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Macro

United Kingdom

Back in May I remember saying that the Bank of England was trapped, and unfortunately for English people it still is. Indeed, unemployment rate went down to 3.8% while at the same time inflation increased by 0.7% MoM on headline and 0.8% on core.

Adding to the concerns, GILTs (Government of the United Kingdom bonds) have returned to the levels that caused the crisis in Autumn 2022. One could argue that companies, funds, and individuals have deleveraged since then, which would be logical. However, since the government actively discussed the idea of allowing consumers to pay only the interest part on their variable rate mortgages, it suggests that things may not be as promising as we had hoped.

The Bank of England made the decision to hike interest rates, surprising the market with a 50 basis points increase instead of the expected 25 basis points, and despite this decision being theoretically bullish for the pound, it sold off.

The simple reason behind this kind of reactions, especially when talking about G10 countries, is that the market thinks the hiking process will not just tame inflation, but hurt the economy as well. I agree with this view. Also, the market is pricing in another 50bps hike coming up on the next meeting, which, everything considered, I believe won’t happen: my base case is for 25bps. For these reasons, I opened a short against the pound at 1.275, which is already ITM.

Europe

If last month was Germany to enter a technical recession, this time it was Europe’s turn. Indeed, the GDP printed another -0.3% QoQ, making it the second consecutive month of negative growth. We can discuss the reliability of the data itself, but one thing is certain: sanctions were a terrible move. I’ve said it several times last year, even when sanctions were still being just discussed. At the time, I was called pro-Russian, but in the end it was proven I was just right.

Inflation is partially decreasing on the headline front, thanks to lower energy prices, which is also reflected in the negative monthly change in PPI. However, core inflation remains unchanged, which is troubling, to say the least.

The market has priced in a terminal rate of 4%, but I believe the PMI carries more weight, and the ECB will likely pause around 3.75%: in other words, we probably have just one more 25bps hike ahead of us. In that case, the euro would once again become a short, as it has no business in staying this high, and the narrative of the ECB out-hawking the Fed would finally crack.

United States

In the United States, the labor market continues to be historically tight, although the unemployment rate increased to 3.7%. We had three weeks of high initial jobless claims, but they then reverted down to the previous range: given how the continuing claims didn’t even react to that spike, that was to be expected.

Moving on to inflation, the data we received this month presents a mixed bag. Headline inflation showed signs of deceleration, with a mere 0.1% MoM growth or 4% YoY, which is encouraging news. However, core inflation experienced a 0.4% MoM growth, which, when annualized, amounts to approximately 5% and is consequently too high. In other words, we’re witnessing the second-worst outcome for policymakers: service inflation getting sticky at a higher level.

However, the problem is that if the labor market remains this tight, employees have bargaining power over the wage. In other words, we risk a wage-price spiral. Therefore, we need wage growth to decline relative to productivity, because otherwise inflation remains a problem. Worse could be the scenario in which wage growth declines because of rising unemployment, as that would cause the US government to use expansionary fiscal policies, making inflation an even bigger problem.

To better see where we’re headed, it’s best to look at both consumer inflation, and producer inflation. The PPI declined by 0.3% this month, but the interpretation isn’t as easy as it seems on the first look. Indeed, while this economic indicator leads to consumer inflation and points to further downward pressure on that, it’s also a leading indicator for corporate pricing power.

Over the past year, corporations have struggled to offset falling volumes with higher prices, which is very visible by looking at the persistent decline in the Redbook Index. But, then, what happens when corporations not only face falling volumes, but also falling prices?

Finally, this month the Fed paused, contrary to what I expected, but raised the dot plot and tried to sound more hawkish.

There are a few things to note here. First, although they decided to skip, it was made clear that at the next meeting they intend to raise the rates once again. In other words, they decided to wait 30 more days before taking a decision. There are two possible explanations here in my opinion: either they saw something developing behind the scenes and wanted to insure against it by waiting a bit more, or they effectively ended the tightening cycle and the last hike is behind us already.

As said in the previous portfolio update, “now that’s confirmed a pause may happen soon, the debate shifted from when will it come to how long will it last”.

In any case, the market has fully priced in a 25bps hike in July and doesn’t currently expect any rate cut before March 2024. It’s still too early to say whether these rate cuts will arrive by then, but one thing is certain: there is no reason for a cut unless something broke. In other words, rate cuts are far from being bullish.

Obviously, raising rates from 0% to 5% will have some negative consequences, and it comes to no surprise that everyone has been calling for a recession by now. However, current data is not yet supporting that view. Indeed, US growth is estimated to be 2.2% for Q2, housing starts surprised to the upside by over 200,000 units, bankruptcies are still low, and layoffs, despite several biased narratives, have yet to surge.

Equities

The month started with everyone talking about how the TGA refill would have caused a crash. However, as it often happens when something becomes popular on Twitter, it didn’t happen. Indeed, so far the effects of the TGA refill on the markets have been inconsequential, as RRP absorbed most of it. In general, we can argue we are not even in a tightening environment, as monetary policy is barely in restrictive territory and fiscal policy is still expansionary. Furthermore, China and Japan pumped liquidity in the markets, which surely doesn’t help either.

Of course, this has resulted in incredible runs in equities. As of now, the S&P 500 and the Nasdaq 100 are respectively 8% and 10% below their highs, sentiment is back at 2021’s euphoria, most traders convinced themselves it’s “a new bull market”, meme stocks are rallying, and we finally hear again from crypto bros.

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.

Portfolio

Since my core focus this month wasn’t the market but rather finishing my exams, the activity on my portfolio was very limited: in other words, I basically went passive. These are the open positions as of June 30th, 2023:

• Long: MOWI.O, FPI, SALM.O, NDAQ, IONQ, ED
• Short: GBPUSD

As anticipated last month, I took the opportunity of the weakness shown in the Norwegian seafood industry, and bought MOWI commons at 180NOK and Salmar commons at 416NOK: the salmon tax was changed and brought lower, but stocks aren’t reflecting that yet. If you’re interested in the salmon industry, MOWI published a good introduction here.

Then, Nasdaq announced its intention to acquire Adenza for $10.5 billion, the biggest acquisition in the company’s history, and S&P Global Ratings downgraded the company from BBB to BBB+ amid concerns relative to the $5.9 billion in debt that Nasdaq plans to take on to finance the deal. On the downgrade, shares fell 11% to $51, and continued to fall for a few days after. In my opinion, it’s a steal below $50, so I bought some commons at $49.36 average.

I added on FPI during that mid-month drop, bringing my overall average in the low $11s. This is one of the biggest positions in my portfolio, and will likely remain so: competent management, relatively small capitalization, good cash flow, recession- and inflation-proof, undervalued… what more can I ask for?

And, finally, I FOMOed in IONQ at around $10 with a very small portion of the target position after a few very good news came out. The good thing is that the position is up more than 35% already. The bad thing is that it’s less than 0.5% of the overall portfolio.