February Newsletter

A new feature of Slice is to publish articles - so posting my newsletter here. The US dollar line of Brumby Capital returned 7.5% this month. This compares to 0.6% return for MSCI World. The fund is now up 16% for the year. In a continuation of last month, Japanese banks continued to do well, as did gold and other stock picks in the long book - name Harbin Electric which was up another 40% as well as wafer stocks and Iseki. The long book made 6% of the total return. The short book benefited from generalised weakness in private equity and private credit shorts, which was offset by a rally in US treasuries and most other non-private equity shorts. The short book made the rest of the return for the fund. As I am writing about this in the second week of March, I feel it would be remiss not to talk about March performance, and how the fund has reacted to war in Iran. The shock of rising energy prices has been felt much more in Japan, Korea and Europe than it has in the US and China. In some ways this makes sense as China and the US have far more robust energy systems, with the US an exporter of energy, and China having developed both a large renewable energy system, a large coal fired energy system and a large fuel storage system. In practical terms, the oil shock has meant that many of the trades that worked last year and in January and February this year, reversed on themselves. The most surprising move would be gold, which normally does well when war breaks out, is actually down in March so far. As of writing, we have given back around half of February gains. As I have written elsewhere, it is extremely difficult to judge how long the war will continue. From a military perspective, Iranian offensive capacity has been severely reduced, and as we have seen in Ukraine, it is possible to open transportation corridors even under extreme pressure. That is the war could continue and the Strait of Hormuz could be opened potentially. While it was possible to see China willing to support Russia in Ukraine, would this also be true with Iran, especially as it is the biggest importer of energy these days? There also seems to be little sympathy for Iran among neighbours. So there is a chance that it resolves itself quickly. But what if it doesn’t what does that mean? Well the fund has been built around a rising cost of capital, and has done very well since launch. I do not see how war in Iran challenges that assumption. What it does do is shine a spotlight on Japanese and European energy policies. The brutal fact is that the US can act militarily in the Middle East now because it is secure in its own energy supply. Japan needs to buy coal and LNG of which Australia is its largest supplier. Its problem is not that Japan was reliant on the Middle East, but that is exposed to price surges when a supply shock hits - the same issue that Europe faces now that its has lost access to Russian gas pipeline flows. This is not new news. Europe, Japan and Korea have been switching nuclear power plants back on as quickly as they can, while adding renewable power also as quickly as they can. Also structurally, LNG market is becoming more stable, as both Australia and the US become large exporters, which is diversifying supply both geographically and politically. For me, what both Russia in 2022 and Iran today has shown is that the potency of energy as a political weapon is much reduced. There are just too many alternatives now. This is not to say that energy prices will fall tomorrow, but the longer they stay high, due to problems in Iran, the more market share the Middle East will lose. However you cut it, Iran is a loser here one way or another. If oil and energy was how superpowers use to fight with each other, it is now obviously tech that is where the battle is. Both China and the US are racing to develop AI and secure their supply chains. The US controls supply of high end GPUs and China controls the supply of rare earths. And for me, as this is a strategic issue, its hard to see how either side backs off from investing heavily, and probably way beyond current needs. When I think about the possibility of deflation, it seems unlikely to me. Every government would take any slack in labour or capital markets as an opportunity to invest and build more. I see it everyday with the proliferation of government jobs, from working in the police force, the army or manufacturing. Governments have been stashing capital for a rainy day for decades now, which has pushed down the cost of capital. But now those rainy day funds are being tapped to build out armies, data centres and tech stacks. Boom times, but with a rising cost of capital. Japan still seems the best place to benefit, mainly as it has so much surplus capital and labour (in so far wages are low). A global investment boom, which I what I am seeing, implies activity remains good, but offset with more expensive capital. This is doubly bad for private equity as their existing investments suffer from rising cost of capital, and the pool of capital upon which they have drawn shrinks. I suspect many people will say I am too sanguine on the risks of higher energy prices for longer. Perhaps that is true - but the relatively small moves in US and Chinese equity markets seems to imply the two biggest nations in the world are doing fine - and if they are doing fine, then can we really be heading to a hard landing? One big benefit of weakness in March is that it has probably cleaned out positions in equities and currencies. While I tend to think long and hard about how I want to invest, the vast majority of funds tend to be variations of momentum strategies - “I own it because it is going up”. If my analysis is correct, then with positioning cleaned up, and no change to the theme of rising capital costs and competition via AI and tech, the fund should continue to do well. In March, I have made some changes to the fund mainly in the short book - but will talk about that in the next newsletter. I may end up adding to the long book - but I am still thinking about it. One benefit for me is that I can see that the fund is about as volatile as I would like. It is impossible to make money without taking risk - and given the strong performance, I wondered if I should have leveraged up the long and short book. Now we have had a sell off, I can see the true volatility of the the fund which has been within the range I feel comfortable with.