The Season has Changed – September 2022

The importance of being aligned to the recent regime change within US and Global equity markets is something we cannot stress enough to our clients. The easy money is over. Rampant speculation is over, and several bubbles have burst and continue to deflate with the dry-up of liquidity. The drivers of return on investment in the last 5-10 years have morphed and are unlikely to come back in the same form. Nonetheless, markets always provide opportunities; and our approach to investing and risk-taking continues to outperform our benchmarks.
At Robin Capital Group (“RCG”) we have proven our ability to identify macro trends with asymmetric risk-reward, deploying a bottoms-up approach to fundamental analysis across the equity space and implement a rigorous risk management framework, allowing us to foresee regime changes and position accordingly into and out of new market cycles. This time, it’s back to basics, welcome to this next chapter in investing. Stay vigilant!

Where we are and what to know:

⁃ Inflation
Inflation is now over 8% in the US but it’s a global phenomenon and impacting every corner of the economy. The cause? How about a decade of easy monetary policy, a dollar printing press with an endless supply of ink, Covid related supply chain limitations, production shortages and near-sighted fiscal policies which responded and still respond eagerly with “more stimulus”!

⁃ Rising Rates and Cost of Capital
We wrote about the unlikelihood of inflation being transitory back in March of 2021 as lumber prices broke through record levels and housing prices reached its peak. All the while, the FED sat back and ate their popcorn absolutely oblivious or complacent with the rate of spend the administration was flooding the economy with. They expected minor rate increases, 25bps they reported, as the rising prices would not persist for long. Here we are, 9 months later, three 75bp hikes for a monetary policy rate of 350bps, after the Sep 22 meeting. Mortgage rates steadily above 6% and rising, 2yr yields at 4%, a deeply inverted yield curve and still no asset class to hide behind as rate increases are yet to cease. In addition, we enter a phase of quantitative tightening where the FED is no longer buying the paper it prints at auction, meaning J. Powell needs to find new buyers for all new issues as his existing portfolio begins to roll off.
As rates continue to increase, the cost of capital also increases across the board, credit markets get tighter and corporate investment begin to decay. In short, risk assets will suffer and IRR’s will have to increase as risk free assets once again become more attractive. Lastly, Europe finds itself in a pickle of its own given its prolonged negative rate environment. They were late to the game on interest rate hikes and it’s worth mentioning the fact that they spent the past 20 years fueling what will soon be the largest energy disaster in history as it sold its soul to a once younger V. Putin, who is proving to have one wicked long game.

⁃ Wars and risk premiums
Back in the early 2000’s, investment firms were selling BRIC funds and loading up on big management fees. BRIC stood for Brazil, Russia, India and China; all emerging economies expected to show massive growth in the decades to follow. Well, with the exception of Brazil whose neighbors are all plagued by a wave of socialism, it is ultimately the RIC crowd who continues to trade with each other at the worlds expense. Furthermore, they each stand at the doorstep of political conflicts that can escalate further at any time. Russia->Ukraine; China->Taiwan; India->Pakistan

⁃ Energy crisis
This is something we have been highlighting since the midst of Covid. The under-investments in fossil fuel since the prior oversupplied cycle is almost stretching a decade now. The reasons are twofold. Lousy historical returns during low oil price environments and a large push into a “green “energy transition. This is already having consequences. We are witnessing it in Europe in a major way, but it will be felt across the globe. We hope it’s a mild European winter but prepare for some anti ESG emissions as Germany has secured substantial coal and wood to heat its homes. The main reason for Germany and Europe’s issues is their dependence for natural gas from Putin. Germany was supplying 55% of its energy needs from Russia before the Ukraine invasion. This is a staggering amount for the largest European economy and should be a warning to every energy minister with a job today.

⁃ Fear, Demand destruction and lower Growth
Rising rates and recession rhetoric plays a big role in introducing fear into the economy. To date, verbal threats alone failed to scare away a strong consumer, synthetic price compression by means of SPR releases has accommodated voting American’s for now, but the reserve is nearly critically low levels and demand is slow to ease. The solutions to existing supply shortages do not seem to be on the political agenda, so reducing consumption is what we will have to deal with. The culmination of prolonged demand-side destruction is ultimately lower or negative growth, higher unemployment and higher cost debt (Fed economists predict only a modest rise in unemployment into 2025 from 3.7% to 4.4% which is when they see inflation normalizing to their 2% targets). They’ve been wrong every time, this is no exception. Layoffs at major US corporations have begun.

⁃ Passive Investing and Machine Trading
There are now three large shareholders across ALL of US public stocks with over 20% ownership and they have the majority share of the ETF market (Blackrock, Vanguard and State Street). What do you think happens to a stock when they start buying or selling?! How about algos and high frequency trading? Almost all of today’s trading (more than 90%) occurs systematically with rule-based decision making. Specialist liquidity providers, primarily High Frequency shops, claim to add value to the end investor, however, most data shows that the market is now dominated by algos which sit behind brilliantly defined parameters designed to avoid exchange fuses once created to protect participants from rapid price shocks, liquidity droughts and general panic.
Instead, we now live in markets that create orderly chaos constantly testing critical price levels on low volumes, extending ranges across asset classes, while ensuring to keep general volatility contained as to ensure exchange alerts are not triggered (the VIX remains under 30 and contained in a tight range). If anyone ever read Michael Lewis’ book Flash Boys (if not we highly recommend it) you will understand that there have been massive firms (Citadel, Virtu, Tower, etc.) reaping in gargantuan trading profits with their HF algos, originally designed to provide liquidity and capture bid/offer spreads. Today, they can be long or short any instrument for as short as nano seconds with their ML and AI algos, accessing markets faster than any human.