Positioning in the market has become less extreme, especially ahead of what has historically been a lower return period for the stock market.
Cross governmental coordination of stimulus, especially to green transitions, may set the next multi-decade investment theme.
Carbon allowances are one example of how governments use open markets to encourage compliance with their long-term targets.
PERFORMANCE YEAR TO DATE
THE MARKET
Important to consider when looking ahead:
Similarly to Tim’s current spirit after a 72-hour bachelor party in Sin City, investor sentiment, according to Goldman Sachs and measured through stock positioning across the retail and institutional landscape, is at a 6 month low. This is quite relevant given the end of 2020 / beginning of 2021 frenzy around retail investing.
We see the above as a positive (i.e. extreme positioning seems to be less of a things now). More broadly, the set up in the market seems to be healthier than in the last months, but still quite optimistic about future returns – short interest is, according to JP Morgan, now close to the lowest level since pre-2008, at just less than 3.5% of the total US Market float, and more than 40% of US households wealth is now in the stock market (the highest ever). Friendly reminder: healthier does not mean healthy.
Market manipulation continues to be top of mind, with this being evident in the one trade we completely missed post-pandemic bottom last year: Crocs. Stock is up almost 10x since March 2020, criminally threatening any last residue of elegance in today’s fashion standards.
The SPAC bubble has partially deflated, with SPAC-floated businesses losing about 40% of their market cap from their early 2021 highs. Who could have seen that coming…
We are now entering the six months period between May and October, known to be the worst returning period for stocks, with a historical 6-month average return of 2%. For reference, the best period is November through April, with an average return of almost 7%, which market specialists at Lykeion attribute to Roger’s New Years’ Eve East London exploits, and to a lesser extent, holiday season retail spending and Q1 institutional rebalancing.
After the frenzy of last year, we’ve now reached a level of Central Bank’s purchases that should be relatively unchanged for the next 12 months. Beyond that point, markets expect Central Banks’ purchases to be flat or even negative… enjoy the ‘brrrr’ while you can.
As of the end of last week, 60% of the S&P500 had reported earnings, with 86% beating consensus estimates (vs 5-year average of 74%). US households have significant savings ammo going into summer, which we may see reflected in higher spending (can sales of White Claws and Crocs finally move Velocity?). That said, savings are concentrated into the wealthier cohorts, which tend to be older and less prone to spending. Will we see boomers go wild this summer, or will a significant portion of the buildup be spent on New Balances and pellet-fed smokers? Jokes aside, Boomers are important customers for the hospitality sector, so this should bring some relief to what has been a disastrous past 18-months.
Goldman has the S&P at 4,300 at the end of the year, making the argument that we’ll see peak economic growth in Q2, so buying into this quarter is likely to produce negative short-term returns and modest 12-month returns. Looks like ‘DJ Sol’ is closing up the dance floor at the party. The question is: are people really ready to leave? We don’t think they’re done yet. (except Tim, who’s probably editing this with an IV drip in him. He’s definitely done.)
Cross Governmental (Green) Cooperation
Policy uncertainty, which during the Trump administration used to be the major driver of headlines (anyone besides CNN and FOX misses those days?) is at the lowest level since April 2019. The world’s political class is projecting a clearer (but not necessarily better) path forward, in unison: huge budgets for green infrastructure, higher taxes, and loose financial conditions. This is one of the most important narratives currently shaping both the economy and financial asset performance. Consider this:
In 2019, the UK announced a legally binding resolution to reduce net emissions of greenhouse gases to zero in 2050.
The EU (we’ll talk more about carbon allowances below) is setting aside 37% of the recovery fund for green transition projects – that’s €265 billion.
President Biden held a global summit on climate change and announced the target of lowering, by 2030, carbon emissions by 50%-52% when compared to 2005 (in 2019, carbon emissions were about 13% lower than in 2015).
There are plenty more examples to give on this theme, but the idea here is to highlight the political agenda delivering large amounts of capital to green transition projects. This is driving related commodities higher, with copper being the primary beneficiary (with demand coming from EV, Solar, and Wind power).
Chip shortage
We had Big Tech reporting in the last couple of weeks, and we must say, it’s impressive how these companies continue to deliver growth numbers as if they were still recently floated start-ups. Apple reported a 54% increase in revenue to $89.6 billion, its net income more than doubled to $23.6 billion. Similarly, Facebook increased its revenue by 48% to $26.2 billion and almost doubled Net Income to $9.5 billion. Between the two of them, they hold almost $270 billion in cash (*Michael Saylor has entered the chat).
For hardware producers (like Apple) though, the current global chip shortage crisis promises to knock off material amounts of revenue in Q3 and Q4 of this year, meaning that a continuation of this outperformance is now highly unlikely.
The global semiconductor shortage, which impacts almost everything that has any hardware, is a serious supply-chain disruption that will have a material impact across industries (the estimated loss for the auto industry related to this is amounts to $61 billion). Why is there a shortage of chips?
The pandemic caused drastically increased demand for Work from Home equipment;
Given the uncertainty of how quickly consumption would rebound post-COVID, hardware manufacturers also changed their orders quite frequently (making order backlog management a living hell for chip manufacturers), increasing supply chain disruptions and messing up delivery schedules;
Add to this the fact that 81% of semiconductor foundry’s market share belongs to two countries (South Korea and Taiwan), and that half of it belongs to one company (TSMC), and you can see why supply bottlenecks (Roger’s favorite)
The shortage has not come as a surprise tough, which has additionally led some hardware companies like Huawei to start hoarding components (especially as the US continues to threaten China with trade sanctions), which has further depressed available chip supply.
This event, in the longer term, will further fuel the growing post-COVID focus on renationalizing supply chains, and in the shorter term, will make gaming
nerds
aficionados a bit more frustrated with the delays in PlayStation gear (#backtoNintendo64).
Carbon Allowances
We’ve all heard about carbon pollution and the need to lower our carbon emission levels in order to fight global warming. Whilst there is a school of thought that believes that carbon emissions are not a precise or even relevant way to track environmental footprint, for the sake of this discussion, we’ll assume that tracking and containing carbon emissions matters (all analysts need to start with some assumption…).
In Europe, carbon emissions came down 21% from 1990 to today. At the European level, the goal is to have emissions in 2030 55% below the 1990 level, meaning that, in less than a decade, Europe wants to reduce carbon emissions by 1.5x what they were able to reduce them by in the last 30 years.
To ensure this target is met, governments and their regulatory bodies have generally tried to contain pollution coming from business activity through two different systems – carbon taxes and carbon allowances.
Carbon allowances differ from carbon taxes as they give quantity certainty (regulators set the maximum amount of carbon emission for a regulated geography within a certain year, and let the price be decided by the market), whilst carbon taxes give price certainty (regulators set the price and companies can pollute as much as they want as long as they pay for each unit of pollution). Carbon allowances should, therefore, be more effective in reducing the total amount of carbon emissions because they actually set a limit to the amount of pollution possible, independently of the price per unit of pollution.
The carbon allowances market in Europe is called the European Emissions Trading System (ETS) – it accounts for 85% of the global carbon allowances market, and it covers around 40% of the greenhouse gas pollution in Europe. It’s the most developed and liquid carbon allowances market in the world and it’s one of those rare cases in which Europe is further ahead than everyone else in the world.
Several industries in Europe are included in this system (Power, Steel, Cement, Aviation, etc.), which means that any business that operates within one of these regulated industries must comply with the ETS.
All this means is that every year the EU sets a maximum amount of pollution that can take place within these industries and issues an equivalent amount of “allowances” that are traded in the open market. These allowances are to be given to or purchased by businesses within the regulated industries, and in return, businesses need to surrender at year-end the number of allowances equivalent to their pollution. If they pollute more than their allowances allow, they need to buy allowances from someone else. If they pollute less, they can keep their allowances for next year or sell them in the market.
It’s a simple supply and demand market, where the regulator sets the level of supply, and businesses create demand based on their level of pollution.
Why are we talking about this in a markets update? Because this is a great example of how financial markets are becoming a tool for governments to make economic participants comply with large, macro, and long-term targets.
Treaties like the Paris Agreement, which attempt to ensure the long-term rise in average temperature stays well below 2 Celsius degrees (sorry Americans, you do the conversion to F), are too broad and macro to give individual businesses guidance on how they need to conduct day to day operations.
Bottoms-up market initiatives, like the European ETS, bridge the gap between the long-term and the day-to-day in a way that, whilst not perfect, certainly increases the likelihood of reaching those goals.
Additionally, carbon allowances might be an interesting investment as well (mixed feelings about this for now). We’ve done some work and we’ll be writing about it in the near future, but all you need to know at this point is that the price of pollution has increasingly become more tangible, and it’s very likely that financial market participants will explore the idea of making profits while supporting a good cause. Even if that’s simply on paper.
Co-founder and Editor-in-Chief. Covers Markets, Business, and Thematic Oversight. Currently a hedge fund Jr. PM, ex-Goldman Sachs capital markets and startup COO.
