We all knew this rally was coming. Bear markets develop slowly and fundamentals are much less important in day-to-day trading than positioning and sentiment. US stocks posted their worst 10-day start ever this year, and hedge funds bore the brunt of it. Through February 16, over 25% of all equity long/short funds were down -10% or more YTD. Of the 490 funds that HSBC Hedge Weekly tracks, a staggering 23% have triggered or are close to triggering their maximum drawdown. All of this pain creates capitulation and when you combine that with improving data the result is a substantial rally.However, the weakening fundamentals that warrant a bear market in stocks have not gone away. As we’ve discussed at length, the epicenter of the slowdown is China where exports slumped -25% Y/Y in February. That number is a little misleading because Chinese New Year fell in February this year, but the combined numbers for Jan-Feb are still alarming weak and import data is not much stronger. Hong Kong, a territory facing the double-whammy of a Chinese slowdown and stronger USD, saw residential property transactions fall -70% Y/Y in February to a 25-year low. Between 2003 and last September residential home prices soared +370%, but have since dropped -10% as uncertainty looms.
Keep in mind this is a city where demand for housing greatly exceeds supply. The abrupt decline in transactions is prompting some Hong Kong developers to slash targets. Sun Hung Kai Properties Ltd. cut its full-year contracted sales target in Hong Kong by 18%. Analysts at BOCOM International Holdings believe prices could fall 30% amid a slowdown. Hong Kong has the highest concentration of trade with China and is the closest in proximity, but this slump will eventually spread across Asia.
Singapore home prices have dropped for nine straight quarters, posting the longest losing streak in 17 years. Home sales posted their worst start to the year since 2009 in January. Singapore was ranked the second-most expensive city to buy a luxury home after Hong Kong in Asia, according to a 2015 Knight Frank wealth report. And it’s the destruction of wealth that we should be watching, because that will eventually trickle down into capital markets. It’s worth noting that 221 billionaires fell off the Forbes billionaire’s list in 2015.
Having said that it’s incredibly difficult to sit through these dead cat bounces. Hopefully you all steered clear of iron ore, which shot up +20% on Monday without much of a catalyst. Ostensibly the rally was due to the Chinese government not coming down hard on state-owned steel producers, but was clearly a major short-squeeze driven by positioning and overly-negative sentiment. This rally might get more juice from the ECB meeting tomorrow (it might not), but the key is to have a view based on fundamentals and build exposure when the market is looking the other way.
The Cup & Handle Fund is up around +3.0% YTD, and +13.0% Y/Y. In an effort to practice what we preach (above) there the portfolio added more short exposure yesterday, trying to take advantage of cheap volatility. Other than that our PnL has remained remarkably stable through ups and downs. Sometimes portfolio construction is better than having the correct view, but we continue to move carefully. Thanks for your feedback on March’s investor letter, and please keep it coming. If you’d like to start receiving these letters click here.
With that I give you this week's letter:
As always, if you have any questions or comments or just want to vent, please send me an email at firstname.lastname@example.org.
Until next time, tread lightly out there,
Managing Editor – Cup & Handle Macro