Fighting in the gaps

This week, my muse is B.H. Liddell Hart, distilling the essence of Sherman’s military acumen into a single mantra: engage where least expected and leverage the path of minimal resistance. The takeaway? Take the indirect route —  fight in the gaps. So, where are the gaps or opportunities to exploit alpha lie? It’s not, by definition, in beta, in crowded areas. Not to question the wisdom of those crowds, of course. They may still be right. Indeed, those rare few to express the scarcities of the AI value chain (data, network, compute) or their suppliers (semi-equipment) remain below price and concentration levels achieved historically (ref Nifty 50 and Transport relative valuation/concentration). However the S&P is already near the consensus FY target (vs the Nikkei, Eurostox and FTSE yet make new highs), the Fed’s own are suggesting the period of US exceptionalism could be waning, CRE is facing the effects of long and variable lags (see NYCB and Azora Bank) and February tends to be a weaker month for US stocks. So, it would surprise no one if we consolidate for a time, until we get further clarity on Fed rate cuts, QT and possible rate cuts in China. And so today’s note is an exercise in discovery, of running towards the flame, and of looking at areas the market loves to hate (China, Steel, UK). We will also explore a few early price signals – suggesting a zig when the market expects a zag.

One such signal is the resurgence in Chrome. Not the Google one, but the colour.

Chrome: a reflection of the times

Trends in design often mirror the collective psyche, signalling shifts in economic, technological, and societal currents. The resurgence of chrome — a detail I admittedly missed until it caught the Economist’s eye — speaks volumes. From Beyoncé’s Lanvin and Boss-clad dancers to Chrome Hearts’ Hollywood allure, and Pinterest’s nod towards “cool silver tones,” the gleam of chrome is undeniably back. "After years in the doldrums, brightly reflective chrome finishes are back!”

But why chrome, and why now?

Fashion, like markets, moves in cycles. Chrome’s prominence during the 1920 Art Deco era and the 1950s symbolized periods of optimism, conspicuous consumption and expansion — the Empire State and Chrysler buildings stand as chrome-crowned testaments. Today, amidst global conflicts and a rallying cry for home grown infrastructure, could chrome’s shine suggest a collective yearning for renewal, a beacon of hope amidst uncertainty? And a good old fashion housing boom? Well, in the UK the Labour party are promising the biggest boost to affordable housing in a generation and ‘new towns’, harking back to those chrome-plated times of the ‘50’s where new suburbs like Hemel Hempstead emerged. We also have the world’s largest construction project (climate change) underway, a chronic shortage of houses in almost every western democracy and the likely US President is, well, a property guy. So, with global construction projects and housing shortages calling for urgent action, the construction supply chain, long neglected, may soon find its moment to shine.

Mad Max

Or maybe I’m over-reaching (it wouldn’t be the first time). Maybe the signal here is not hope and optimism but more the punkish retro-futurist chrome aesthetics of the post-apocalyptic and dystopian ‘Mad Max’ film series, which interestingly has an adaptation due for release this year. In Mad Max the most precious resources are basic necessities and survival skills – principal amongst these, spot welding! And the scarcity, and therefore value, lies in fuel, water, ammo, food, medical supplies and car parts. So, your risk hedge to the above is adding more systemically-important companies active across sectors like pharma, defence, public utilities and manufacturing – and collecting a few Ford XB Falcons. Quite a car.

If you want to get rich? Learn to spot weld and move to Australia

Now of course, the ultimate survivor in a Mad Max world is the girl who knows how to spot-weld. While Ford Falcons were great cars, they were prone to rust. So knowing how to spot-weld is critical. And before that, you could name your price either working for a miner, or a military. “The biggest risk facing the nuclear-powered Aukus submarine build is whether enough skilled welders can be recruited and trained”. Australia is short of welders, a reality that’s not only impacting submarines, but ammunition. According to the FT, such is the scarcity of skills, it will take two years to make enough ammunition so Ukrainian soldiers are as well-supplied as the Russians. Nvidia can do a lot of things, but it can’t fill that gap. Those companies that can keep and retain critical skills in areas that face a generational cliff (welding, building, mining) still, I believe, represent the greatest value transfer opportunity in markets.

Building on build-to-rent’s momentum

Savills Research caught my eye this week. It highlights the surging investment in the build-to-rent sector, marking last year as a record-breaker, particularly in single-family housing. This boom comes as private landlords exit and the demand for rental homes soars, driven by changing perceptions of homeownership and demographic shifts (ref: Foxtons recently raised its guidance and its stock price is up nearly 75% in the past year). Institutional investors have a prime opportunity to consolidate this fragmented market, leveraging scale to create resilient, inflation-linked revenue streams. This sector’s growth, likely buoyed by government support, outshines traditional investments like long bonds, offering a tangible pathway to meet the growing housing demand. A luxury one can’t avoid.

The market we love to hate

It’s important, I think, to keep an eye on Chinese price action, especially in property related sectors (SHProp/HSP). Property is important because it impacts system collateral, confidence and therefore consumption. So, any signs of improvement which equities may discount early, will be worth paying attention to. Curiously property stocks failed to make new lows this week, despite the news of Evergrande’s demise. Could this be a tell? Only time will tell but another sign to watch for is for real interest rate cuts. While RRR cuts help at the margin, policy is still restrictive. Prime rates are well above 3% with core inflation closer to zero, meaning real rates are +3%. Interestingly, the governor of the PBOC said recently that Fed cuts would provide them space to cut their own rates. So at some point we could have both the US and China loosening monetary policy, an outcome the market will no doubt call ‘Reflation’. And one gap you might like to fill before they do. Narratives always follow price.

Long and variable legs

The significant downturns in US and Japanese bank stocks with substantial commercial real estate exposure underscore the market’s vulnerability to interest rate hikes. At the time of writing both New York Community Bancorp and Japan’s Azora Bank are down -45% and -33% respectively, the latter from an all-time high, suggesting a degree of complacency/shock. As we’ve discussed prior, the one concern with using the ‘Goldilocks’ metaphor for the global economy is how that story ends – with her running for her life. We don’t hear much for long and variable lags anymore, and I worry there are parts of the economy yet to experience the full contact of the enemy (i.e. higher rates). And so, we will need to ensure either this is contained and/or that the system has sufficient provision to absorb this shock, but clearly the move in traditional safe assets like gold and 10Ys suggests a less rosy picture than, say, the message from Meta.

More on this next week.