Where does Value lie in this Market? + August Stock Watch



So the August Stock Watch just went out over the weekend (link here).

To recap a bit of background – in the July Stock Watch, I said that that I see recession risk being mispriced.

A recession will come, but not as soon as the market is pricing in.

The market is pricing it as if we are in a recession right now, but I think a recession is more of a 2023 story.

Accordingly, the 3 sectors that I saw as holding value (in July) were:

  1. Oil & Gas
  2. Cyclicals (eg. Banks, Industrial, possibly Semiconductors)
  3. China Banks

Over the past month, both (1) and (2) have rallied very strongly. To the point where I think they are fairly priced right now.

Don’t forget that there is a good chance we see a global recession in 2023, so you don’t want to overstay your welcome in these stocks as well.

China banks are still trading at about the same prices as they were last month, but the China picture has gone more bleak since. So I would not be adding in a big way to China banks just yet too.

All in, much of the short term opportunities have exhausted themselves with the recent market rally. I would probably just sit in cash for a while here, and let the next few months play out.

More opportunities will emerge as the Feds take us to 3.5% interest rates by end of the year, don’t see a need to rush into this market given that assets are more fairly priced now after the rally.

Taking a step back….

Let’s take a step back for a moment, and survey what we know from a high level.

Firstly, the mid term picture here is likely to be inflationary in nature.

For all the reasons discussed in previous articles, it is likely that at some point the Feds will start to tolerate higher inflation for longer, and this will spark a huge rally in risk assets.

So if you look at the mid term, it is likely to be inflationary in nature, and asset prices will go up.

It’s the short term that is tricky.

As the past 8 months have shown, you can be right about the long term direction of the market, and yet still lose money in the short term.

Where do opportunities lie in this market?

For Traders / Short Term Positions?

If you are a trader, this is one of the richest environments in a while.

You can trade the vicious rallies, or you can short the big dips.

I’ve been trading a small basket of alt-coins the past two months, and results have been decent given the huge rally since mid June (which is now in the process of reversing itself).

If you trade, the best results come from the most volatile, high beta assets. Think crypto, loss-making tech stocks, meme-stocks etc. Many of these names are up 50-100% from lows the past 2 months.

If you want to trade, be careful to position size carefully, manage your downside risk (have a stop-loss), and don’t get too attached to your position.

Remember you’re just trading, and not investing.

For long term investors?

For long term investors, it gets a bit more tricky.

Remember that I don’t dispute that in the mid to longer term, asset prices are going up.

The tricky part is in trying to buy as close to the bottom as you can.

And this becomes a strange mini-game where investors are forced to try and second guess what the Feds (or Jerome Powell) will do.

You want to buy as close to the point where Jerome Powell will flip dovish on monetary policy as possible.

The recent rally in risk assets, and softening in inflation data, has complicated matters.

On one-hand the rally in risk assets has resulted in a loosening in financial conditions. This gives Jerome Powell more room to raise interest rates, without breaking the economy.

At the same time, the softening in inflation data indicates that what the Feds are doing is working, and there is a slim possibility in the Feds achieving a soft landing if they play it right.

If you ask me, I don’t think the lows for this cycle are in, and we’ll have one final flush out before Powell finally flips dovish.

How am I investing?

If you gave me $1 million in this market and forced me to deploy it long term right now, the asset classes I like are:

  1. Cash
  2. Oil
  3. REITs/Tech
  4. China

Cash to me is a no brainer. If one thinks that the markets are headed lower in the short term, one will need cash to buy when it comes. With cash yielding close to 3% risk free these days, the opportunity cost of holding cash has gone down significantly, and I’m holding one of the highest cash allocations I’ve had since early 2020.

Oil to me is a mid to longer term play. A lot of the oil names have rallied 20-30% the past month, so a lot of the short term value is probably gone here, and it may make sense to wait for a pullback before adding again. But mid to longer term, I continue to fear an inflationary future, and I think oil is one of the best hedges for that.

REITs/Tech to me are all part of the same long duration trade (which are very sensitive to interest rates). All are down significantly from the 52 week highs, but at the same time all have rallied strongly the past month.

For example – Names like Ascendas REIT, Mapletree Industrial trust etc are up 10-20% the past month. At these prices, they’re trading at 5-5.5% yields, which work out to a 2-2.5% yield spread against the risk free rate. If you buy and hold a basket of them long term at these prices, you’ll probably still make money. But with rising rates, I still think a better opportunity will arise before all this is over.

China we discussed in great detail last week, so I won’t belabour the point. The risks are very real, which include political risk, a slowing economy, a very serious real estate deleveraging problem, zero-COVID, and risk of sanctions by the US.

So China is not for everyone, and at the very least you need to position size carefully. But if you think the CCP will backstop the economy (and they have the means to if they want, so it comes down to a question of desire), then the banks are trading at 8.5% yields, and you can get offshore real estate names at big discount to book values, and 5%+ yields. Do be prepared for a volatile ride though.

But.. Timing?

That being said, from a timing perspective, I still remain very neutral and low conviction in this market.

I am very flat on risk at the moment, and I may even use this rally to cut down further on risk exposure.

If I am right and a bigger flush out is coming, one will need cash to buy the lows.

As always – love to hear what you think!


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