Where ZE Sees Strategic Positioning in Markets, Following the week that Turbulent and Losing Week in the Market's on AI Concerns Take Stocks and Treasuries Down:
- By Chinedu Okoye
Paper Synopsis:
• Stocks had one of their worst week in months on AI over investment fears. MSCI World index slipped -1.6%, in Asia stocks dipped by -1.7% on aggregate, on Friday's close.
• Treasuries which saw yields dip to about 3.9% are back up to 4.09%, owing to bond traders reacting to the hawkish stateiments from Fed Presidents and FOMC members in the Powell camp.
• The concerns about the AI boom has seen stocks under pressure as the market is moving gradually from the cautious optimism ZE presented and/or stated, and moving towards fear..
• ZE Analysts view this as a much awaited - and to some extent, needed - correction and portfolio rebalancing rather than a full blown bear market which is defined as a 20% decline.
• Thus far, that is far from the case, and only an economic or balance sheet recession can trigger such market moves, seeing growth as value stocks dip alike.
• The effect on treasuries would depend on central bank policy action, but most importantly, guidance.
Why, Where and When We See A buying Opportunity:
We believe that, despite the comments by Fed officials and the Fed chairman, there's still a strong possibility if a 25 basis points (bps) cut, in that it would lull market diquiet, and give the Fed time to adjust QT measures with a counterbalancing effect.
But most of all, a rally in equities from the erratic nature of a market that has essentially priced-out - for the most part - the chances of a 25bps cut in December.
A deviation from the expected interest rate policy path however, would be disconcerting to market's, making the ZE projections - and expectations - of a Q4 ending rally null and void, as it is dependent on the Federal Reserve easing monetary policy by a modest rate cut.
Per ZE methodical, analystical and informed expectation, a 25 bps cut would be have a lesser effect on inflation, than it would have on consumer spending or confidence, keeping price changes sufficient enough to induce investmen, but also appreciaive of the consumers' income/budget constraint – basically less of an aggregate demand booster more of a stabilizer, hence, a lesser price increase tradeoff.
But this confidence boost - or aggregate demand increase - effect will not be, and is not limited to consumers alone, producers too would somewhat be empowered either by cheaper rates on working capital loans, or by a non-increase in bank offer rates on business support Ian facilities. So, any inflationary effect would affect producers' goods as well as consumers' goods (to borrow Frederich Hayek's term for broad goods (and services) categorization), but the former would be hit first.
The effect on production goods (or producers' goods) be partially offset by the eleminaton of price increases associated with trade barriers trade truce (for as long as it lasts). This would also temporarily improve business confidence and perhaps, slow the cooling in the jobs market (as employers are ‘cost’ incentivised to either hire more or reduce layoffs), leading steady jobs growth numbers goin forward.
The Fed, taking these into consideration, might be inclined to go for a safe 25bps cuts which, from a ZE poin of view, gas more upsides (on easing labor market pressures) than downsides (on reigniting inflation). And on this the erratic market would react positively, towards risk assets with EM and DM stocks benefitting.
Fed Put Not Going Away:
The quanatitative easing episodes in 2008 and 2020 - after the Fed started a rate normalization process initited under former Fed President and Treasury Secretary Janet Yellen - ignited investors believe the Federal Reserve will cut rates, pause rate hikes, or inject liquidity to stop mark
ets from crashing, and thus “protecting” the downside like a put option would.
A Fed Put could involve;
• Rate cuts during market stress
• Liquidity injections
• Emergency lending facilities
• Forward guidance meant to calm markets
• Occasionally large-scale asset purchases (QE) (this occurs when crises are severe, as in Japan buying ETFs and Mortgage backed securities)
This extends to other sovereign and influential central banks such as the European Central Bank (as seen in chart one above), the Bank of Japan, and the Bank of England.
The charts above and below show the balance sheet size of three of the most sovereign monetary authorities (central banks), namely; the Federal Reserve (Chart 5 below), the European and the Bank of Japan, with the BoJ outpacing the Federal Reserve and European Central Bank from 2000 till date.
(Chart 3: Japan's Central Bank balance sheet size {Billion Yen ¥})
For the Fed, BoE and ECB, balance sheet size as seen in the charts was fairly stable from the years 2000-2006, before the GFC of 2008 which prompted central bank aggressive easing, in response to one of the deepest financial crashes since the great depression.
The replication in 2020, also gives credence to the idea that, as hawkish as they may sound, when it comes to it, these central bankers would step in and stop the bleeding. Rate cuts would only fuel that optimism, even though markets could still tank, the expectation would drive calculated risks sufficient to steady the markets and even drive higher gains.
ZE Analysts Positioning Per Asset Class:
Equities: For the above reason, ZE sees any deep dives in stocks with proven market share, that pays dividends, has a healthy balance sheet, and cash flow and an overall strong going concern.
This is especially if the slash in stock price has nothing to do with the finances or business model of the company.
It is our view that with stocks hitting new highs in developed markets (like Japan, see Nikkei chart below) ,emerging markets, and frontier markets, the market is somewhat betting on a cushioned fall in the even if a crash, as the Fed (and other central banks) step in with accommodative policies as they have done in the past(2008, 2020).
As a result, quality stocks, and certain financial instruments (like Mortgage Backed Securities and even Exchange Traded Funds), become to the insidtiional investors an insurance at a level below which prices can rebound. Though that level cannot be accurately forcasted it methodically and/or statistically determined.
Fixed Income: The prospects for monetary policy accomodations also makes sovereign bonds look attractive (5-10 yrs). Holding DM bonds and EM bonds provides a hedge against (EM) exchange rate and inflationary risks, whilst EM compensates for the low yielding DM sovereigns whose major appeal is capital preservation and price appreciation.
(Chart 9: Vanguard Emerging Market Government Bond ETF. Year-to-date)
At $67.55, the Vanguard ETF - by which we gain broad exposure to the EM sovereign bonds - is up +6.68% despite being down marginally on a week on week and monthly basis of -0.01 and -0.03%, we still see a lot of upside in this asset.-
Commodities: For commodities and commodity linked stocks we expect institutional drives to uphold precious metals, with crude demand dependent on consumer patterns, and industrial metals dependent on overall economic expectations, only recessionary fears would cause a corrective slump in ZE view.
Crypto: This segment reminds volatile and carriers the most upside potential and downside risks. This makes it the riskiest asset in the ZE watchlist and portfolio. PAXG has seen marginal declines holding on to it's gold reflective movement.
Down 20.81%, the Bitcoin rally seems to have corrected from the $100k plus levels, and as such we are holding onto the asset.
Buying lows and shorting highs is a risky venture, but viable depending on ones risk tolerance and appetite. The ZE strategy is to buy at appropriate entry points and holding past the volatility cycles. A hedge with PAXG as ZE is helps minimize loses and ease the pressure on the crypto segment of the portfolio.
The optimal strategy for entry would be to dollar cost average into crypto monthly through Q1 ending 2026. Unrealized loses from price declines would be mitigated by more units accumulated, and price increases which reuces the units the one can purchase would be mitigated and somewhat offset by unrealized profits. Bitcoin is still 40% of ZE Crypto Asset Portfolio, so we would be following it keenly.
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