the distributions of recent market lows, contrary to the S&P 500.

We said earlier that workers were going to ask for a bigger slice of the revenue in the future.

Governments are likely to do the same… The marginal voters will soon cease to be baby boomers and will be cash and asset poor favoring redistribution policies financed through higher taxes.

In the meantime, from GMO…

Market - Japan

Another reason to like Japan… lots of “undercovered” stocks!

Others

Flight to quality?

Larry, please… Some years ago you were saying this…

Of course, only fools do not change their mind but here it feels a bit… opportunistic.

• Hope springs eternal
• Yield curves dynamic
• Fear the unknown unknown
• Debt services on the rise
• The mighty bond market
• Liquidity, only CTAs experienced stress
• Price and earnings breadth remain weak
• Intermarket movements do not bode well for equities

Macro – Hope

A recurring theme, and another way to show it with history going back to the mid 90’s…. the title of the graphs says it all!

Macro – Yield Curves

As  feared, the yield curve has started a bear steepening phase which is expected to make the inversion which started more than a year ago, history. It is when the yield curve start this dis-inversion process that equities bull or bear market rallies die.

The US will not be the only one in this situation…

Macro – Households - Employment

We discussed the divergence  between GDP and GDI recently and why they have been the harbinger of recessions in the past. Chapter 11 fillings are not diverging with GDI…

And small businesses are suffering too. It has been our contention that, as low-income households, they would be the first to feel the blunt effects of the Fed tightening policy. Don’t forget that the BLS Birth-Death adjustment (which try to estimate the contribution of (very)small business to employment) which represents a large share of the past 6-month employment growth, is most likely to be revised dramatically down in the future.

There are other cracks appearing in the job market confirming the plethora of employment leading indicators we have presented in the past

Macro – Households - Savings

And remember that employment is the only thing keeping households afloat, hence our current obsession with it, excess savings are gone for most…

… and guess which cohort is in the top 20%

Macro – Households – Debt Burden

Households' debt carrying costs have risen to level which may be sufficient to induce a recession…

Macro – Corporations – Debt Burden

… while in the corporate sectors, the usual cash-rich suspects have profited from rising interest rates (and will only suffer when a weakening economy hits their bottom lines), smaller companies are suffering…

Macro – Corporates - Debt Burden

This is, we believe, the consequence of the “winner takes it all”, antiquate anti-trusts regulations plaguing the US today.

On this subject, we highly recommend Thomas Philippon “The Great Reversal”!

Let’s also not forget managements’ tendency to try to hide problems as long as possible……Michael Green had the following interaction with a reader recently…

Macro – Housing

Before we move to the elephant in the room i.e. the bond market, let’s discuss a couple of graphs on the housing market on which we have argued there are many things investors and ourselves, don’t know that they don’t know!

Do you remember our graphs on Airbnb's potentially flooding the market and on hidden inventories?
Is Austin a Canary in the Coalmine?

On the credit scores of mortgage borrowers, we would be interested to understand how all the various debt repayment moratorium have impacted these in the mid 2020 to early 2022 period.

And once again while we are less sanguine on the US housing market than the majority, it still looks great compared to some other countries… Serious bank crisis and recession in the making for some…

Markets – Bonds

This section will spend some time on the bond demand dynamic, as what is happening has nothing to do with what happened in 2020.

The composition of the demand is changing in a way which makes a return of the bond vigilantes era more likely, at least until the next time the Fed comes to the rescue (but as said while we are convinced it will, the bar to do so is probably much higher than before and as such “Fed Puts afficionados” are likely to experience a nasty wake up call).

Price sensitive investors are rapidly increasing their relative ownership of the Treasury market.

All of this as issuance is going through the roof…

It explains that the rise has been a rise in real yields, as breakeven remained unchanged

As such, the rise in real yield was principally due to the increase in the term/risk premium

On an investment side, yields have now reached what we would consider an interesting buying level (note that we usually prefer to buy a leveraged 2 years position with a 10 years Treasuries DV01).

There are plenty of graphs touting the now positive correlation between bond and equity prices which back this.

While the correlation is likely to remain positive, if, as expected, governments choose the inflation path to erode the real value of their debt and the debt of the people who will put them in power (yes asset rich baby boomers won’t be able to decide elections anymore), we suspect that the correlation will turn highly negative in the short to medium term when the equity bear market reasserts itself!

And to finish this section a nice graph from 2Fourteen Research…

Market – Liquidity

This CrossBorder Capital  graph shows that the “Shadow” monetary base is declining rapidly. This does not bode well for risky assets…

The same is true for US specific liquidity where the decline in RRP and issuance of Bills by the Treasury have delayed the reckoning. No coincidence that bond yields started their recent rapid ascent and risky assets their correction almost to the day when the Treasury announced that it would increase its longer-maturity issuance in the coming months.

Both systematic (read value agnostic) strategies and discretionary investors have decreased their allocation in the past few weeks.

Most of the systematic strategies selling was due to CTAs. Indeed, volatility did not rise enough for volatility target funds to be heavy sellers. The large increase in fixed income volatility also reduced the need of risk parity funds to shed equities.

CTAs selling was so large that, for the US markets, they will be buyer over the next month, even on a declining market. We’d like to know how they get to this conclusion but... we carry the news…

Nevertheless, asset managers remain very long (which, in itself, is not a problem in a bull market) and leveraged funds have covered half of the short positions they had last October.

At the same time total stock allocation by individual investors surveyed by the AAII remains high in the context of an ongoing bear market

Market – Intermarket

Dividend yield should be much higher (valuation lower) given where real long-term yield are…

…while bond yields, oil and the USD are not going in the right direction for equities.

Market – Breadth

No comments needed…

Same for earning revision breadth…

Market – Valuation

Investors  are not compensated for the risk they take…

Others

Sometimes investors overcomplicate things… and now you understand why we build all our strategies like a combination of Lego pieces (Duplo even as each piece is so simple).

Remember this when economists try to forecast any macro data more than a month forward… and try not laughing!

So sad…

• Soft Landing is the new “transitory”
• Higher for longer becoming consensus narrative…wait until something break
• Valuation agnostic strategies could put gas on the fire
• Time to diverge from the benchmark?
• Japan after 35 years of underperformance…

Macro - Soft Landing?

Here at Kroma we are in the middle of a marathon 2 weeks roadshow as such the current and next week mashups will be much shorter. We will start with two memes. The first one describes our views on what lies ahead while the second is a  reflection on last weeks Fed decision.

Macro - Uncertainty

We have always treated macro forecast using decimal points, with a little humour. Broadly forecasting a recession has value as this impacts asset returns. Being right on 2.7% or 3.2% GDP growth has little value investment-wise.

The Fed econometric models are all over the place right now. We do not see conditions as positive for medium-term growth.

Macro - Yield Curve

Once more… equity markets do not like it when the yield curve steepens from an inverted position.

Macro - Employment

As with many other datapoints we have touched upon previously, employment is not behaving  as might be expected for a soft landing…

The persistance of permanent job losses is another sign that the job market is weaker than it appears.

Macro - Defaults

Credit Card default rates are the highest since 1991 for the «non top 100» banks…

…while bankruptcy filings are reaching highs only seen during the 2008 GFC and 2020 Covid Crisis.

Macro - Housing

Here is a good long-term graph. The average size of new houses over time in the US and Canada. Bigger families is not likely to be the cause!

Markets - Liquidity

CTAs are now at a crossroads, if the markets fail to rebound from current levels they will experience significant downside pressure.

The same is true for risk parity and target volatility strategies…….

Furthermore, dealers have a negative aggregate gamma exposure which implies that they will sell declines and buy rallies……..

Markets - Breadth

Market breadth continues to be really narrow, we see this as a really bad omen.

Markets - Intermarkets

For those who think that the past 20 years Stocks-Bonds-Correlation was the norm, this graph will be dissapointing.

Markets – Sentiment

We showed before how Wall Street feasted on dumb money during 2020-2022, here is another way to view it ………

Firms unable to cover their interest payments have outpeformed the S&P 500 by almost 10% so far this year. This seems perfectly legitimate when the Fed is aggressively raising interest rates and telling anyone who is willing to listen that rates will stay high.

Cracks are starting to appear for even the «magnificient 7».

Markets - Valuations

Valuations for the purpose of short-term market forecasts are useless, but the longer the holding period, the better (no surprise for many including old-time readers).

Is it time to deviate from the global benchmark?

Time to move from cap weighted to equal weighted indices?

Markets - Japan - Valuations

Japan has been a focus for us for some time. Equity markets have risen substantially while as expected the Yen has fallen. Currently the Yen is historically cheap while the life expectancy of the Japanese YCC experiment is getting shorter by the day.

The equity markets has been rerated but remain relatively cheap compared to other markets, and balance sheets are of much higher quality on the liability side while there are strong regulatory pressures to improve the asset side.

Lots of progress has already been made, mostly for the bigger, export-oriented companies but more needs to be done.

Nomura gives a nice summary of the challenges ahead and how it could benefit makets going forward.

Markets - Japan - Shareholdings

The shareholding dynamic is also a positive. Corporates cross-shareholding is slowly melting while city and regional banks relative importance is declining. No more “Japan Inc.’s Love Affair With Itself” as the WSJ put it in the past. No more “copinage”.

This will enable activist funds to push for more shareholder friendly management.

We will have much more to say on Japan going forward…..

• Divergences, again
• Lots on Lags
• Households and Corporations – tailwinds turning to headwinds
• Diverging sentiment
• Those mighty valuation agnostic flows
• Breadth is not good
• Commodities underinvestment and lack of future engineers

Macro – Divergences

The second week in a row that we start with a chart from the excellent J. Hussman. He has critics but we are a huge fan.

GDP - As we will see later in this week MashUp, in his analysis he likes to see uniformity. If we add ECRI’s persistence concept, this chart would tell you that a recession has already started or will soon do…

Macro – Lags

We were on the outlook for a schematic of the slow dispersion of increasing rates into the economy. Apollo has a good compact one.

If one looks at where the various growth drivers currently are, compared to the beginning of previous recessions, one can see that the main outliers are employment (as you know we believe it is weaker than the likely to be massively revised numbers show), investment (thank you Inflation Reduction Act, other government programs and AI frenzy!) and production expectation.

Bridgewater has also an excellent take on why the economy has been more resilient than perhaps expected, aside from the dichotomy we have written so much about, between those initially profiting from raising rates and the others.

Income growth has been the big contributor to the increase of household nominal spending. This as we showed in previous editions, came from relative employment strength, short duration assets, rising interest incomes (vs long duration liabilities) and stable interest expense (for the more affluent).

Macro – Headwinds

The tailwinds mentioned above are now in the rearview mirror. We can already see that consumer sentiment is much lower than what it should be according to the macro data. This is most probably due to the dichotomy we have referred to at numerous time, between the one taking advantage of rising interest rates and the others……..

… for whom it is increasingly difficult to live beyond their limited means because of the unwillingness of lenders to accommodate them and the very high interest rate they would have to pay.

‘Buy now pay later’ growth has been rapid but even this won’t be as supportive going forward.

Employment Retention Credits have also peaked now (they reached more than 15% of total corporate profits if annualized during a couple of months recently).

For the best take on recent energy prices increase we refer to @INArteCarloDoss

There is also the end of the moratorium on student loan payments since the end of August.

And while we know full well that correlation is not causation, beside supporting higher consumption, it probably also encouraged speculation because as we also know, savings are for oldies so let’s YOLO!

We won’t go over our views on the job market again, beside this tweet from Michael Kantrowitz.

Weakening job markets, when combined with falling real income, are not a recipe for booming consumption.

Falling real incomes and the success of some mediatized contract negotiation (UPS, Delta,…) are encouraging unions to fight harder and workers to join them. The next big confrontation is taking place in Detroit…

When we read the following we feel complacency as it is the psychological effect on the entire workforce that will really matter, not the inuendo of this particular deal.

Macro – Lags

Really matter because…

As an aparté, were you aware of this? Don’t be surprised to see a booming Japanese labor market during the next expansion.

Note too that inventories are also key to the recession calls, our guess is that levels are sitting too high almost everywhere…

All of this is occurring while refinancing is getting more and more expensive, the coverage ratio is deteriorating and duration declining.

Macro – Housing

We are on record saying that we are not as reassured by the state of the housing markets as many others. Investors using leverage are finding it very hard to participate.

There is also the potential risk of a grossly undercounted inventory of house (and inventory in the making). If anyone has confirming or infirming info on this, we would love to hear from you.

Related to the student loan non-payments used to speculate on stocks before, why not on housing too!

Once more a graph on the Canadian housing market. A graph I am sure will end up in many financial history book…

Did Europe also need this? Having lived many years in Sweden, the influence on the housing boom (frenzy) on the whole economy was palpable. How will Europe dig itself out of the hole it has put itself in?

Macro – Central Banks

Historically, soft landings have occurred when the Fed has been quick to lower rates. “Higher for longer” won’t do it.

What better to transition with to the market sentiment section……

Market – Sentiment

Four week moving average inflows into equities funds reached their highest level since early 2022 last week. Buying the dip?

At the same time HFs have been busy selling.

When the behavior of retail/RIA and hedge funds diverges, you are usually better off following HFs.

Same here…

Really?

Especially when shorting volatility has been so successful… While the timing is uncertain, there is an accident waiting to happen. Don’t be a hero, please!

Market – Liquidity

Mike Green has written for years about the metastatic influence that passive, value agnostic strategies have on the market. He just published this tables which shows the influence of issuance on relative demand for equities and bonds.

We said that buybacks (unfortunately also often agnostic to valuation) which have been THE main drivers of the US equity bull run since 2009 would decelerate. This looks like is happening as we write…

Bridgewater is also highlighting it. We have long argued that once rates fall below a certain threshold, it is not productive investment which is done but Central Banks simply create an incentive to raise debt to reshuffle existing capital. CB’s basically encourage the creation of debt unbacked by new productive capital. We wrote an article on the subject in… 2013… https://www.linkedin.com/pulse/central-bank-enablers-global-instability-damien-cleusix/

Market – Intermarkets

Ion Zulueta Zabaleta noticed the large divergence between US and European growth companies. Probably due to several factors not all due to speculation (higher margin, better balance sheet,…) and you’d guess way, way, more valuation agnostic demand....

‘Cyclicals’ are outperforming ‘defensive’ while the ISM survey would suggest underperformance. When there is a divergence, the Cyclicals/Defensive ex commodities ratio usually snaps back to the ISM survey implied level.

Mike Green with another great chart showing the divergence of 5 years forward S&P500 dividend yield and 30 years TIP yield. Higher for longer with falling inflation implies something equity bull are not going to like.

Market – Breadth

When it comes to markets internal analysis, we warmly recommend everyone to read J.Hussman historical comments. Everyone should incorporate the study of uniformity in their toolbox.

The NYSE McClellan ratio adjusted summation index is weak and has just stated to curl down while in a downtrend.

Market – Valuation

The US market ‘up move’ this year has mostly been the result of PE ratio expansion. The only hope for the bulls now is EPS growth…

… will need help from more than 7 stocks…

How many analysts are adjusting FCF for SBC?

Market – Fixed Income

The debate on the cause of the recent pick up in yields and where they are heading to is raging now. This week we show Andy Constan’s view that unfunded players (the answer to his question is banks) are an important drivers.

Anyhow the risk-reward, at least for US government bonds, seems pretty compelling given the carry cushion.

We are not yet ready to jump on high yields and loans…

Market – Commodities

We documented the insufficient capex going into commodities due to the rise of ESG related constraints and reputational risk.

This is also impacting students’ career choices…

No capex, no engineers… Consequences?

Market – Asset Allocation

You know by now that we have our reservations on Private Equity…

…even if we take PE performance at face value, reallocating 10% of the 60/40 portfolio to PE produces one of the lowest Sharpe Ratio improvement…..

Others

It is hard to beat the markets year in and year out. Most of the best managers have had several stretches of underperformance.

• Divergences
• Regimes
• No Landings? In your dreams!
• Households – Interest rates sensitivity, employment and delinquency
• Corporations – Interest  rates sensitivity, credit and more
• Concentration, again
• S&P 500 fair value
• Volatility… beware

Macro – Divergences

Some analysts have noticed the increasing divergence between GDP (gross domestic products) and GDI (gross domestic incomes) with the latter badly lagging recently.

John Hussman, another big proponent of the study in uniformity, GDI is a better predicator of the business cycle.

Macro – Regimes

Before we move to the rest of the macro section, we want to present 2 graphs from the insightful P. Saner (who is almost weekly in our Mashups!).

Macro – No Landing?

As described in previous MashUps, the narrative has moved from hard landing to soft landing and now no landing. One can also see it in recent US GDP forecasts recent change and in the number of S&P 500 companies citing recession on earnings calls.

If one look at this excellent analysis of @countdraghula, one can see that economists track record at forecasting 1 year forward GDP and inflation is pretty dismal. A falling line indicates that their expectation were too optimistic.

10 years real yields seems to be restrictive now. They are going to get even more so if rates stay where they are and inflation continues to fall. As said in previous mashups, while the initial consequence of rising yield had more than an expansionary macro effect, the more time pass the more it becomes a headwind, first hitting low cash high revolving loans households and companies and slowly moving up the ladder. Quantitative tightening should have been much more aggressive to slow the economy in the initial phase of rate increases.

Macro – Rates Impact

How did the S&P perform after the Fed last rate hike? Jaroslaw Jamka analyzed the path depending on the inflation cycle.

Marketwatch analysis is not bullish. NEVER in the past 7 decades, a post inversion equity market rally (10/1) has not been fully reversed in the ensuing bear market

Macro – Government Spendings

Eaton Vance recently produced interesting slides on the Uncapped Inflation Reduction Act spending. While we have shown previously that the budget deficit has increased mostly because of falling revenues and not increasing spending, the IRA has been a big contributor with large mutliplier effects (and very unsure final return on investment but the government money part usually does not really care as long as they win the next election. Après-moi, le déluge).

Macro – Households - Prices

We have described ad nauseam the impact of raising rates on households and companies (the lower incomes/assets/balance sheet quality/volatility of earnings, the quicker the impact of raising rates). Low income households were helped by falling gasoline prices. They are rising again on a YoY basis and not far from the levels which impacted consumptions seriously in the past.

Macro – Households - Interest Payments

The impact of rising rates can be shown using different time series. The one below show the percentage of interest payments as a % of interest income and it is rising quickly to new historic highs. Most importantly, the richest households have low rates and long duration liabilities so the graphs is not even close to show how hard times are for poor households…

The same is true for personal interest payments as a % of disposable personal incomes (which include interest incomes).

Non-mortgage interest expense as a percentage of wage and salary disbursements gives a better picture

Macro – Households - Employment

According to Bridgewater, US wages are still growing much too quickly to reach the 2% inflation target.

Labor unions approval are going through the roof. The media coverage of the UPS drivers new contract deal and the ongoing discussion of the UAW with the major auto constructors, will push more and more workers to ask for higher salaries and benefits. This will make the work of the Fed harder and also eat into companies margins.

Downside revision to the Payroll numbers have continued to be negative (7^th month in a row). This is something we have warned about in previous Mashups.

One can even see, courtesy of the excellent Michael Green, that the 2^nd and 3^rd revisions have been negative most of the time. He had a great chart on why the first number published, beside the Birth Death adjustment, could not be trusted i.e. response rate.

LinkedIn hiring rate is declining again...

… and David Rosenberg had a good summary of the latest JOLTS report.

We can add that it was the biggest 3 month decline in job openings on record excluding the Covid shutdown

Some graphs on the report…

The job openings to unemployed workers ratio remain historically high though…

Macro – Households - Consumption

Lower income households struggle can be seen in the retail sales number and…

Macro – Households - Delinquencies

… while mortgage delinquency remain low…

Auto and Credit Card delinquency are on the rise (sign of the dichotomy of the new class struggle).

Macro – Households - Housing

Two graphs on housing.

The first on first time homebuyers affordability…

And the second one on the gap between buyers’ and sellers’ price expectation for US multifamily apartments deals. The gap is big which explains the lack of current activity. Sellers are waiting as long as they can. “Higher for longer” is going to hurt them a lot.

Macro – Households – Global

Given lower, sometimes much lower mortgage maturities outside of the US. falling real disposable income combined with nosebleed housing prices and a more sensitive corporate sectors (more dependent on bank loans as shown later) is a perfect combination……..

Macro – Corporations – Interest Rates

As with households, the refinancing squeeze will be first felt (and should start to be felt now) by lower quality balance sheets. In the graph below one can see that the spread between current bond yield and coupon is elevated. Given the low current corporate bond activity, this gap is probably an understatement.

The Federal Reserve Bank of Boston recently published a paper on the delayed impact on corporation cash flow.

The lag can be clearly seen in the SG graphs here below.

One can also see how European companies, more reliant on bank financing are hit more quickly by rising rates.

The latest National Association of Credit Management report make for a bleak reading...

Macro – Banks - CRE

Oops… Combining this with rising long-term rates, we are sure bank balance sheets looks great…..?

Market – Liquidity

The market section will be brief this week.

Lots of companies are buying back shares globally. In future mashups we will show why we believe this is going to be a positive factor for some part of the world.

Inflows into the tech sectors have reaccelerated recently. It could be a swan song.

Market – Sentiment

We alluded to the debate on the real influence of the boom of 0dte option on market structure in the past. The CBOE published a paper on the subject.

Market – Breadth

Markets are still dominated by mega cap tech names. Bigger seems to be better for now but it won’t last…

AQR published a good paper on the problematic of market concentration, good companies and good investments.

Lack of concentration into the top 10 stocks can also be used for factor allocation.

Market – Valuation

The spread between the most expensive and the least expensive stocks is historically wide. It is not due to the absolute cheapness of the least expensive stocks but to the extreme overvaluation of the most expensive stocks.

Vanguard Value vs growth model is at an extreme again. It implied a strong outperformance of value vs growth in the next few years.

GS seems to reach the same conclusion. With regard to global markets, the US seems to be the outlier in term of extreme overvaluation.

Japan on which we have written a lot in the past has a low median net debt to equity.

We receive a lot of question on what we think the S&P fair value is. We have written an article on the subject in December 2021 https://research.nava.capital/market-valuations/  You can see our MAPE corridor in which we strongly believe the S&P 500 will wander at least once in the next few years (probably sooner than latter).

While our methodology differ somewhat, J. Hussman works reach a very similar conclusion.

Market – Volatility

Realized correlation has fallen precipitously in recent months. It has more often than not been the precursor of a big increase in implied volatility.

Remember than when/if, the VIX start a rapid move to the upside, it does not need to reach the strike price to rise exponentially… Selling high strike calls might seem like printing free money but it can rapidly turn into a nightmare. We feel that one should refrain from it in the current environment.

Others

Indeed…

• Lags
• Households not impacted homogeneously
• Inflation, battle won?
• Central Banks and lack of humility
• China, again
• Markets –Liquidity, breadth, sentiment and valuations

Macro –Lags

Sometimes a picture is worth a thousand words. Why overcomplicate with fancy explanations…

Thanks @MichaelAArouet for the following 2 gems - second one from Herb Greenberg but twitted by  @MichaelAArouet

Game of Trades expanded the ‘Recession’ vs ‘Soft Landing’ story counts back to 1990. As the press clips we have shown in the past, one can see that the ‘Soft Landing’ narrative becomes dominant just before the ‘Recession’ starts…

Goldman is giving up on the recession while…

…the Citigroup US Economic Surprise Index is turning downwards. It did 2 times in the past 12 months but the main difference now is that revisions to past macro numbers are negative.

Macro –Households

We have spent numerous pages in past MashUps on varying lags of increasing rates on households and corporations. Here is an attempt at a schematic illustration (suggestion for improvement welcomed!).

Now that the Covid excess savings are mostly gone (completely gone for the below median income earners) and that the social security inflation adjustment bonuses are spent the cycle will start to unfold as it has historically.

Business owners, courtesy of the Employment Retention Credit, are still getting money to spend but it seems that the IRS and Congress are (finally) looking into that…

Auto Loans… not good…

Credit Cards, not so good either…

Home equity was tapped early but now it is too expensive…

Non-mortgage interest payments are going through the roof…

… fortunately real wages are compensating… or not?

Let’s not forget the end of the student loan payment suspension.

Macro – Inflation

Some really smart analysts are expecting a resurgence of inflation. There could definitely be some surprises into November-December but our main scenario remains that before a longer-term resurgence of inflation, we might have a deflation scare sometimes next year.

One should still keep an eye on what is happening with wage negotiation now that the US are striking as it is usual in some European countries…

And that the average reservation wage is going to the moon!

Macro – Central Banks

Some commentators were expecting discussions about the level of inflation the Fed should target in Jackson Hole. There won’t be. They will have to change it one day given the endemic level of leverage but doing it now, would be an error. They will use the next recession as an excuse.

On this subject and going along with our longer-term inflation forecast we recommend to read C. Calomiris paper (well it is more than a recommendation, read it!).

When the inflation path is finally chosen, remember this from @BobEUnlimited. Look at the Stock/Bond correlation column too… 60/40 portfolios won’t work as they used too.

So what will the Fed do in the meantime? In the graph below you have this and next year voters on a «dove-hawk»-ometer

One thing for sure most members of the Fed will continue to base their policies on unobservable measures for which they will build new models (or adapt old ones) to fit the narrative.

Two examples from a recent  article of @NickTimiraos.

What is the longer-run fed funds rate? It seems to be moving as much as the short-term one.

What is the difference of the real federal-funds rate and the neutral rate of interest?

It is time for economists to realize that economy is a social science and that it is ALWAYS better to be appoximately right than precisely wrong. We use to joke that forecasting most macro variable 3 months in the future and using a number with a decimal point, one either has a very good sense of humor or is grossly overconfident.

Being a non-economist by education, J. Powell is refreshing on this point.

Macro – Budget Deficit

Before we move on to China, let’s see if you can guess why this happened (hint: November 5, 2024)

Macro – China

From one of the most astute and successful macro and market observer distilling his wisdom freely on Twitter (is this even legal?).

Some more graphs…

Market - Liquidity

Value agnostic systematic strategies had their first notable selling last week but they remain very long. There are hundreds of billion of potential supply on further decline (domino style).

Market - Intermarket

This graph is based on the idea of M. Green. Some see it has the markets discounting fiscal dominance.

This is even more noteworthy now that the majority of the MSCI World market cap prefers declining bond yields (wasn’t the case 5 years ago).

Market - Breadth

Breadth remains unsupportive.

Market - Sentiment

Hedge funds have decreased their net long exposure recently while mutual funds have decreased their cash holdings. The latter is very low given prevailing short-term interest rates and does not leave much cushion were investors rushing to the exit.

Hedge Funds remain very exposed to mega cap tech names.

The rolling one month flows into ETFs are giving the same message.

There has been much talk about the rise of 0dte options which are representing an increasing volume (directly or indirectly) of the overall market volume.

Goldman Sachs estimates that it puts woods into the fire of last week decline.

Bank of America analysts do not think they really change the market behavior with regard to day trends.

Yet given the option volume and increasing size of dealers’ gamma exposure, it seems unlikely that they have no effect. It will be interesting to see what happens if the markets experience large gaps to the downside.

As for now, option sellers are still in party mood!

Market - Valuation

Households equity exposure as a percentage of total liquid assets has been popularized as an alternative to valuations to forecast multi-years forward.

More positive than our valuation-based estimate but…

While it is still too early (due to small cap higher sensitivity to the macro cycle), small cap value stocks outside of the US could outperform large cap growth stocks massively in the future.

The UK market is universally hated. While the GBP might be a total return headwind for foreign investors going forward, this market must be a fun playing ground for value investors of all kind.

And Nvidia could not not being mentioned this week. Important to say that we have no special insights on Nvidia, so do not take our word for it. We neither have any short positions in the stock but… exploding revenues and profit with declining costs on such a short-period feels like a pure pricing power play. Might continue but with such margins many will try to produce alternatives. Remember Cisco explosive growth in 1998-2000? The stock lost almost 80% into 2011. Once again not a prediction!

Others

Some wisdom from M. Pettis. The balance of payment is often misunderstood.

M. Summers, I have another graph for you!

More of the same

• Yield Curve

• Budget Deficit

• Central Banks

• Inflation

• Households

• Housing

• Liquidity, breadth, sentiment, valuations

• China, China and again China!

Macro – Make Math Great Again

While we have some sympathy for J. Milei  resentment towards Central Banks (we recommend everyone to read M. Rothbard “The Case against the Fed” which can be found for free here), we are still wondering what the fourth category is…

Macro – Yield Curve

We always need to keep in mind that correlation is not causation, that’s why one should always accumulate as much loosely related data, build as many structurally different models as possible and look at consensus to get conviction. One should be as agnostic as possible to individual data and model parameters.

Thanks for reading Damien’s Substack! Subscribe for free to receive new posts and support my work.

The yield curve is inverted in the US and elsewhere, often deeply so. As we showed in the past, inversions can be a sign of the market anticipating a recession, but it can also be the market expecting inflation to fall sharply.

Macro – Budget Deficit

The «Soft Landing» narrative continues to gain momentum. We showed plenty of examples in our previous MashUps why this is exactly what happened before previous recessions.

An interesting graph from Piper Sandler showing that the US budget deficit has increased predominantly due to a decrease in revenues and not an increase in spending.

Remember that for Californian the tax declaration deadline has been moved outside of the 2023 fiscal year (ending September). They now have to file in October and it represents circa 15% of total US household taxes!

Macro – Central Banks and Inflation

The Bloomberg Intelligence Fed hawkish sentences score has rebounded in the past few weeks.

While fund managers surveyed by Bank  of America almost universally expect lower global CPI.

The ECB credibility (if it still had any) is tested by the markets.

Macro – Households

The varying impact of rapidly increasing interest rates on households and corporations, depending on their  income /balance sheet  quality, has been predominant in our last MashUps.  P. Atwater and
H. Greenberg disagree on the impact. We would tend to agree with P. Atwater. On a 10 year horizon, savers buying power will also be severly curtailed given the global debt overhang. There is no escape.

Accumulated excess savings are now on aggregate gone. The lower the households are in the income ladder, the quicker those savings disappeared. Now only the richest, with the lowest propensity to consume households still have some...

… but households still have > USD 1 tn real personal income shortfall relative to trend. You now know why employment numbers are so important going forward (and you know we think it will disappoint).

The people who were lucky to have enough money to buy a house or could refinance it per 2022 have low interest rate, 30 years mortgages.

Macro - Housing

The others are faced with rates not seen in more than 20 years.

Another way to show how unaffordable housing is to new buyers today…

Even now that homebuilders are using their income statement and balance sheets to «help» the households buying new houses.

The situation is similar in many other markets with the main difference being that, contrary to the US, mortgages have on average a much shorter duration.

In the US the first real signs of stress are in the multifamily sector. As said before, we believe this will be the epicentre of any  potential  residential real estate crisis. Financing is short-term by nature and there is too much construction going on (see our latest MashUps for more on this).

We alluded to the short-term rentals boom in the US before. The sector is more exposed to short-term interest rate moves and experienced a bubbly boom in the past few years. Some signs of stress are slowly emerging. Looking at Austin, for example, there are 12’127 Airbnb rentals and now 3’329 housing units to sell. Leverage goes both ways!

With regard to single family houses, the vacancy rates are still very low. If the employment market deteriorates significantly, the current units under construction, for sale and in planning, could drag prices down and/or create an overhang.

Macro – China

Let’s now move to China which made headlines recently.

M.Pettis is an astute observer of the Chinese economy so let’s start by one of his threads and a recent article he wrote.

Here is a very good schematic illustration on the Chinese macro machinery.

China is becoming less transparent. Macro statistics were known to be ‘massaged’ but now many are discontinued (lastly youth unemployment which was reaching extremely high levels).

And one should not forget that the Chinese residential property market is the largest asset in the world, by a wide margin and that it has an estimated inventory of more than USD 10 tn!

The sector is also highly levered which, combined with inventories, is not a good combination.

And everything indicates that the quality of the investment made with this leverage has been rapidly declining (nice way to say that we probably witnessed the biggest malinvestment boom in human history).

The real estate sector is suffering with some large bankruptcies.

There are some signs of capital outflows, but they remain modest.

In order to avoid a rapidly falling Yuan, which would exacerbate outflows, the PBOC is, as it did last year when the Yuan fell precipitously, fixing it far from market expectations. Anyhow, given the decline in the JPY and the current Chinese macro backdrop, the CNY could easily break above 7.3 and move much higher.

Rate differentials are also pointing that way…

We will finish this section with some tweets from B. Elliott

Market - Liquidity

China importance for the world economy is well known. Markets are hoping for a new debt-financed stimulus package. Who cares about tomorrow!

And liquidity momentum is not supportive elsewhere too.

CrossBorder Capital World Shadow Monetary Base is not supportive either.

Systematic strategies (Vol target, risk parity and CTA) have barely started to sell the equity positions they have accumulated since the bottom of October 2022.

Market - Patterns

Looking at price only the S&P 500 is not pricing in a recession.

The 2023 Charles H. Dow Award Winner paper is being tested right now. The markets need to fall early this week for a bearish 5% Canary signal to trigger.

Market – Breadth

A quick rebound on strong breadth would, on the contrary, potentially generate a «Zweig Breadth Thrust».

Yet overall breadth remains poor. One example below…

Market – Sentiment

B. Farrell was a very smart investor…

Foreigners have been heavy, very heavy buyers of US stocks recently. This has historically been a good contrarian signal.

Single stocks and ETF’s short positioning is historically low.

Positive short-term correlation between the S&P 500 and VIX can sometimes pinpoint reversals.

Option markets are showing early sign of stress…

Market - Valuation

US equity risk premium are diverging from the ISM manufacturing.

And the S&P 500 forward PE ratio is 30 to 40% above what short-term Treasuries would imply.

Some parts of the markets are more overvalued than others…

From Horizon Kinetics…

Should the US markets really be 60% of the total world capitalization? Japan almost reached it in 1989…

The fact that EM are forecasted to outperform the US by a significant margin in the next 10 years, does not imply that they will be always up when the S&P 500 is down. As you can see EM were only up 6% of the time when the S&P 500 was down since 1988.

Earnings have not been good this quarter…

Market – Fixed Income

The JGB markets was characterized as the global anchor for longer-term government bond yields explaining partially (we insist on partially) the rapid recent global up move. JGB auctions tails are increasing quickly…

Others

I also have a bridge to nowhere to sell if you want!

52 years ago

40 years ago

What is a moat?

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• Divergences everywhere
• Inflation down and then…
• Employment weaker than what it seems
• Households more of the same, difficulties slowly rising the income ladder
• Housing wealth effect, some countries will suffer more than others
• What if bond supply is almost irrelevant?

Macro - Trifecta

The first graph of this week is a reproduction of a graph by M. Kantrowitz.

The US economy is faced with a trifecta of headwinds:

•Rising Fed Fund rates

•Tightening lending standard

•Rising gasoline price

Macro - Yield Curve

Bear steepening is usually the last nail in the coffin of the macro expansion - and this is what we might be in the process of getting.

The dispersion of expectations of future Fed Fund rates has widened dramatically during this cycle making the short end of the yield curve more volatile.

Macro - Divergences

This is probably the consequence of the divergence we see in the performance of cyclicals (and the market in general) and leading indicators versus the short-term memory of market participant expecting the Fed to cut rapidly rates at the smallest signs of macro deceleration.

We can also see this in the resilience of the markets despite rapidly rising fed fund rates.

It seems that only base metals are pricing in a recession.

Macro - Inflation

Last week news about the Teamsters win in the new UPS employees pay negotiations sent shivers through the markets. Who is next?

The “déboirs” at the Panama Canal are not helping either, but…

...the Adobe Digital Price index is falling. While inflation might be higher, potentially much higher in the future, a deflation scare in the next 6-12 months is still a distinct possibility.

Macro - Employment

The leading indicators for the employment environment are all pointing in the same direction as we will see in the next few pages. First look at the Beveridge Curve during this cycle. …

Except for the construction payroll dynamics which we explained in our last MashUp, employment is behaving as would be expected after a yield curve inversion.

The Conference Board Employment Trend Index is diverging negatively as it has before every major employment turn.

The Birth/Date adjustment have never been higher (we explained why we think this is wrong in previous Mashups).

Macro - Households

We have explained at length why the expansion has been resilient to rising interest rates in the past few months (rising rates were an income tailwind for both households and corporate in aggregate). We have also noted that they are now a headwind for below median income households (the one with the highest propensity to consume), that the 50^th to 75^th percentiles of incomes are starting to feel the weight of higher interest rates and that lower quality corporates (small private ones) are struggling.

If your income is not sufficient to cover your consumption, borrowing is the solution, until it isn’t.

Household revolving credit is starting to decline.

The decline is partly due to tightening bank standards and inability to qualify even with older lending standard.

Are the signs of retrenchments apparent?

Johnson Redbook data is showing that not everything is rosy……

….except for those taking advantage (legally or not) of the employment retention credit boom. These are probably the same group who have no revolving personal debt and hold fixed 30 years sub 3% mortgage cohort.

Before we move to the housing markets, we found a great graph from ECRI showing that the consumption % of GDP sometimes still rises during recession. Yes, consumption is not what tips economy into recession, it is cyclical investments and inventory corrections that do.

Macro - Housing

Today renting is much cheaper than buying in the US. The incoming wave of rental completions are likely to have difficulties attracting renters, this glut of property probably gets worse with any meaningful decline in house prices and/or mortgage rates.

Another way to see that buying a house today is out of reach for many isby reference to the ownership affordability monitors suc has that of the Federal Reserve Bank of Atlanta.

One of the reasons that this waves of new rental property may not be absorbed promptly is that vacancies in existing property are already rising quickly.

Regarding house price decline and its consequences, this paper might become a classic. Yes, there were signs!

To close the real estate chapter, a look at the share of adjustable rates mortgage and the housing wealth effect on consumption. The US is far from the worse…

Macro - Corporations

While corporations have yet to feel the real effect of rising interest rates, they will soon have to start refinancing debt, or issuance for new investment. The increase in interest payment should be felt…

T. Slok has a good way to show that new debt will be more expensive than current debt. More than 90% of US investment grade is trading below par!

Around 25% of the Russell 3000 members are generating less operating income than the cost of servicing interest on their debts!

Falling earnings (if this happen) should have a disastrous effect.

Macro - Outside of the US

Some graphs on Europe now before we move on to China. The El Niño effect usually implies a colder winter in Europe. According to the always well-Informed A. Stahel, less than 20% of last years European energy savings came from “behavioral change”. A cold winter with still limited US LNG export and could have nasty consequences.

And it’s not that Germany is in best shape right now……

The boom of Chinese car exports will be another headwind for the old continent.

All is not rosy in China. After almost 2 decades of an infrastructure and housing debt financed binge, things are looking though. The shadow cold war between the US and China is not helping either.

Things look rather bleak…

Markets - Sentiment

Sentiment remains bullish. The CBOE Equity put/call-ratio has now moved higher after having reached “exuberant” levels. It has been historically (except in 2021) a headwind for the markets.

Given the explosion of 0dte options volume and a return of individual investors in the option market since the start of the year, a repetition of 2021 can not be ruled out… but this seems a low probability scenario.

Individual investors appetite for risk can also be seen in the beta of the top 10 stocks held by BofA private clients.

We are also seeing a large divergence between implied volatility and the CBOE Skew Index. Historically, high Skew and low VIX have resulted in falling markets.

….and implied volatility has been low and with an historically long M1:M2 contango streak…

Markets - Liquidity

Cross Border Capital weekly global liquidity index has turned down abruptly in the past few weeks.

Another data point on our “passive flows are distorting the markets” mantra…

A nice graph on the impact of vol control funds by Deutsche Bank.

….and on the exploding exposure of multi asset funds to equity.

To conclude our liquidity section, another data point confirming what we have been saying in some of our recent MashUps, Buybacks won’t support the markets going forward, as much as they have in the past.

Markets - Valuation

Some valuation graphs now. Let’s start with the breakdown of the relationship between real yield and the forward PE ratio.

There is a similar breakdown in the relationship between Cyclically-Adjusted PE ratio and core inflation…

There is also a breakdown between equity to net worth (equity too high) and nonfarm productivity…

...and between profit margin and the unit labor cost to GDP deflator ratio

Regarding future earnings growth and forward stock returns we recommend the following paper from Michael Smolyansky.

LOIM propose a model to evaluate the S&P 500. It is basically a regression of the S&P 500 on profit and 10 years rates.

Before we look at some country/sector specific metrics, we found this great graph from Oxford Economics on the ROI vs. cost of capital of some industries. It could help you limit your hunting ground…

Which markets will have the best 10 years real forward total return in USD according to Research Affiliates.

We can not put a graph of RA without putting one of AQR on the same page…

There is some great value lying around in the UK markets (especially if you are ready to pick smaller companies). If the GBP were to decline against the USD one could start to be aggressive (or not?).

And yes, we repeat that a cheap essential sector starved of capital is going to print money….

Why, the biggest stocks have historically (except during the past 10 years) not been good investments…

Markets - Technicals

For D. Sornette fans, some instability bruising…

Some new breadth divergence warnings…

Markets - Fixed incomes

There are lots of discussions about the rapidly increasing of longer duration Treasuries and how they are going to push rates higher. Patrick Saner had a masterful way to demonstrate that this might not be the case.

First let’s show some graphs “”bear use”.

Patrick Saner shows that rates might rise because what he calls the “global low yield anchor”. JGBs have been loosened by the recent BOJ decision but not because of…

Issuance… Indeed, according to his work, a common factor explains 96% of the variance across the major government bond markers. So, as he puts it:

“10y yield across countries appear mostly driven by a common factor and not idiosyncratic supply points, inflation and policy stances,…”

The high yield markets seems to be overvalued when looking at the macro and default dynamic.

Other

On the things future generations will scratch their head about...

And when democracy wins!

The background:

· The US stock market is more overvalued than it has even been (https://research.nava.capital/market-valuations/) which in itself has little influence on short-term market gyrations. To this we must add that the Grantham behavioral PE ratio (trying to justify higher PE ratios by low volatility, macro and ROE volatility) is now indicating that the markets are way too high as well.

· Debt level around the world is the highest it has even been (https://blogs.imf.org/2021/12/15/global-debt-reaches-a-record-226-trillion/) and much of this debt has been raised for unproductive use (buyback of existing capital, fiscal largess for short term consumption,…) while the stock of capital has failed to raise as much, by a wide margin (https://www.linkedin.com/pulse/central-bank-enablers-global-instability-damien-cleusix).

· Central Banks uber-expansive monetary policies have failed to see the imbalance develop and are over-confident on the strength of the financial system. They think that because banks, especially in the US are better capitalized, because household and non-financial companies balance sheet appear strong, that everything will be fine.

Banks are stronger but this time the lending spree is occurring elsewhere, in less regulated entities and that can only end badly (https://www.ft.com/content/7bd7a109-2dd5-4d3b-ba7a-5fb8ad25ed45).

Households and non-financial companies’ health are deceiving. First you must analyze the distribution. Few households own an incommensurate share of assets and few companies earn an incommensurate share of profits. The asset side of both balance sheet contain many items whose valuation are in unchartered territory so every debt to asset ratios looks good by definition. Don’t be fooled!

· One of the posterchild of increasing debt for the purchase of existing capital is buybacks and M&A. While both can be justified when they are done in a price sensitive, opportunistic way, today’s binge buying cannot be justified (https://corpgov.law.harvard.edu/2020/10/23/the-dangers-of-buybacks-mitigating-common-pitfalls/).

Buybacks and dividends are not yet siphoning 100 % of operating earnings (https://www.yardeni.com/pub/bbdivepsyield.pdf) but remember that earnings have been pushed way above trend thanks to the huge recent fiscal deficits which are now waning (https://twitter.com/hussmanjp/status/1500947365620027393?s=20&t=4xkKStm0GGef6Ti-62KgRA).

Buybacks are one of the current best example of passive, value agnostic, buying activity pushing the markets higher.

· To the Passive, value agnostic buying and selling, we also have to had risk parity and other target volatility strategies and trend following. All of them also bolstered by the rise of the robot advisors.

The explosion of option trading where the notional traded in options is now surpassing the trading in the stock markets has add also profound implications in sustaining the current boom (https://www.zerohedge.com/markets/shocked-goldman-trader-admits-after-following-market-18-years-i-could-never-imagine-typing) If buying such large amount of extremely short-term options is not market manipulation then what is?

· A final point to consider (and we are not exhaustive we know…) is the fact that households have embraced the stock market again, big ways. Households have increased their share of the overall stock market by USD 1.6 Trillion in 2021 (in comparison the whole Hedge Fund US equity holding is 2.3 trillion)!

Some  people (SPACs?) have taken advantage (literally) of this.

OK now enough for the background and let’s look at what has been happening recently

· In November, our LT warning models (we have many of them) triggered sell signal one after the other. We ended up with a total which was making the other historical precedent (beginning of 2000, Summer 2007, Spring 2015, September 2018 and December 2019) look trivial.

· Since the start of the year we have witnessed a flurry of +1% and -1% days. When we see such concentration of volatility after a long period of calm, the probability is high that we have entered a cyclical bear market.

· The Fed which has been the chief enabler of the current massive bubble seems to understand that it is now cornered and won’t be able, as long as inflation remains high, to offer the now expected Fed put anytime soon. J. Powell even said that it could continue to raise rate in a recession if inflation remains sticky. The Fed restrictive policy will not be limited to aggressively raise rate but with an accelerated Quantitative Tightening. We doubt that it will deliver everything the market expect if a cyclical bear market materialize but the damage to investors psychology would be large enough that even a reversal would not save the market immediately.

· This brings us to the recession debate. While our recession indicators have yet to flash a definitive signal, most of them are very close to trigger. Given what we have said about the Fed above and the fragility of the markets, our guess is that the lead time of those indicators will be shorter than what they have been historically and the recession could well start in 2022 in the US. It is significant because bear markets tend to be much more severe when a recession occurs (https://www.yardeni.com/pub/stmktsp500recess.pdf)

We have now entered the buyback blackout period where opportunistic buybacks are not allowed.

At the same time the S&P 500 has staged an impressive rebound from last week low and yet we are still seeing more 52 weeks new lows than highs. This (almost) only happen in bear markets.

Given the quarterly bonds and equities relative performance we should witness some sizable rebalancing towards bonds (even if bonds increased volatility could make it less sizable than some commentators are expecting).

With the S&P 500 slightly more than 5% below its all time high we see it as a perfect opportunity for those who haven’t yet done so to aggressively de-risk their portfolio.

About us:

NAVA Capital SA (‘Nava’) is a Swiss based advisory firm. It is a spin-off of a large Swiss single Family Office and it has developed since 2005 several proprietary quantitative strategies under active use, managing significant amounts of money.

Kroma Capital Partners Ltd. (‘Kroma’) is a Dubai based, DIFC incorporated - DFSA regulated entity holding a Category 3C license. This license allows Kroma to Managing Assets, Holding and Controlling Client Assets, Arranging Credit & Advising on Credit, Advising on Financial Products and Arranging Deals in Investments. As a distributor we have advised clients on funds and bespoken solution since 2017 with assets raised > 1.3 bn $. As an adviser we advise 3 investment vehicles: a fund of private markets funds, a volatility fund of funds and a US long/short equity fund.

Nava and Kroma have entered into an exclusive partnership offering quantitative investment solutions under the Sentinel Family of Strategies. We offer institutional investors solutions with our Sentinel Gurus US Long/Short strategy, our Sentinel Enhanced Long/Short indices strategies (which can be run on any sufficiently large stocks universe), our asset rotation strategies and our volatility strategy. All strategies are highly liquid and offer full transparency and Mark-to-Market pricing.

Bespoke investment solutions are available as:

· AMC’s on the UBS Platform

· European Funds under the OpenFunds SICAV AIF / UCITS

· Cayman Funds (exp. 2022)

If you are a qualified or an accredited investor and want more information on the above, you can contact us at:

contact@nava.capital

If you have any comments on this article, you can contact us at:

blog@nava.capital

The methodology looks like this:

For most of the rest of this article, we will concentrate on the universe of stocks generated at the following step:

While the biotech sector has been underperforming recently, the biotech holdings of our managers (some of whom are biotech specialists) have experienced their worst return ever.

Here is the performance of an equal weight portfolio of the biotech stocks held by our managers (Gurus  Biotech) relative to the iShares Biotech ETF. )

Ouch!

Jason Goepfert, the always insightful founder of Sentimentrader, recently posted a couple of great graphs showing of oversold the sector is.

Using his composite breadth indicator he created an oversold timing model.

As one can see, the model triggered two signals in the past 2 months with the first having the worst 1 months return of all the signal (and not by a little!).

We can also see, courtesy of Goldman Sachs (h/t  Thomas Callum), that

Valuing the Biotech sector is tricky as individual stocks success depends on drugs trial which are uncertain by nature.

Anyhow, looking at the Price to Sales of the Nasdaq Biotech Index, one can see that we are at the bottom of the past 20 years range while operating margin are still slightly above average. Our hunch is that the Price to Sales could still fall significantly if the overall market experience a cyclical bear market.

We believe that some large, historically successful,  biotech funds are in a precarious position with some forced selling currently occurring in the market.

What to do?

Well, let's see if we can use our managers biotech holdings to come up with something simple and effective. All models use monthly rebalancing schedule if not indicated otherwise.

If we look at the relative performance of the equal weight portfolio of the biotech stocks held by our managers relative to the iShares Biotech since November 2006 we can see that the portfolio outperformed the ETF by more than 6% a year but with higher volatility and a larger drawdown.

What if we only select the 20 stocks which have the highest smoothed 6 months momentum?

The annual outperformance moves from 6 to 11% but the volatility and max drawdown increase too.

Biotech companies tend to be heavy diluters as many have to print shares to stay alive while trying to successfully  launch a product.

So what if we remove the 50% of the shares having the highest recent dilution from the portfolio?

The annual outperformance increases slightly and the volatility and max drawdown are lower compared to the momentum portfolio.

So both the momentum and the dilution factor seems to be producing significantly higher returns than the basic equal weight portfolio. What if we combine both.

We will remove the 50% of stocks with the highest "dilute" factor and then, from the remaining stocks, buy the 20 with the highest 6 months smoothed momentum.

The annual outperformance is now 13%. Volatility and drawdowns remain higher than the iShares biotech index though.

The current portfolio comprises the following stocks:

A last strategy we will look at is the performance of the equal weight portfolio of biotech stocks held in the Sentinel Gurus US strategy. The rebalancing here is quarterly.

We are thus looking at the biotech stocks of the Sentinel Gurus US Core Portfolio. The  biotech stocks which have been selected from the 30+ screens run on the Managers Top Holdings universe. They have historically represented between 4-11% of the stocks selected in the Core Portfolio.

14% annual outperformance with higher volatility and drawdown. It  is very similar in performance statistics to the low dilution momentum portfolio presented earlier.

A further possibility would be to add our US Beta Management Overlay to the portfolio. It is not biotech specific but adding it (net exposure moving from -50% to 125%) would make the annual outperformance reach almost 20% with slightly higher volatility and similar drawdown than the IShares Biotech ETF.

To conclude, we have no way to know if we are near an absolute bottom for the biotech sector and, as per our previous articles, we are not very optimistic with regard to major US stock indices.

The above strategies are a good substitute for long only investors who want to get exposure to the biotech sector.

Given the recent underperformance of our manager biotech holdings relative to the sector and given that our market beta overlay is currently recommending a market neutral position and likely to recommend a net short position if the markets continue to fall, the low dilution momentum strategy with market timing seems  to be a good place to put some money to work already now.

About us:

NAVA Capital SA (‘Nava’) is a Swiss based advisory firm. It is a spin-off of a large Swiss single Family Office and it has developed since 2005 several proprietary quantitative strategies under active use, managing significant amounts of money.

Kroma Capital Partners Ltd. (‘Kroma’) is a Dubai based, DIFC incorporated - DFSA regulated entity holding a Category 3C license. This license allows Kroma to Managing Assets, Holding and Controlling Client Assets, Arranging Credit & Advising on Credit, Advising on Financial Products and Arranging Deals in Investments. As a distributor we have advised clients on funds and bespoken solution since 2017 with assets raised > 1.3 bn $. As an adviser we advise 3 investment vehicles: a fund of private markets funds, a volatility fund of funds and a US long/short equity fund.

Nava and Kroma have entered into an exclusive partnership offering quantitative investment solutions under the Sentinel Family of Strategies. We offer institutional investors solutions with our Sentinel Gurus US Long/Short strategy, our Sentinel Enhanced Long/Short indices strategies (which can be run on any sufficiently large stocks universe), our asset rotation strategies and our volatility strategy. All strategies are highly liquid and offer full transparency and Mark-to-Market pricing.

Bespoke investment solutions are available as:

· AMC’s on the UBS Platform

· European Funds under the OpenFunds SICAV AIF / UCITS

· Cayman Funds (exp. 2022)

If you are a qualified or an accredited investor and want more information on the above, you can contact us at:

contact@nava.capital

If you have any comments on this article, you can contact us at:

blog@nava.capital