November 2023 Update

November, 2023

Well, we got what we expected in October, but it is darkest before dawn. November is typically a good month for equities.

In September and October, we cautioned that the higher for longer interest rate message was being dangerously ignored, that the banking system was exposed to significant Commercial Real Estate (CRE) risk, and that a seasonal sell-off was a distinct possibility. So, it went. October saw a decline in equity markets with global markets falling almost 3.5% in US$ terms and just under 3% in A$ terms as the Australian dollar weakened a little (again).

September 2023 - Remember October is just round the corner
October 2023 - Bondfire of the Vanities? September Update

To exit from equity risk now though is sub optimal. We have no doubt CRE problems will reverberate, and some over levered badly placed companies won't and shouldn't make it (eg WeWork). However much of the equity market is not stretched even against 5% bond yields. It is likely we are coming to the end of this rapid and significant bond market sell-off.

We believe the "Boom Bust and Bail" of the last 20 years is dead as an economic paradigm, and so don't even anticipate the rate cuts that are discounted for late 2024, but also reckon it is unlikely that the "Scorched Earth" of the monetarist 1980s will be revived. From our network we pick up vibes that the asset price pain won't be allowed to extend from CRE into house prices, and that large scale unemployment is also not considered the answer to the problem of inflation. We're not going back to the early 80s when real interest rates were at 6%+ levels, and unemployment hit 10%. Increased adoption of "National Industrial Policies" is likely to be supportive of employment but consequently Government is going to get bigger. This will reduce potential economic growth rates but be deemed necessary and popular. You should invest with that in mind. In short, we're through the worst of the rate pain - at least at the short end, the bit that central banks can influence.

We await the next paradigm gift from the 'well-educated but completely stupid' technical geniuses in central bank and Treasury department dungeons and suspect that "inflation is good for you" and "we need to redistribute wealth more and intervene more, to be fairer" will be three of the key tenets.

One should therefore invest in equities that pay dividends and meet "needs not wants" if one wishes to survive the double taxation increase imposed by inflation and government, and some increased regulatory risk. Perhaps one should evaluate the skill and technical competence embedded within governments and on that basis Japanese MITI bureaucrats are worth backing? That's for the long run. Short term, we now point out that November is typically the second-best month for returns, behind April which is the best. So, after the 10% sell-off it's time to put any cash to work? Here is our reasoning:

1. US growth is coming almost entirely from a large increase in government stimulus which will abate. There are clear signs of a slowdown in the private sector. Thus, as the government stimulus fades so will growth, and thus long bond yields are approaching a peak, and certainly a peak in the rate of increase in their yields. More subtly, the volatility in price due to duration and convexity effects, is also past its worst for bond holders such as the mid -tier banks whose balance sheet problems are now well known and perhaps therefore discounted by the equity market.
2. Central Banks are unlikely to wish for a repeat of a 1980s asset price massacre and unemployment surge, but will have to, or wish to, let inflation run a little hot declaring victory at 3% "with expectations of a trend reversion to 2% in the long run" or some such soothing meaningless platitudes. If inflation is at 3-4% this is ok for equities which are a claim on nominal growth.
3. Bond investor discipline appears to be returning meaning that Yellenomics will be harder to continue into 2024, the election year. Thus, this quarter's issuance of $1 trillion in debt by the US Treasury is probably the worst period of fiscal incontinence.
4. If bond investors can become happy to buy debt issuance with yields at 5%, versus official rates of inflation at 3%, and we're correct about issuance size declining, then we're pretty close to equilibrium already? Base effects will bring inflation down from here.
5. China has begun to stimulate by CUTTING TAXES - PM Albanese please take note. Japan has hinted at and is gradually now moving away from Yield Curve Control. They'll be trying something else - we believe 'less control more market' will be positive for economic growth in this region.
6. Elsewhere in the world a move to the right in politics generally and swing back from the Net Zero / Year Zero fanaticism, will help stabilise input costs for EVERYTHING. This will help inflation abate.

The best hedge against mild inflation is equities and given the high correlation currently between bonds and growth stocks (long duration assets) the best diversification for risk purposes could well be within equity styles - combining value and quality tilts, or investing in Asia including Japan for example.

We made a few trades in October as one should in the face of heightened cross-sectional volatility. We sold Honeywell Tokyo Electron and Fortum in the Global Equity portfolios and purchased Emcor, a US construction and engineering company specialising in the installation and maintenance of, and services for, the electrical power grid.

In the Global Listed Infrastructure strategy, we purchased a new holding in Otter Tail a US based electric utility operating in the upper Mid-West and added to mobile telephony companies Proximus and Vodafone and the Japanese utility Tokyo Gas. We sold Hydro One and TransAlta Corporation after their bid for TransAlta Renewables which we had owned.

We're still overweight and max bullish on Japan. It's a net creditor nation, the Yen is very undervalued on any PPP measure, and many companies have ceased to overinvest and are returning cash to shareholders.

Delft Partners November 2023