From the team at Freedom Asset Management
Guernsey was in good spirits last week, with a visit on Tuesday from King Charles and Queen Camilla. It is quite remarkable that Guernsey, the size of a small town in England (with only 62,000 inhabitants), receives its own visit from the King. He also visited Jersey a day earlier. It was a lovely sunny day for his trip to Guernsey – and it rained whilst he was in Jersey… say no more!
Pictured: Guernsey’s capital St Peter Port, with blue skies and decorated yachts to celebrate the royal visit.
For the last two weeks, like many people, I have been hitting “refresh” intra-day on my various news services so as not to miss the moment when Biden resigns. As I was sitting down for dinner last night it happened. We are going to have plenty of time to parse what this all means, so we will not talk about it this week.
Whilst we were waiting for Biden to resign, something dramatic has been happening to US Small Caps…. And I am grateful to Justin at Canaccord for his special piece for us below:
Small Caps: Rebound or rotation, 22/7/24
By Canaccord’s Justin Oliver – Adviser to the Opus Global Growth Fund
Equity markets in the US are standing close to all-time highs, having rallied by nearly a fifth this year. However, in the last week, there has been a significant shift in both the internal dynamics and the breadth of the US equity market. We have seen a sharp rotation out of ‘Magnificent Seven’ stocks and into smaller companies. So far this month, the S&P 600 Small Cap index is up over 8% for the month to date, against 1.3% for the S&P 500 and just 0.3% for the ‘Magnificent Seven’. But this has only brought US small vs large stocks back from being oversold into in-line with its trend decline. The question for investors is whether US small caps can break through this trend, or whether they resume their relative decline.
The trigger for the rotation was the benign June US CPI inflation report. The common rationale is that US smaller companies have been bearing the brunt of higher interest rates, since they are typically less able to fund themselves through fixed rate borrowing. They have therefore seen their effective interest rates rise faster than larger companies, and so are seeing profits squeezed by higher interest rates. If the Federal Reserve now has scope to cut rates through lower inflation (and react to any weakness in the labour market), then small caps could see their financing costs fall sharply. In addition, these companies have been most exposed to slowing demand from over-stretched and indebted customers.
But while investors are buying smaller companies there is a question about how much of a ‘recession discount’ remains to be priced out of the sector. While a chart of the discount of the S&P600 (small cap) vs S&P500 (large cap) forward PE is showing an extreme discount (large blue gap), much of this is because the S&P500 is trading at historically high valuations, rather than the S&P600 trading at low valuations. The current forward PE of small caps at 15x is only 2 notches below its 20-year average, and once bond yields are considered, the S&P600 is actually trading on a premium to its 20-year average.
What will help US small caps vs their larger peers is the broadening out of earnings growth. There are signs that this is happening with the S&P500 ex Magnificent Seven expected to grow earnings by 9.5% over the next 12 months, and the earnings growth gap is narrowing. How this broadening continues is dependent on the monetisation of AI. Investors should watch closely how companies such as OpenAI and Anthropic, that have built generative AI models such as GPT and Claude, are able to generate and grow revenues. So, in the upcoming results season, we will watch Microsoft’s Copilot (currently based on OpenAI’s GPT models) as a bellwether for mass adoption of the technology: can they sell it at $30 per month, per seat for coding assistance?
The conclusion is that the benign US CPI report has allowed the Federal Reserve to consider interest-rate cuts, and this has reduced the risk of a sharp economic slowdown. As a result, the most economically sensitive stocks have rallied sharply. A broadening out of earnings growth needs to take place to sustain this rotation out of large caps and into small, and that is far from a certainty.
Justin’s 2 minute weekly review can be found here:
https://freedomasset.com/two-minute-weekly-market-review/
It usually appears during Monday morning, but as soon as the latest one is available, we post it as this same location, every week.
Weekly funds performance
After a strong few weeks, it was time for a little reflection in markets and consequently our global private client/family office strategies were a little down on the week, bringing performance YTD numbers to:
- Our balanced, Opus Global Freedom fund c.+7.4% YTD in US dollars
- Our growth fund, Opus Global Growth fund c.+14.4% YTD in US dollars
(Source: Estimates Freedom Asset Management, Bloomberg as at 21/7/24)
Our private markets strategy is below:
- Astro Diversified Alternatives c. +1.0% to 1Q’24 in US dollars – please note 2Q’24 performance numbers due in September
(Source: Freedom Asset Management, as at 21/7/24)
Our institutional public markets strategies are below:
- CIM (Asian) Dividend Income Fund (Class I) c.+17.6% YTD in US dollars
- QIC GCC Equity Fund (Class B) c. +1.7% YTD in US dollars
(Source: FT Markets as at 21/7/24)
This week, I penned our article below. With Trump in the ascendency, and with his new pick for running mate JD Vance, who also is not a fan of “forever wars”, I think it is helpful to look at how Ukraine could play out under a Trump win.
Wishing you all a wonderful week ahead,
Adrian
Adrian Harris
CEO
Freedom Asset Management Limited
M: +44 7781 40 11 11 // M: +971 585 050 111
—————————————-
“Ukraine – where now?”, 22/7/24
By Adrian Harris
The Center for Strategic and International Studies (CSIS) published an article on 4/3/22 (about 10 days after the invasion of Ukraine) which looked at how wars end. They wrote that “the window to end violence and find an offramp from the escalating crisis in Ukraine will shrink after the first 30 days.” How right they were. They analyzed data compiled by the Uppsala Conflict Data Program (UCDP) looking at conflict terminations since 1946, to draw the following conclusions:
|
War ends (%) |
War lasts (average) |
Outcome |
|
< 1 month |
8 days |
44% end in a peace agreement or ceasefire |
|
< 1 year |
|
24% end in a ceasefire |
|
> 1 year |
Extends over a decade |
Sporadic clashes |
Looking at Russia’s campaigns since 1939, CSIS further analyzed that they have typically been much shorter:
|
Year |
War |
Duration |
|
1939 |
Winter war between Soviet Union and Finland |
3 months |
|
1956 |
Intervention in Hungary |
7 days |
|
1968 |
Prague Spring |
2 days |
|
2008 |
Russia-Georgia War |
13 days |
|
2014 |
Crimea |
Just over a month |
Source: CSIS.org, 4/3/22 “How does it end? What past wars tell us about how to save Ukraine.”
So we can understand that when Putin gave the order to invade Ukraine on 24th February 2022, he genuinely believed that this would be over in 3 days. It also points to the fact that in those early days when it was not working out well for Russia, Russia badly wanted a deal.
Given developments in the US Presidential elections in recent weeks, the increased likelihood of a Trump win, and his stated mission to favour peace negotiations straight away, it is helpful to look at how this might play out.
Let’s start by looking what was allegedly on the table in April 2022 (two months into the war).
The April 2022 “deal”
Russia and Ukraine’s early “deal” in April 2022 at the Istanbul peace negotiations, taken from the communiqué, centred on:
(1) Ukraine remaining permanently neutral and non nuclear,
(2) security guarantees from the UN Security Council (incl Russia), along with Canada, Germany, Israel, Italy, Poland and Turkey, and
(3) the 2 sides seeking to peacefully resolve their dispute over Crimea in the next 10-15 years.
Interestingly, the draft communiqué on the deal did not address borders and sovereignty, which was to be the subject of direct negotiations between Zelensky and Putin sometime later.
Source: BNE Intellinews, 17/4/2024 referencing the work of Samuel Charap and Sergey Radchenko in an article for ‘Foreign Policy”.
Whilst the deal was ultimately rejected in April 2022, it shows that a chastened Putin might have settled for considerably less than where we are now. Who rejected it and why will be the subject of deep historical analysis for many years to come – many blame Boris Johnson, and clearly NATO stood to benefit from a depleted Russian war machine.
Deaths and casualties in war
Whilst the exact numbers of deaths and wounded are impossible to verify, recent estimates from BBC News Russia, put the number of Russian troops killed at 139,000 and the wounded take that number closer to 500,000. The US estimates this later number to be 350,000.
On the Ukrainian side, the estimates are less clear, but the US was estimating 70,000 killed and 120,000 wounded as long as a year ago.
Adapting an uncomfortable Russian saying, “if you cannot win a war with men, win it with more men.” And that is the playbook – Russia can throw more men at this war than Ukraine. Ultimately, Ukraine will run out of men.
What happens in November?
Right now the war has entered a stalemate position. Zelensky said 2 weeks ago that the future of Ukraine depends on November (i.e. the outcome of the US presidential elections).
The talk about what Trump might do is coming from the America First Policy Institute and specifically a paper written by Lt. General (Retired) Keith Kellog and Fred Fleitz and first published on 11th April 2024. Politics aside, it is well worth reading in full:
https://americafirstpolicy.com/issues/america-first-russia-ukraine
Some of the noteworthy elements of the paper are:
- The majority of American people are opposed to sending more military aid to Ukraine
- The war is depleting stocks of weapons in the US/Europe at a rate that cannot be replenished any time soon
- A prolonged war risks deepening the alliance between Russia, China, Iran and North Korea, which cannot be good for global security
- Henry Kissinger stated in his spring 2023 interview with the Economist that it was essential to end the war as soon as possible – and that a peace agreement would involve territorial concessions by both sides
- Putin indicated in late 2023 that he was open to a ceasefire “on the basis of current battle lines”
- Trump proposed in February 2024 that any military aid to Ukraine should come with accountability, i.e. an interest free loan to be repaid after the war is over, which seems to have garnered bipartisan support
The proposal for the change in stance looks like this:
- A formal US policy to seek a ceasefire and negotiated settlement in Ukraine
- The US continues to arm Ukraine to ensure there are no further military advances from Russia
- Future US military aid will require Ukraine to participate in peace talks with Russia
- The US offers to put off NATO membership for Ukraine for an extended period
- Limited sanctions relief would be offered to encourage Russia to come to the table, and
- Full sanctions relief offered when a peace deal is reached that the Ukrainians are willing to sign.
The Kellog/Fleitz article does not come up with all the solutions – like who is going to pay for reconstruction, they suggest a tax on Russian gas exports – but it does give us a sense of what Trump is looking at, and therefore how this might play out.
To anyone who says, but maybe the Europeans will step up where the US is signalling it may soften its support, all you need to do is to look at Afghanistan. Once the US signalled they were leaving, it was all over in 30 days. Putin knows, as do the leaders of the Middle East, that in matters of expensive, long, overseas conflicts, the US is an unreliable ally.
Of course, to many, this makes uncomfortable reading, because it seems to acknowledge that “aggression pays”. But to think only that way would also fail to acknowledge that Ukraine’s hurried rebirth amidst the rapid break-up of the Soviet Union was always going to leave behind some unfinished business.
In future weeks we will explore at what a Kamala Harris Presidency could look like for Ukraine.
Whichever way you look at the outcome, it is likely to be profitable for the defence industry and that is why we have made a small allocation in the Opus Global Freedom Fund to the VanEck Defence ETF.
Adrian Harris