TheBigQuestions ARPLLC
TheBigQuestions ARPLLC
Return Letter
January 2024
“As you go through life, there are thousands of little forks in the road, and there are a few
really big forks – those moments of reckoning, moments of truth.”
Lee Iacocca
To cut a long story short, it all resulted in the launch of a new investment vehicle,
which I cannot mention by name in this context, as it is only open to professional
clients as defined by the FCA. If you click here, you can see how the regulator defines
the term “professional client”, and whether you qualify as one. Allow me to provide a
bit of guidance: if you work in the financial industry, zoom in on COBS 3.5.2 (per se
professional clients). If you don’t, zoom in on COBS 3.5.3 (elective professional clients).
That will make it a great deal easier.
Going forward, the January letters will continue to be somewhat different from other
Absolute Return Letters. Overall, they will set the tone for the year to come, i.e. I will
discuss what we, as a team, think will be the most important issues to focus on in the
months to come.
The way it is going to work in practice is that, in December, I will ask the team what
they think are the most important questions/issues to be addressed, assuming a time
horizon of 12 months. I will then seek to answer those questions in the January letter.
This year, four questions stand out:
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January 2024
In the US, it is very different. Analysts are deeply divided whether the US economy
will go into recession this year or not. Some believe so, whereas others argue a soft
landing is the more likely outcome. I belong in the latter camp, and I do so for two
reasons: (i) the spending power amongst US consumers, who make up 70% of US GDP,
is still significant with meaningful excess savings aggregated in the early stages of the
pandemic (Exhibit 1), and we know Americans love to spend; (ii) the recent increase in
US unemployment is consistent with a soft landing – not a recession. The US labour
market is still too strong (graph not shown here).
The reason a soft landing in the US is good for risk assets worldwide has to do with
the prominent role of US financial markets. I do not expect more than a modest
correction in European risk assets if US risk assets do well on the back of a soft landing
over there. Having said that, I actually expect Japanese risk assets to outperform both
US and European risk assets, but that is a story I will come back to over the next month
or two.
If I combine the early signs from China that it has now turned the corner with my
forecast that the US economy should escape the worst in 2024, commodities should
actually do quite well. That said, commodities are many things – energy, industrial
commodities, precious metals and agricultural commodities to name a few, and you
are in danger of over-simplification if you argue that the picture is broadly the same
for them all.
In my book, two types of commodities stand out at present. Firstly, if China has indeed
turned the corner, and if a soft landing, not a full-blown recession, will be the outcome
in the US, industrial metals offer good value at present. Secondly, capex amongst oil
drilling and exploration companies is now less than one-third of what it was a decade
ago (chart not shown). If history repeats itself, lower capex going into drilling and
exploration will, in the foreseeable future, lead to a much lower output. In other words,
demand may be on the decline, but supply may fall even faster, and that should lead
to higher prices.
Q3: Will green stocks continue to rebound after having had a tough
year?
The are many sub-groups of green stocks, but most of them have been through a
dreadful couple of years after hitting new all-time highs in 2021 (+/-). Towards the
end of 2023, most of them started to perform better, though, hence the question –
are the bad times well and truly over?
Let’s begin with the bubble forming in 2019-21. At the time, green stock could do
nothing wrong, and all (green) boats were lifted. Investors paid little attention to the
earnings outlook, i.e. the rally was far too indiscriminate. Suddenly, the tone changed,
as investors began to ask questions, and most green stocks have never fully recovered.
Now, a couple of years later, the outlook for the climate is worse than ever (Exhibit 2),
i.e. the need for solutions is higher than ever. The short-term earnings outlook has not
necessarily improved a great deal (these sorts of things take time), but green stocks
are valued far more attractively today after undergoing a 2-year bear market.
Adding to that, it is indeed possible that the massive challenges that many green
companies, particularly wind turbine manufacturers, have faced over the last couple
of years could reverse in 2024-25. Profits on most green projects turned negative, as
companies were caught out by a combination of significantly higher material costs and
punishing interest rates.
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January 2024
Some of these contracts have now been renegotiated, as it was not in governments’
interest to see these companies go out of business. It is now possible that the new,
renegotiated contracts will be followed by lower material costs and falling interest
rates. i.e. many unprofitable companies could quite possibly turn profitable over the
next few years. (See also Q4 below re unprofitable companies.)
On the back of that, I conclude that, yes, the rebounce should continue. That
conclusion becomes even more affirmative if the economic slowdown in China is now
largely behind us. Having said that, a recession anywhere will dampen demand for
green solutions. Governments have a long and solid track record when it comes to
letting the environment suffer in times of economic hardship.
As I don’t expect the armed conflict in Gaza to end anytime soon, ships passing
through the Red Sea will continue to be at risk for a fair bit longer. The only alternative
route, around Cape of Good Hope at the southern tip of Africa, may be cheaper as far
as insurance is concerned but much more expensive in fuel costs. You may argue that
this is not a US but a European problem. Whilst partially correct, in today’s
interconnected world, and as we learnt during the first supply chain crisis, rising
inflation in one part of the world will quickly affect prices in other parts of the world.
Should this force the Fed to keep interest rates higher for longer, first and foremost,
‘junk’ stocks will be at risk. Allow me to explain. I define ‘junk’ stocks as:
(i) listed tech companies with negative earnings, thus dependent on borrowed
capital to finance the business; and/or
(ii) the most shorted, listed companies.
As you can see in Exhibit 4 below, ’junk’ stocks performed exceedingly well, following
Jerome Powell’s half-promise to lower interest rates at least three times in 2024.
Having said that, as you can also see, unprofitable tech companies had a horrid time
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January 2024
in Q3 as interest rates rose, thus raising the cost of capital, and so did the most shorted
stocks. I assume short covering was a major factor behind them rallying in Q4.
If interest rates have to stay higher for longer, and that is indeed a big “if”, if one takes
Jerome Powell’s recent comments into account, the recent Q4 rally is unsustainable.
Therefore, the answer to the question is that ‘junk’ stocks are most at risk. That said,
just like the ‘junk’ rally lifted all boats, the end of the ‘junk’ rally could sink all boats
again.
Niels C. Jensen
3 January 2024
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January 2024
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