“People’s minds are changed through observation and not through argument.” – Will Rogers
“If you make listening and observation your occupation you will gain much more than you can by talk.” – Robert Baden-Powell
“The important thing is not to stop questioning. Curiosity has its own reason for existing.” – Albert Einstein
Autumn months are more volatile; 2017 was an aberration
October is, on average, the most volatile month of the year for US equity markets. From 1993, the year the VIX index was launched, through 2017, the average level for the VIX for the month of October has been 21.8 per cent.
In October 2017, the VIX averaged 10.8 per cent, which at the time was the lowest monthly average for any month on record since the VIX index was launched. The complacency witnessed in capital markets last year was an aberration and should not be the yardstick by which investors manage their portfolios.
US mid-term elections: History is on the side of equity markets
Regardless of how midterm elections turn out, equity investors tend to be the big winner. At least that is what history suggests.
The S&P 500 index has climbed in the twelve months following each of the midterm elections going back to 1946, with an average return of 16.7 per cent. That is eighteen elections irrespective of who won and what changes were wrought on the balance of power.
Do not let the typical level of volatility witnessed in months starting with the letter ‘O’ put you on the wrong side of history. Stay long US stocks.
Treasuries: “The dog that didn’t bark”
If stocks go down, treasuries go up. Rinse and repeat. This is the axiom on which strategic asset allocations of institutional investors and quantitative investment strategies, such as ‘all-weather’ and ‘risk parity’, have been built.
Yet this past month we have seen treasuries fail to bounce even though global equity markets have sold off. This failure is even more surprising given that speculative short futures positions across the US Treasury bond curve are at or near record highs. The inability of bonds to rally in the face of an equity market sell-off gives credence to the argument that the short bond positions are not speculative but rather hedges to long positions held by institutional investors and / or hedge funds.
Gold: Risk-off rally?
Unlike treasuries, the recent sell-off in stocks has coincided with a strengthening of the price of gold. This is all the more surprising when we consider that the US dollar has not weakened but rather strengthened as well.
Is gold the new hedge to stock market volatility? We are not sure. The recent rally might just be a case of unwinding of oversold conditions or of speculative investors closing their short gold positions in response to redemptions or margin calls caused by their declining long positions.
Alternatively, we wonder if a new bull market in precious metals is getting underway. It is, we feel, too early to tell and with gold miners remaining weak despite the gold price holding strengthening, it should give anyone bullish on the prospects of precious metals some pause.
For example, Newmont Mining, one of the few ‘blue chip’ gold mining companies, reported solid third quarter earnings yesterday that handily surpassed consensus estimates but still saw its stock price decline by almost 7 per cent. (Admittedly, at the time of writing some of yesterday’s weakness has been reversed today.)
SoftBank’s Vision Fund and the race for venture capital exits
Over the last twelve months there has been little to no incentive for venture capital backed companies to go public. They have had a much better alternative that does not come with the scrutiny faced by a publicly listed company: sell to SoftBank’s Vision Fund.
The Vision Fund, the largest ever venture capital fund raised anchored by capital commitment of US dollars 45 billion from Saudi Arabia, has been deploying capital at record pace with, what appears to us at least, limited consideration for valuation and due diligence.
Take for instance Benchmark Capital’s partial exit in Uber. The venture capital fund was able to monetise one of its most successful investments without a trade sale or public listing. Benchmark sold 14.5 per cent of its holding in Uber for around US dollars 900 million to the Vision Fund. Considering that Benchmark originally invested US dollars 12 million in Uber, the partial exit is quite the coup and something, we feel, that would not have been possible without a public listing were it not for the Vision Fund
Given the recent events surrounding Saudi Arabia and deceased Washington Post columnist Jamal Khashoggi, there is likely to be little appetite in Silicon Valley to accept Saudi Arabian money henceforth. For example, Ari Emanuel’s media and entertainment group Endeavor is considering terminating a US dollars 400 million investment into the company by Saudi Arabia’s Public Investment Fund.
SoftBank’s Vision Fund is synonymous with Saudi Arabian money.
Masayoshi Son, SoftBank’s founder, was as recently as August talking up the prospects for a second Vision Fund with Saudi Arabia once again the cornerstone investor. Talks of the second fund have died down given recent events.
Given recent developments and Silicon Valley likely to shy away from engaging the Vision Fund any further, we suspect many venture capital backed “unicorns” are actively soliciting proposals from investment banks to help them go public.
We expect a flurry of tech-led IPO activity in the first half of 2019.
Brazilian election: Fears of a Latin Rodrigo Duterte
Brazil held the first round of general elections on 7 October, 2018 to elect the President, Vice President and the National Congress.
Rio de Janeiro congressman Jair Bolsonaro came first in the first round of the election. The run-off will be between him and former São Paulo mayor Fernando Haddad.
Fernando Haddad represents the Workers’ Party – the leftist party that has won the last four elections held in Brazil.
Former army captain and seven-time congressman Jair Bolsonaro is the right-wing candidate representing the Social Liberal Party. Barring a late twist, Mr Bolsonaro is expected to be elected as Brazil’s next president on Sunday. Mr Bolsonaro has ridden a wave of populism and angst against the incumbent party to put himself in pole position.
Since Mr Bolsonaro’s victory in the first round of the elections, Brazilian assets have rallied even as other emerging markets struggled. Market participants do not want the Worker’s Party back in power – fearing that the leftists will undo the reforms that have stabilised the Brazilian economy in the aftermath of the 2014-16 recession. Moreover, there is hope that Mr Bolsonaro will continue on the path of reforming the Brazilian economy.
Mr Bolsonaro’s proposed economic team, should he come into power as expected, will be made up of technocrats under the leadership of University of Chicago-trained financier Paulo Guedes. Mr Guedes is an advocate of deep public spending cuts and deficit reduction with the seemingly incongruent goals of reigniting consumer and business confidence. He has advised Mr Bolsonaro to push ahead with painful reforms, should he be elected, from the very beginning of his term. In particular, Mr Guedes is pushing for social security and pension reform that would trim benefits and raise the state retirement age to 65 for men, and 62 for women to be at the top of Mr Bolsonaro’s agenda.
While right-wing candidate’s economic agenda appears to be encouraging, his social agenda is eerily reminiscent of the type of opinions expressed by Philippine President Rodrigo Duterte. Mr Bolsonaro, to quote the Financial Times, “is known as an apologist for the 1964-85 military dictatorship, for endorsing torture and for making disparaging remarks about homosexuals, women and black people.”
We are concerned that Mr Bolsonaro will try to prolong the wave of populism as much as possible by prioritising his social agenda over economic reforms. In particular, we would be surprised, if he makes the unpopular social security pension reforms his key priority early in his presidential term. In fact, during his campaign, Mr Bolsonaro went as far as criticising current president Michel Temer’s planned social security system reforms as well as the tax changes proposed by Mr Guedes.
Brazilian assets may continue to rally should the country elect Jair Bolsonaro as its 38th president on Sunday. We, however, prefer to tread carefully until there is more clarity on Mr Bolsonaro’s priorities once he is in office.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.