Portfolio Update – October 2022

October wasn’t such a great month, as we started a violent bear market rally that caught me completely off-guard. I was expecting one to come, but I didn’t expect the indices to get so high so quickly. My monthly performance reflected this, as after the losses started to built up and I understood it wasn’t just a small correction to the upside, I’ve closed all the positions in a matter of some minutes.

Performance and positions

My monthly performance for the month of October is -7.53%, underperforming all the indices and putting my portfolio in severe drawdown. Being fully exposed and leveraged against the euro contributed to the underperformance, as the renewed stability of the United Kingdom made the currency stronger by sympathy. As I’ve anticipated, I’ve closed almost all the positions, and the ones still open are:

  • Tortilla Mexican Grills Plc: 5.50% NAV
  • Teucrium Wheat Fund – Apr23 15/7 debit bull spread: 1.16% NAV
  • SPDR Blackstone Senior Loan ETF – Feb23 36P: 0.70% NAV
  • Société Générale SA – Mar23 20P: 0.57% NAV
  • Credit Agricole SA – Mar23 8P: 0.47% NAV

The rest is in cash, mostly in dollars with some negligible percentages in euro and sterlin.

Trades

Usually I did post in this section all the trades with the Twitter link for each one of them, but I saw it wasn’t very much of an interest for my readers. Hence, from now on I won’t report every single trade here, but just the ideas behind the ones taken and the ones that I’m considering.

Starting with Tortilla, I was following this illiquid UK microcap since early June 2022: it caught my interest because of the incredible use of resources, profitability, and marketing strategy. However, after a valuation based on its closest peers, it resulted the price at which it was trading was way too high. I set my limit order to buy at my price and almost forgot about it. Earlier this month, however, Tortilla reported their quarterly results showing that inflation was indeed affecting their operations and margins: shares fell by over 30% that day, and my order got filled. If I have the time, I might write a full qualitative analysis of the company on the website, because I find it very interesting, but my remark on their earnings can be summarized this way: inflation in the UK is very high, Tortilla has input costs that can’t control, and they want to increase sales volumes by not raising their prices. Since they have high margins, they can afford it. From the perspective of a shareholder, it may be a bad decision, but business-wise, it’s clever.

The position on SPDR Blackstone Senior Loan ETF (”SRLN”) is a bet against the market of CLOs, which didn’t suffer a big decline yet, which is particularly strange considering how the financial conditions have degraded overall. Year-to-date, the index is down just 10%. These option contracts are highly illiquid, but may they decrease in value, I’ll increase the position until reaching a maximum of 5% NAV.

As the quarters go by and the financial conditions continue to degrade, I expect the private market firms to markdown their holdings substantially. Some of them are already doing it, although in a very “creative” way to say the least: for example, this quarter Blackstone announced its private (”illiquid”) credit funds are outperforming the liquid counterparts by 10%+, which I find very hard to believe. When the volatility will become cheap again, I guarantee that I’ll open contracts against these names as part of the portfolio.

Views on the economy

I’m almost tired to write it, as it’s becoming the theme of this year, but this month many important things happened.

Starting as always with the United States, contrary to common beliefs at the time, October’s CPI came in way higher than expected: one could see it coming, though, looking at the Cleveland Fed’s estimates. The market rapidly sold off, hitting new lows, and then, in a matter of minutes, it quickly recovered ending the day in the green. I’ve spent a lot of time trying to understand what happened that day, and I’ve come to the conclusion that many people were hedged to the downside and, as puts quickly got in-the-money they got capitalized, which drove prices up as market markers were in negative-gamma territory. I’m still not completely sure about what happened that day, this is just my best-explanation theory.

However, the point is that inflation is still high and accelerating. Cleveland Fed sees October CPI at +0.78% MoM and Core at +0.54% MoM (as of October the 28th): these numbers would be even higher than September’s, which is worrying. Interest rate hikes have delayed effects on the economy, so basically as of now we are experiencing the effects of just the first hikes. Still, the fact inflation continues to accelerate puts the Fed in the position to tighten even more, and I wouldn’t be surprised if they announced this week to increase the rate of QT.

Another important economic data from the United States this month was the quarterly GDP growth, which was positive at +2.6% QoQ. The number is not surprising, as it was driven mainly from higher exports and increased government spending. However, since many traders/investors don’t actually know the equation to compute GDP, the sentiment turned even more positive as the “recession was cancelled”. Little do they know about what’s coming this Winter.

The day the CPI came out, as I anticipated earlier, the market rebounded and started what’s now clearly another bear market rally. The day before the Fed’s blackout the market was losing momentum, but conveniently enough the WSJ leaked an article stating that the Fed may be actually thinking about slowing down the pace of rate increase: of course, the momentum was quickly regained. Once again, although the rally started for technical reasons, the narrative around it rapidly became “Fed pivot”, which is ironic considering the fact unemployment is still extremely low and inflation keeps accelerating. Also, now the definition of the word “pivot” itself changed: whereas once it meant change in monetary policy environment (expansive vs. restrictive), now it’s interpreted as “slowing down”.

It’s important to keep in mind, though, that although there is no fundamental reason backing this rally, it’s just a feature of bear markets, and being caught on the other side of the trade might have painful consequences: I know from experience. Always look at what credit markets are saying, they point to the right direction. Also, since this year is characterized by relatively low volumes in the equity market, most of the moves are option-driven, and understanding volatility might help a lot for positioning.

Moving to the European Union, unsurprisingly it continues to be a mess. October’s harmonized CPI (”HICP”) was +9.9% YoY: the country with the lowest inflation rate was France at +6.2% YoY, while Estonia had the highest at +24.1% YoY. The response to inflation continues to be highly contradictory: on one hand, we have the ECB hiking key interest rates; on the other, we have governments increasingly spending in stimuli and caps to lower the effects of inflation. Of course, fixing excessive money in circulation adding even more money in circulation is not a good idea, but what do I know?

On its latest meeting, the ECB hiked by 75bps all the three key interest rates, which is finally a good move from their part, but said no words regarding QT. It’s somewhat understandable, though, as the ECB is stuck between a rock and a hard place: if it hikes too much and/or too fast, it creates systemic risk by starting yet another sovereign debt crisis; if it doesn’t, inflation continues to run rampant and we get to experience what living under the Weimar Republic felt like. Let’s not forget that under period of high economic uncertainty, declining living conditions and increasing poverty, the worst happens: be prepared.

Also, the ECB talked about TLTRO, which this article explains way better than I’d be able to.

Moving to Italy, Meloni became officially the prime minister of our country. As I anticipated last month, the first thing that she said is that she’s pro-EU, pro-NATO and pro-sanctions, which wasn’t so well received by her electorate: there was no reason to worry about some drastic changes of the status-quo. Those that really want to change something in the country, don’t have the number to do that, and to reach those numbers, they have to become part of the status-quo themselves: no matter who you vote, nothing changes. If you voting made any difference, you wouldn’t be allowed to do it. Aside from these considerations, it’s still too early to judge her administration, and I’ll be happy to do that when the time will come.

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