2024: First Quarter Review

Portfolio Update
Our Man made a smattering of changes to the portfolio in mid-January.    The changes saw some new dislocations/themes added to the portfolio, as well as some adjustment of existing position sizes.

- Added Argentina (new Dislocation):  Following President Milei’s victory in the Argentine elections and the initial burst of reforms, especially the moves to liberalize the exchange rate, OM took an initial position in Argentine Banks.   OM will pen something in in greater depth, should this position be materially increased, but for those with interest you can read the positive case, as articulated by one of OM’s friends (an EM specialist).

- Added American Reindustrialization (new Theme):  Professionally, OM has been discussing this as the biggest under the radar theme in markets today.   The difficulty is that it’s hard to express well given it’s a tailwind for a broad swathe of largely mid-cap companies, but a primary driver for very few.   Thankfully, the First Trust RBA American Industrial Renaissance ETF (AIRR) captures many of the names impacted by the theme.

- Carbon Credits (new Theme): OM re-entered the Carbon Credits theme, taking exposure to California Carbon Allowances (KCCA).  

- Reduced Shipping/Tankers:  OM exited the position in EURN as following its transaction with FRO the company is no longer a tanker play.

- Reduced Uranium (URNM):  OM took some profits in Uranium, given the exceptional performance in recent months.  URNM rallied over 60% between the end of June 2023 and OM’s trim in mid-January 2024.

- Added to Brazil – OM made a small addition to the Brazil position.


Performance and Review
The portfolio rose with the markets during the first quarter of the year; its +11.04% increase slightly surpassing both the S&P 500 TR (+10.56%) and the MSCI World (+10.09%).  

First Quarter Attribution

 

There were four primary drivers of performance in Q1 - two long-held positions and two of the newer positions.   The positions in Uranium (+248bps) and Tankers/Shipping (+230bps) were again the largest drivers of performance.   They both continue to benefit from a continual stream of incrementally positive news and have gone from controversial and ignored ideas, to broadly accepted but underappreciated and underinvested ones.   

The US’ relationship with nuclear (and thus uranium) is similar to the rest of the world; over the last 2-3 years the US has seen growing bipartisan acceptance of nuclear culminating in President Biden’s recent endorsement.  However, despite this the US is likely to be the last place to commission a significant expansion in nuclear power as the US has high construction costs and amongst the lowest electricity prices in the world.  OM’s expectation is that US firms will first learn by building plants overseas, using this to help reduce the cost structure to something closer to that achieved by the Koreans (but still more expensive than the Chinese).   Thus, despite the broad acceptance, new US nuclear plants are likely to signal the end of the Uranium trade than being a purely positive sign.

The newer positions in Argentina (+210bps) and European/UK Financials (+169bps) were strong contributors.  The UK Banks continue to suggest improvements in their earnings and have been rewarded with steadily increasing estimates and investor interest.  In Argentina, it has quickly become clear that President Milei is seeking to make major changes very quickly.  There is, and will continue to be, much debate about the pace of the changes but Milei has learned from Macri’s failed attempt at gradual reform a decade ago.   The reforms are broadly things that have been discussed about Argentina for years including liberalizing the exchange rate regime, shrinking the money supply (including running down the central bank notes, LELIQs, which were held by the banks), balancing the budget and the start of structural reforms.  The reforms will no doubt fail to be perfect, and their passage into law and implementation will be complicated, but the general direction is positive.

Elsewhere, the portfolio received healthy gains from positions in the Blockchain thesis (+117bps) after a spot Bitcoin ETF was approved by the SEC.  The most successful time to own cryptocurrencies has historically been from ~6mos before the Bitcoin halving to ~1 year afterwards.  Despite this being well known, OM suspects this will once again prove to be the case around the May-24 halving.  Thus, while the exposure here may increase in 2024, expect it to only last till this time next year.

Elsewhere the gains slightly outpaced the losses, which is unsurprising given the strong market performance.  There were solid contributions from Reindustrialization of the US (+64bps), Tin (+43bps), Greece (+31bps), India (+25bps), Biotech (+21bps) and Commodities (+14bps).  The only detractors came from positions in Brazil (-41bps) and Carbon (-24bps).


Portfolio (as at 03/31/24 - all delta and leverage adjusted, as appropriate)
Dislocations: 46.3%
24.2% - Uranium (URNM, CCJ, NXE, PALAF, DNN, BNNLF, URG and SMR)
10.7% - European/UK Financials (BCS, LYG, NWG)
6.2% - Argentina (BMA, GGAL, SUPV)
5.2% - Brazil (EWZ)

Thematic: 48.2%
13.4% - Shipping/Tankers (STNG, INSW, TNK, DHT and FRO)
6.6% - Tin (AFMJF, MLXEF and SBWFF)
5.5% - Biotech: 4th Industrial Revolution (IBB & XBI)
5.5% - India (IBN, INDA and SMIN)
4.4% - Blockchain/Crypto (ETHE and OSTK)
4.0% - Greece (GREK & ALBKY)
3.3% - US Reindustrialization (AIRR)
2.5% - Carbon Credit Allowances (KCCA)
1.7% - Software: 4th Industrial Revolution (JD & WCLD)
1.4% - Commodities/Mining (FLMMF)

Idiosyncratic: 5.2%
5.2% - Equities (TPL & JOE)

Shorts/Hedges: 0.0%

Cash: 0.3%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.

Things from my Newsblur; 2024 Part I

OM aims to publish six Newsblur posts this year instead of waiting to accumulate numerous articles. Thus, expect shorter posts with 4-5 articles but with more timely content.

The Best Day.  The Very Best Day.
OM loves football (aka soccer), especially his team - AFC Wimbledon. Recently, they faced their hated rivals in a heated match, echoing John Green's sentiment that "football is the most important of all unimportant things."  I’ll spare you all the details, but this is a short 5min video that OM will come back to whenever he needs a pick me-up!

For those who don’t want to watch it; as OM tells his kids – prepare, give your best, and control what you can.  Success isn’t guaranteed, but sometimes – just sometimes – you will score a 94th minute winner in front of your fans, the roof will be lifted off and everything will make sense for a little while.   
(John Green/@vlogbrothers on YouTube)

The Profile Interview: Rob Henderson on Why We Hold ‘Luxury Beliefs’ and Develop ‘Status Anxiety’
A slight departure from the norm but I think a good one;  I have read Rob Henderon’s blog for a few years now and I’m working my way through his just released memoir (Troubled: A Memoir of Foster Care, Family, and Social Class).   I like them both a lot but it’s not for everyone, amongst other things it requires holding conflicting views of the author and some of his ideas at the same time.  For those who are curious, The Profile’s (also a good read) interview is a good starting point.

The most interesting of Henderson’s ideas is the term he coined, ‘luxury beliefs’, which he defines as “ideas and opinions that confer status on the affluent, while often inflicting costs on the lower classes and everyone else.  A core feature of a luxury belief is that the believer is sheltered from the consequences of his or her beliefs.”
(The Profile)

Things I Don’t Know About AI
There is no shortage of opinions on AI, but this is an interesting way to think about what we don’t know.   Written by a Founder/VC, the opening sentences sum it up; “In most markets, the more time passes the clearer things become. In generative AI (“AI”), it has been the opposite. The more time passes, the less I think I actually understand.”
(Elad Blog)

Can Trade Intervention Lead to Freer Trade
OM believes that there’s something wrong with the version of ‘free trade’ today, and that the next 50-years are likely to see something quite different from the last 50-years.   Michael Pettis article delves more into this, and his introduction sums the issues up well!

“A well-functioning trading regime would permit neither the large, persistent trade imbalances that characterize the current global trading system nor the perverse flow of capital from developing economies to advanced economies. Global trade needs new rules that encourage a return to the benefits of free trade and comparative advantage.”
(China Financial Markets)

2023: Fourth Quarter Review

Portfolio Update
All of OM’s portfolio changes happened at the start of November:
- European/UK Financials:  OM built the recently discussed position in European/UK Financials.   
- Biotech:  OM increased the Biotech position by ~1.75%.
- Shorts/Hedges - Higher Medium-Term Rates:  OM exited the position in PFIX at the start of November, as the 10-Year Treasury traded around 5% meaning that higher rates for longer were finally being priced in.  The timing proved fortunate as subsequent economic data and commentary from various Fed/Treasury officials led markets to change their view and expect numerous rate cuts in 2024.

Performance and Review
OM’s portfolio rose with the markets during the final quarter of the year; its +10.73% increase fell between the S&P 500 (+11.69%) and the MSCI World (+9.84%).  This resulted in the portfolio ending the year +31.29% for 2023, which was ahead of markets (S&P 500: +26.29% and MSCI World: +23.18%).    While a solitary year means little, 2023 ended up being decent overall performance especially considering the portfolio protected capital in 2022.

Fourth Quarter Attribution

While there has been much talk of the ‘Magnificent 7’ (aka MAG7), a small cadre of technology-related stocks driving the market higher with limited contributions from others, that was not the case for OM.    While OM owns none of the MAG7, it was in many ways close to an ideal year for the portfolio.   

The portfolio benefited from the timing/maturity of its core exposures; the Shipping/Tanker theme drove performance in 2022 and early 2023, before handing over to the Uranium positions that contributed over +1,000bps to performance in the second half of the year.   With the Shipping/Tanker theme in its ‘beginning of the end’ phase, it will likely continue to be cut back and shrink during 2024.  Uranium is – after a long wait – finally in the sweet spot of its investment lifecycle as the opportunities on the demand side, challenges on the supply side, and the material gap between demand/supply are now beginning to be understood by industry players and reflected in market pricing.   More generally, OM’s belief remains that the demand/supply trends we are seeing in the Uranium sector are likely to be repeated in many other mining/commodity sectors in the coming years.

The turbulent and uncertain markets in 2022/2023 were also generous in helping offer up new opportunities (European Financials) and the chance to increase exposure to some existing ones (Biotech).  This is something that has continued into the early part of 2024, with OM having started new positions in Argentina (Dislocation) and American Re-industrialization (Thematic) and added to the Brazil position.

The portfolio’s fourth quarter performance was largely reflective of the market, with everything contributing to performance.   The standout was the exposure to European/UK Fins (+197bps) that rose 20%+ as their third quarter earnings began to further highlight the value proposition for investors.  The portfolio’s Blockchain (+177bps) exposure was helpful, with the position in ETHE benefiting from the expectation of a Bitcoin ETF getting SEC approval in January 2024, and the belief that an Ethereum one would be next.

The non-Uranium commodity positions continue to lag, with Tin (+4bps) and Commodities (+8bps) making marginal gains.   In many ways there are similarities to where the Uranium (+186bps in Q4-23) position was in 2021, with clear signs of the coming stresses in the market visible to the few who are looking.        

Elsewhere, the weakness in the US Dollar helped the international positions; India (+56bps), Greece (+48bps), and Brazil (+104bps).  The rise in rates early in Q4 saw OM exit the Short/Hedge exposure (via PFIX, +16bps), while the subsequent change in rate expectations helped Technology – 4th Industrial Revolution (+26bps) and Biotech (+101bps) names rally strongly in the second half of Q4.   There were also decent contributions from the Shipping/Tankers theme (+122bps) and the Idiosyncratic names (+23bps).


Portfolio (as at 12/31/23 - all delta and leverage adjusted, as appropriate)
Dislocations: 45.4%

29.6% - Uranium

10.1% - European/UK Financials
5.7% - Brazil

Thematic: 44.5%
14.7% - Shipping/Tankers 

6.9% - Tin 

5.9% - Biotech: 4th Industrial Revolution 

5.8% - India 

4.2% - Greece 

3.7% - Blockchain/Crypto 

1.9% - Software: 4th Industrial Revolution 

1.4% - Commodities/Mining 

Idiosyncratic: 5.8%
5.8% - Equities 

Shorts/Hedges: 0.0%

Cash: 4.3%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.  

European/UK Banks - Dislocation postion (Q4-23)

During the middle of the fourth quarter of 2023, Our Man built a dislocation position in European (and specifically UK) Banks.   The crux of the thesis can be summed up as European banks spent the last 15 years using profits to rebuild their capital base and are now ready to start returning those profits to investors, and it comes right at the moment when profits are likely to rise due to higher interest rates.  The market doesn’t believe this as everyone knows European Banks are terrible no good investments, and that a UK recession is coming and thus rates will go back down.

Yes, I know you’re disgusted that OM bought European/UK banks – perhaps almost as disgusted as Mrs. OM was - but that’s a necessary condition for a dislocation investment!  As a reminder, dislocation investments should be unloved by investors (hated is even better!) and thus absolutely and relatively cheap, but with something upcoming that will help change the narrative and price.

Everyone knows that European banks have been an awful investment for over a decade.  Here’s Barclays over the last 10-years; a whole of ugly!  
 

And it’s not just Barclays, the entire European Bank index has a measly 2% annualized total return over the last decade, and negative returns over 20 years!  And yes, OM did notice the 2023 demise of Credit Suisse!  

However, the terribleness of European/UK banks is a known known and it leaves Barclays – a premium UK bank (stop laughing in the back!) – trading at ~0.5x book and a P/E of 5x.  Furthermore, expectations are low with market analysts expecting little to no growth in earnings in the upcoming years.  

Yet, the dirty secret is that after spending over a decade of using profits to repair balance sheets and capital ratios, the European banks are finally ready to return some of that lucre to a moribund shareholder base.  Whisper it quietly, but European banks are much better capitalized than their US counterparts (and with far less of the not marked-to-market financial chicanery)!

 

While OM could walk you through all the financials, Barclays were kind enough to provide a slide that goes directly to the heart of the matter.
 

What’s going on here?   Well, Barclays invested in a massive long-term interest rate swap portfolio to smooth its P&L.  Their timing was suboptimal, locking in exceptionally low rates – as seen by the average hedge yield of <1% through 2022.   However, the good news is that about 20% of the portfolio (50-60B GBP) rolls off each year and in 2022 and 2023 it began being reinvested at much healthier rates (4.57% at Q3-23).  This is why the light blue bars for 2024 and 2025 are a cloudy white at the top; if the entire portfolio generated 4% (vs 1.54% as of Q3-23) then the hedge income would be ~10B GBP, off the charts compared to the dark blue bars of 2019 to 2022.

So why doesn’t the market see this or care?  Well, the uncertainty is of course over the 5-year swap rates in 2024 through 2026, given it will take till 2026 for the low rates to be rolled out of the portfolio.  For simplicity think of the portion of the hedge at 2019s rates being rolled into 2024s rates, and 2020s in 2025s, etc.  The market’s belief is that the UK economy is weak, a recession is coming and that rates will fall.   While this is certainly possible, it helps create the kind of dislocation trade that OM loves; hated, cheap and with the market already assuming bad things and pricing that in.  If nothing happens, and the UK just muddles along with rates remaining broadly similar then Barclays will profitably roll that massive hedge portfolio and the stock is seriously mispriced.  

The same analysis broadly holds true for other European banks, but OM has focused his positions on the UK since (i) inflation is likely a little more structural there (in part due to Brexit) and (ii) ‘everyone knows’ that the UK economy is weak and rates are coming down.

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.