The Long/Short Lens - Newsletter Ep.2
In this edition, we dive deep into several crucial market developments that are shaping the global financial landscape as we approach the end of 2024.
We will cover the highly anticipated Federal Reserve meeting next week, where markets are closely watching for potential rate cuts and their impact on US Treasury yields.
We'll also examine the ongoing challenges in the Chinese economy and their ripple effects on global markets, alongside oil market.
Finally, we'll analyze shifting consumer behavior patterns and what they tell us about the broader economic outlook.
Federal Reserve's December Rate Decision
Next week we're going to have an FOMC Meeting with a rate cut decision. Market participants are pricing in one cut on December 18, 2024, before the new year begins. The probability of a rate cut stands at 95.7%. Given the current labor market conditions and potential inflation risks from tariffs and geopolitical tensions, we don't see an urgent need for additional cuts next year. Nevertheless, the market anticipates another rate cut in March 2025. This perception could shift once new labor data becomes available.
Over the past week, we've seen clear bear steepening of the yield curve, with long-term rates rising more rapidly than short-term rates.
Additionally, the important 3-month/10-year spread has disinverted for the first time since November 2022. This disinversion of the three-month versus 10-year curve makes it more attractive for carry traders to buy longer-term debt, reducing the risk of an abrupt withdrawal of leverage from the system and allowing deeply negative swap spreads to rise.
Bonds are typically funded at short-term rates around three months. With 10-year yields now exceeding three-month rates, carry traders have more incentive to purchase longer-term Treasuries.
This applies to both domestic and foreign traders, who hedge FX costs based on short-term US rates. Japanese investors' hedged yen-dollar costs track the US 10-year versus three-month spread, while the 10-year versus SOFR spread remains inverted.
U.S. Small Business Confidence Surges to 3-Year High
US small-business optimism hit a three-year high in November as the NFIB index jumped 8 points to 101.7, while uncertainty dropped 12 points following the presidential election.
NFIB chief economist Bill Dunkelberg noted businesses are optimistic about potential tax and regulation policies that could support economic growth and ease inflation.
Nine of 10 index components improved, with business conditions outlook seeing a record 41-point gain. 14% of respondents view it as a good time to expand, while expected sales reached pandemic-era highs.
Key challenges remain: inflation, labor quality, and hiring qualified workers. 28% plan price increases, while 18% expect to create new jobs. The survey included 532 respondents through Nov. 29.
China's Economic Challenges
European markets opened (Stoxx 600) lower following disappointing news from China's Central Economic Work Conference. The CSI 300 index fell over 2% on Thursday, leading regional declines. China is facing its fifth consecutive quarter of deflationary pressures.
To illustrate the severity of the situation, China's high-yield real estate sector has experienced an unprecedented decline of 82% over the past two and a half years leading into 2024 with the real estate market experiencing a substantial contraction coinciding with deflationary pressures.
China risks falling into a prolonged deflationary stagnation, drawing comparisons to Japan’s economic struggles in the 1990s.
While China’s middle-income status and growth potential set it apart, the challenges are formidable - ranging from high debt levels to a real estate slump and structural demographic shifts. Policymakers must move beyond traditional investment-led growth strategies to address these deep-rooted issues.
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The opportunity for upside remains significant if Beijing can deliver bold and targeted reforms. However, the costs of inaction are equally stark, potentially relegating the world’s second-largest economy to a prolonged period of subdued growth.
The US stands to neutralize any efforts by OPEC+.
The primary mechanism is through supply dynamics. Current U.S. oil production has reached unprecedented levels and is projected to maintain this upward trajectory. This growth is primarily attributed to enhanced well efficiency metrics. When considering both crude and gasoline inventories, U.S. supply is projected to contribute approximately three million additional barrels of crude to global markets in 2025, as illustrated in the subsequent chart.
Furthermore, potential policy implications merit consideration. Independent of tax policy adjustments, current economic proposals could exert downward pressure on oil prices, primarily due to their potential impact on crude demand growth dynamics.
It is noteworthy that the U.S. supply enhancement capabilities referenced in this analysis are substantially supported by existing crude oil and gasoline reserves, which maintain robust levels. These inventory levels have consistently exceeded 300 million barrels since late 2008, demonstrating sustained growth following the technological advancements in shale extraction during the mid-2010s.
In the absence of sustained supply disruptions due to geopolitical conflicts, multiple macroeconomic factors are positioned to counterbalance any price appreciation strategies implemented by OPEC+. A primary consideration is the declining oil demand in China, which is anticipated to be the predominant factor contributing to the projected 1m bbl/day supply surplus in the coming year.
Consumer Behavior Trends
Recent consumer behavior trends indicate a significant shift towards value-driven purchasing, particularly in the beauty and fashion sectors. Market data suggests that companies effectively leveraging social media platforms, especially TikTok, are seeing substantial growth in both engagement and sales.
Elf Cosmetics (ELF), with 10% short interest and 70% margins, emerges as a potential short squeeze candidate this holiday season, driven by its viral $8 lip oil glimmer product garnering 8 million TikTok views.
Ralph Lauren (RL) exhibits strong holiday momentum with a 50% year-over-year sales increase in November based on online checkout data—its largest in 5 years—despite a 20% decline in overall web traffic.
Vans (VFC) and Nike (NKE) show concerning trends, with Vans seeing a 30-35% year-over-year drop in November web traffic and Nike declining 27%, suggesting weakness in North American sales.
Birkenstock (BIRK) shows impressive momentum with a 50% year-over-year increase in both web traffic and checkout data, indicating strong holiday performance.
Lululemon's (LULU) international growth compensates for weak U.S. web traffic, as confirmed by their latest earnings report.
What’s next?
During the upcoming week we will track the following economic releases that we consider may have an impact on our Long/Short portfolio
United States:
Rest of the World:
Conclusion
As we wrap up this week, the global financial landscape presents a complex mix of opportunities. The Federal Reserve's anticipated rate decision could mark a significant shift in monetary policy, while China's economic struggles continue to influence global markets. The U.S. oil production is effectively counterbalancing OPEC+ efforts, reshaping energy market dynamics.
The upcoming week is quite heavy on the economic releases and will shaping market sentiment and investment strategies as we approach the end of 2024.