What Mattered #12 – Short everything

Welcome to the September edition of What Mattered. A collection of narratives and stories driving the markets every month.

September has not been very kind to the markets historically. As this chart by Michael Batnick suggests, stocks have been down more often than not in the month.

Average historical returns by month, Source: The Irrelevant Investor

This year wasn’t an outlier by any means. S&P 500 was down 4.7% with Europe and U.K also lower 3-4.5%.

September returns, Source: Koyfin

This came after an incredible YTD returns for everything, as I wrote here last month. We had plenty of narratives making the markets nervous after all those gains since last year. So let’s get straight to them.


Evergrande and the debt shockwaves

The Evergrande fiasco sent shockwaves through the markets being touted as the next ‘Lehman Brothers’, the infamous recession bearer of 2008. The Chinese real estate developer defaulted on its both offshore and onshore bond payments with a debt pile of more than $300bn, which is roughly equal to 2% of China’s GDP. This is the biggest player in the biggest property market in the world and the largest issuer of dollar denominated Chinese junk bonds.

The Chinese banks froze its accounts, which led to a sell-off in its bond prices after which everyone started taking note. The markets were wary of ripple effects of a player of that size to go down. After all, its junk bonds were held by major foreign institutions across the U.S, Europe and Asia. A massive selloff in Hong Kong and other Chinese real estate stocks fearing a credit crunch in the sector spooked the global markets.

Chinese and Hong Kong real estate 3M returns, Source: Koyfin

The Chinese government has kept things under control so far. Maybe because the sector that contributes to roughly 30% of GDP and a borrower that is now too big to fail cannot be left to dealt with by the unforgiving forces of free market capitalism.

We are short everything

The demand-supply interplay usually dictates most of the moves in the economy. Supply chain issues have dominated the headlines since the start of the year, but when demand, backed by government stimulus and a strong economy, comes back roaring, the balance tilts towards the latter even more so.

Severe gas shortages in Europe has not only pushed gas prices into the stratosphere, but has also made carbon extremely expensive to produce. For context, power producers started buying coal due to lower availability and higher prices, which pushed the price of carbon futures north of $76 for the first time ever. Gas prices have also risen across the region on the back of higher expected demand for heating in the winter. Power prices rose in tandem, with German power prices reaching 114.7 euros/MWh.

Carbon futures, Source: Bloomberg

A shortage of truck drivers in the U.K led to a severe energy crisis in the region last week, as fuel stations across the region were left high and dry. Oil prices are therefore gaining momentum too. First, being an alternative (oil-products) for power generation and second, a restricted OPEC supply and third, an economy that is trying to fire on all cylinders.

Then, China’s economic growth, an engine for the global economy also slowed down last month as its manufacturing activity contracted due to a power shortage. We are short everything, everywhere.

Higher power prices and even higher energy prices coupled with a lack of supply is stoking inflation fears across the board, and has left everyone wondering whether these price rises are here to stay. When it comes to the markets, this could impact the margins for a whole lot of businesses and slow down consumer spending (higher spends of power and energy means lower spends elsewhere).

Natural gas and a related ETF 1Y returns, Source: Koyfin

Inflation fears and tapering

The higher inflation narrative also gained traction this month, as higher energy and power prices are expected to raise producer, transportation, storage and consumer, all sorts of prices. The supply chain issues and unprecedentedly high shipping costs are adding fuel (pun intended) to these sparks without a doubt. The markets do not like surprises when it comes to inflation. A CPI print that is too high for comfort could bring the bond tapering deadline a bit further up, and push up yields across the curve.

Yields have started to inch up again, Source: Koyfin

Yields have starting moving up already after the Fed announced that it would start slowing down its bond purchases by 2022. Higher yields and inflation have a significant impact on the markets via lower valuations, higher borrowing costs, and most importantly higher opportunity costs.


Putting these stories together, one could see higher yields, and cyclicals outperforming the broader markets. The economic recovery is still on track, and stocks is still the place to be in as earnings trend up.

High growth sectors could be volatile, but the companies with cost efficiencies in place, aka the large companies stand to benefit when pricing pressures start biting the rest of the competition.

The playbook might have changed a little bit but we are still playing.

Where the flows are

Now onto the world of ETFs. Despite everyone labelling the high growth tech rally and the flows into the popular ARK funds as ‘exhausted’, Goldman Sachs launched a new tech-focused ‘Future Tech Leaders’ ETF this month with the ticker GTEK.

GTEK will own 60-80 global tech names with a market cap of less than $100bn, focusing on chipmakers, software, fintech and cybersecurity stocks. Thematic ETFs have gained a lot of attention lately, as investors and advisors get more comfortable with allocating some funds to emerging sectors and stocks not present in the usual market based indices. So far it has garnered $43mn in AUM and has 66 holdings. Non-U.S tech is an interesting space and is seeing increasing activity. GTEK could be a way to play that trend.

For the best and the worst ETF sectors or themes for the month, flows into Energy and Financials ETFs saw a sharp pickup inflows for the reasons cited above. Bulkwave Dry Shipping ETF (BDRY) is still going strong as shipping prices fail to come back to earth.

For the worst ETFs, outflows from Chinese stocks accelerated as negative newsflow kept emanating from the region. Crackdown on the tech sector, crypto and then Evergrande and the real estate troubles have contributed their fair share to that. Metal ETFs also took a step back from the incredible run this year after fears of a slowdown in China (and of course its property sector, one of the largest consumer of global metals).


Atomic idea of the month

We are short everything, but with so much many narratives in play, there shouldn’t be a dearth of investing ideas for the months to come. If you believe that higher prices are here to stay, commodities could be an interesting opportunity for the alternative allocation in your portfolio.

Not only these are a nice inflation hedge, shortages in energy and gas are driving prices of most production processes and the costs to produce most commodities. Stack higher growth on top, and you get even higher prices, at least till the supply balances the demand side pressures.

ETFs like PDBC provide an exposure to the world’s most traded commodities, along with actively helping you avoid negative roll-yield that you get when investing in commodity linked futures products.

The October edition of What Mattered should be even more happening. Stay tuned!

The Atomic Investor

2 Comments

  1. Croissant says:

    this was indeed what sept was for global markets! whirlwind!

    Like

  2. niftyfifty1994 says:

    Who needs a paper when we have such enligtening posts @ atomic investor 👏

    Like

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