The portfolio update you’re reading right now it’s the first anniversary of this newsletter: I couldn’t be happier seeing how it grew and improved over the year. I started to publish my portfolio updates last July as a way to express some thoughts about the market in a longer and richer form than Twitter or LinkedIn allowed me to. Initially, the only people reading such articles were a few close friends of mine who, although not interested in the subject, wanted to support my initiative: now it’s more than 300 people between traders, analysts, and other professionals.
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Macro
Recently, I made an announcement on Twitter regarding my decision to shift my trading focus from equities to currencies. This strategic shift is primarily attributed to the recognition that currencies are superior instruments when one’s focus is on macroeconomic factors. Of course, since this newsletter not only recaps the monthly market events but also documents my personal journey as a trader, its content will reflect this shift as well.
Consequently, the forthcoming issues will feature a substantial increase in insights pertaining to the actions and intentions of central banks. As of now, I’m focused mainly on the Fed, the ECB, the BoE, and the BoJ. However, my ambition for this year entails extending this level of detailed monitoring to encompass all G8 central banks.
United States
July began with a significant upward surprise in the labor market as reported by ADP. However, the subsequent NFP miss the following day reminded us once again that ADP’s reliability as a statistic is questionable, to say the least. Analyzing the NFP report, we find that the economy added 209,000 jobs in June, with the unemployment rate declining to 3.6% from May’s 3.7%. It’s worth noting that hourly earnings continued to grow at a rate of 0.4% MoM (equivalent to 5% annualized), which raises concerns about a potential wage-price spiral. In other words, when you’re running out of workers, hires decelerate and wages increase.
In any case, this data is far from being recessionary. Looking at the strong momentum of the housing and construction market, the IRA deficit spending, and the strong nominal wage growth, it’s not surprising we saw an acceleration in nominal GDP and the Fed maintaining its hawkish stance.
Indeed, during the final week of July, the GDP for the second quarter was released, revealing a 2.4% QoQ growth. Despite concerns and speculations, the data does not indicate any signs of a recession in the United States. While many, including myself, were apprehensive about the possibility, the current economic indicators remain positive. However, it is essential to acknowledge that after a decade of persistently low interest rates, there is a likelihood of repercussions as the effects of these rates gradually permeate the economy. However, the accuracy of any predictions heavily depends on their timing, making it challenging to precisely forecast when potential economic challenges might arise.
Jobless claims were also lower, proving once again that the June spike was an exception rather than a new trend.
Moving to inflation, all the data we got in July was extremely positive. Headline CPI surprised lower at 0.2% MoM and 3.0% YoY: however, given the base effects, we shouldn’t be surprised by seeing headline CPI getting near 4% YoY again in the next months. Given the movements we had in commodities, I would expect a rebound, but being this obvious the markets have likely priced that in already. In any case, 0.2% MoM is good.
PPI and core PPI surprised lower as well. As said in my previous portfolio update, PPI can be seen as a proxy for corporate’s pricing power, and it will likely have bad repercussions to Q3 earnings.
Federal Reserve
The Fed hiked by 25bps as expected, and didn’t give guidance for the future meetings. In the statement, not a lot changed: inflation remains elevated, they remain data-dependent, and the economy expanded. Of course, they acknowledged the fact inflation data was positive, but reaffirmed that one single data point isn’t enough for them to change direction.
However, the presser was interesting for another reason. Every time the Fed says something with certainty, it is betting on its own future credibility, so it’s not surprising they rarely give full confidence in their estimates. The last time they did, it was the famous “inflation is transitory”, which greatly damaged their reputation. During this presser, they did it again, twice.
However, the presser was intriguing for another reason. The Fed, aware of the weight of its statements on its future credibility, tends to refrain from expressing unwavering certainty in its estimates. We all remember the widely-known proclamation of “inflation is transitory”: it had a detrimental impact on the Fed’s reputation when the reality turned out differently. Surprisingly, during this recent presser, they expressed very confidently some views on the economic outlook, not once but twice.
The first credibility check arises from the belief that 2% inflation will not be reached until 2025, while the second is based on the assurance that a recession will be avoided. However, my concern with these statements is that positive real interest rates exert upward pressure on unemployment. This, in turn, may lead to a decline in demand, allowing inflation to reach the 2% target well before 2025 (and causing a recession). Essentially, these two statements are interlinked, and given that the Fed was previously anticipating a recession in 2023 just a few months ago, their current stance represents a bold call.
I don’t know whether this was the last hike or not, but I would argue that at this point it doesn’t matter that much anymore, as the marginal difference between current rates and 25bps higher is negligible. At least, it is for equities.
However, the fact this may be the last hike shouldn’t make you think we’ll see cuts anytime soon: there’s no reason to cut, or in other words stimulate the economy, if GDP is growing so much and the unemployment is so low. Therefore, I stand by my thesis that we won’t see any cut in 2023 unless something breaks, in which case it won’t be bullish anyway.
Europe
As I noted previously on Twitter, almost every country in the eurozone has a PMI lower than 50, which in other words means that the economic conditions are getting worse. So far, we got the newly updated PMIs for the eurozone aggregate, Germany, and France, and I want to comment them briefly as I think they had some interesting insights in them.
Eurozone
Starting with the eurozone aggregate report, it’s noted that inflation expectations further cooled across the monetary union, although companies remained fairly conservative towards the outlook for profits, which suggests that pricing power is set to be constrained in the coming months. In other words, as I said in the previous update regarding the United States, firms offset lower volumes with higher pricing, and now they’re left with just lower volumes. Overall, there is some optimism in the service sector, and none from the manufacturing sector.
France
Moving to France, firms relied more on backlogs of work due to weaker sales, leading to a marginal decline in outstanding business volumes. However, private sector businesses continued to add to their workforce, although the pace of hiring slowed to the weakest in the year-to-date.
Both manufacturing and services output fell in July for the second month in a row, with the rates of contraction accelerating in both sectors. Interestingly, prices continued to rise in July, but manufacturing and services sectors showed contrasting trends: while manufacturing prices fell due to declines in raw material costs, service prices continued to increase at a high pace, primarily driven by higher labor costs.
Despite the challenging state of the French economy, companies were more optimistic than in June, mainly attributed to recent employment growth, especially in the service sector. However, sentiment in manufacturing remained more pessimistic towards the next twelve months.
Germany
Similarly to what happened in France, rates of input cost and output charge inflation slowed due to falling manufacturing costs, while inflation in the service sector slightly increased. New business fell in both the manufacturing and services sectors, leading to the sharpest drop in total inflows of new work in over three years: this decline in demand was influenced by factors such as customer hesitancy, destocking, high inflation, and rising interest rates. I think it’s safe to say this was far from being the best quarter start for Germany.
Looking at this data, the probability that the country will find itself in an actual recession during the second half of 2023 is high. Indeed, manufacturers are responding to the drop in activity and new orders by reducing their workforces, and hiring in the services sector has also slowed, which means we could easily see an uptick in the unemployment rate in the coming months. Although it’s not a good indicator for actual recessions, let’s not forget that the country entered a technical recession back in June already.
European Central Bank
The ECB hiked by 25bps to 4.25%, and hinted at this being the last hike by saying rates will be “set at” sufficiently restrictive levels rather than “brought to” as the previous times. Although the euro rallied hard ahead of the statement, it lost all the gains and some more after the release, as the hike premium got priced out. The fact Lagarde was very dovish didn’t help either.
There are a few interesting things that were said in the presser. First of all, data shows the inflation will continue to decline although it will stay remain above the target of 2%. Of course, between inflation and the tighter financial conditions, domestic demand suffers from the lower spending.
Then, many times Lagarde was asked about the pause, and whether this meeting market the last hike, and every time she said it wasn’t a pause, the market got more convinced it indeed was.
The actual reply was that they may pause, they may not, and any pause might not be for an extended amount of time. The only thing certain is that they won’t cut. They follow data, and they want to get to 2% inflation.
However, the combination of saying “we’re not even thinking about pausing” the meeting before, bad PMIs all around the eurozone, and them not giving guidance anymore, makes it very easy to understand why the market interpreted it as an actual pause.
All in all, the belief the ECB would outhawk the Fed was the greatest joke of 2023.
United Kingdom
The only interesting data point we got in July regarding the United Kingdom is the PMI report, which regrettably painted a less than optimistic picture. Indeed, the report indicated a worsening manufacturing downturn and a cooling of growth in the service sector.
Unsurprisingly, rising interest rates and increased living costs have impacted households, leading to a decline on leisure activities. Similarly, manufacturers have reduced production in response to a severe decline in orders from both domestic and export markets. If this wasn’t enough, forward-looking indicators point to further growth decline in the coming months, with a risk of GDP falling in Q3. While weaker demand should ease inflationary pressures, and we are seeing it with service sector inflation moderating and manufacturing prices falling at a higher rate, service sector upward wage pressures aren’t helping.
It’s worth revisiting an article I wrote back in January that delves into the concept of wage-price spirals, as the current economic climate provides a perfect opportunity to reevaluate its implications: you can read it here.
Next week we’ll have the BoE meeting, which is expected to hike by 25bps, which is likely what they’ll do. The British pound has already reached relatively high levels, and the current COT positioning shows the market is excessively skewed towards long positions. Given the circumstances, and considering the likelihood that the BoE may not be as hawkish as the market expects, it seems reasonable for me to consider opening a short GBP position against some stronger currencies following the BoE’s decision.
Japan
The central bank leaked through Nikkei (Nikkeileaks?) their decision roughly 10 hours earlier than the release, causing volatility across all markets. Of course, since something similar happened the Friday before as well, it was hard to know whether the leak was the BoJ testing the waters or an actual leak, so I had to follow live. This was my first time ever trading the BoJ, and overall it’s an experience I won’t repeat.
Summarizing what happened, the central bank made a fundamental change in how it operates YCC (Yield Curve Control). First of all, the previous 10-year JGB yield ±0.5% hard stop limit has now become a general reference level to allow for trading around 0.5%. Second, the previous fixed-rate open market operations, where BoJ offered to buy an unlimited quantity of JGBs at a fixed price level, on 10-year JGBs, has moved from 0.5% to 1%.
In other words, the bands were effectively widened to ±1%, but it has been done in a way in which the BoJ can still cap yields anywhere below 1% whenever and however it sees fit, whatever “sees fit” means.
I’ll attach below the infographic made by the BoJ itself to explain it better.
Equities
Moving to the general equity market, last month I was writing the following:
“My view is the same as last month: it’s not healthy to have parabolic runs with no correction whatsoever, nor it’s sustainable to bid companies with no more revenue growth into higher and higher multiples. Yet, it shows no signs of stopping. As said last month, it’s too late to buy and too early to sell: ride the wave till it lasts, but be prepared to quickly change your positioning.”
I have to say I still agree with that statement. Most of the S&P 500 reported their earnings already, and very few companies disappointed the expectations: you could argue that the bar was set low, which is true, but objectively speaking, it’s hard to spin them as bad earnings.
As growth shows resilience, earnings improve, and most of the rate hikes are behind us, we’ll need another story for stocks to drop meaningfully (10%+). The possible reasons for such a drop would be credit events, Japan blowing up the carry trade, or geopolitical events. Or, more simply, one day we will wake up, and the markets will have decided to change direction. Either way, I find it unwise to put up a short position until the reversal started: waiting might make you miss some points of the move, but there is enough meat on the bone for the trade to work well regardless.
Positions
After the recent earnings report, Farmland Partners experienced a substantial decline, with its stock selling off by over 13% within a single day. While I had initially taken a position in the company as an investment opportunity, I had placed an SL order slightly above my average entry point anyway. As you can imagine, that order got filled. At the end of the day, the position was closed with a gain of two quarterly dividends and roughly $0.20 per share, so I can’t really complain: of course, I could have sold before the earnings, but hindsight is always 20/20. Looking at their numbers, I think the market judged the company badly. Nonetheless, my primary objective in the markets is making money, not being a corporate fanboy.
Furthermore, I had the luck of buying IonQ at $10 last month and the stock exploded higher. Since I adhere to a strict strategy of safeguarding profits and avoiding preventable losses, when the position was more than 30% in the money I placed a trailing SL, which now sits at $17.
Finally, during the month I initiated a position in Pirelli, an Italian company, at an average of €4.53. Although I consider myself skilled in stock picking, the fact shares jumped more than 5% higher in the span of a few sessions is pure luck. I applied the same rationale as with IonQ, meaning I have strategically placed a trailing stop loss to secure a portion of the profits and protect my gains.
Positions as of July 30th, 2023:
- Long: MOWI, PIRC, IONQ, SALM
- Short: None, for once
I also have a small QQQ bear put spread for October as a hedge against my long positions, but so far it has been nothing but a waste of cash.
Trades
- Short GBPUSD from June, closed at breakeven (tweet), then tried again unsuccessfully (tweet)
- Long USDJPY at 139.55, closed at 141.5 (tweet)
- Long EURJPY at 156.34, closed at 157 (tweet)
- Short EURUSD at 1.1100, closed at 1.1055 (tweet)
- Long AUDUSD at 0.6658, closed at 0.6685 (tweet)
Overall, I can happily say I’m very satisfied with the results. Every day that passes, I learn more, and get closer to being a FX Jedi.