Welcome to Bespoke Brunch Reads — a linkfest of the favorite things we read over the past week. The links are mostly market-related, but there are some other interesting subjects covered as well. We hope you enjoy the food for thought as a supplement to the research we provide you during the week.

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On This Day in History:

ETFs in 2023: A Tale of Success and Failure (Morningstar)
The ETF market experienced substantial growth in 2023, with significant inflows and more than 500 new launches. As a result of strong competition, though, there were almost 250 closures. Many of these were linked to factors like low assets, high fees, and poor performance. Commodities-focused ETFs had the highest number of closures, along with closures in leveraged equity ETFs and active ETFs. [Link]

Hedge Funds’ Popularity Flags Among Allocators, per Consulting Firm (Chief Investment Officer)
Hedge funds are losing their popularity according to Agecroft Partners. Despite growth in hedge fund assets, investment inflows are slowing, with smaller and midsize funds outperforming larger ones. For some time, hedge fund returns have been in the single digits along with higher fees. The overall hedge fund industry is predicted to experience consolidation, with stronger managers attracting more investments and underperforming ones facing potential closure. [Link]

AI & Technology

This iPhone fell out of Alaska Airlines Flight 1282 (The Verge)
At this point, most of us have seen the video of the Alaska Airlines Flight that lost part of its fuselage shortly after takeoff. If you haven’t, this link has a clip of it embedded in the article! The incident, involving a Boeing 737 Max 9, led to an emergency landing at Portland International Airport. The National Transportation Safety Board confirmed two phones from the flight were found on the ground, including one that survived the fall to Earth! Pretty crazy to think about when some of us have dropped and cracked phones from just a few feet. [Link]

New material found by AI could reduce lithium use in batteries (BBC)
Microsoft and the Pacific Northwest National Laboratory, with the help of AI, discovered a new material that could reduce lithium usage in batteries by up to 70%. AI screened through tens of millions of materials in less than a week to identify candidates for the job. Once AI could identify qualifying materials, it took less than nine months to develop a battery prototype. The material called N2116 has the potential to be a sustainable energy storage solution because it’s safer than lithium. The quick AI finding is also beneficial because of the lithium shortage that could occur in just a year. [Link]

California wants to reduce traffic. The Newsom administration thinks AI can help (Los Angeles Times)
The California Department of Transportation is exploring the use of AI to reduce traffic, not just for the cars jammed up in LA and other dense cities, but also for pedestrians and cyclists. AI would be employed to analyze data from traffic sensors and cameras. The technology would be able to identify narrow roads, frequent site crashes, dimly lit areas, and other factors that clog up traffic and lead to more accidents and then present solutions to those problems. [Link]

Our fingerprints may not be unique, claims AI (BBC)
Columbia University is challenging the belief that every fingerprint is unique with the help of AI to analyze 60,000 prints. With 75-90% accuracy, AI could identify whether different fingerprints belonged to the same individual. There are some issues with the research though, as the methods used by AI aren’t fully understood due to untraditional analysis. If this research continues to develop, AI could have implications in biometrics and forensics. [Link]

How AI Replaced the Metaverse as Zuckerberg’s Top Priority (Bloomberg)
Since starting Facebook at Harvard in the early 2000s, the CEO of Meta Platforms, Mark Zuckerberg, has seen a fair share of technological changes. Perhaps the development of AI is the biggest evolution yet, and Meta’s AI research group is now focusing more on developing consumer-facing AI products. The company’s strategy includes leveraging AI to enhance user engagement on its platforms. After the launch of ChatGPT, which has quickly accelerated public interest in AI, Zuckerberg has shifted focus from the Metaverse to AI-driven initiatives. [Link]

Environment & Energy

America’s Carbon Emissions Fell for the First Time Since Covid (Heatmap News)
In 2023, the United States saw a 1.9% decrease in greenhouse gas emissions even as the economy grew. That marks the first time this decade that economic growth and emission reduction occurred simultaneously. The decline in emissions was driven mainly by the power sector, with notable reductions in coal usage and increases in solar and nuclear power. However, transportation and industrial sectors still present challenges, with rising emissions in air travel and heavy industries. [Link]

A huge battery has replaced Hawaii’s last coal plant (Canary Media)
In 2022, Hawaii shut down its last coal plant and replaced it with the Kapolei Energy Storage system, featuring 158 Tesla Megapacks. The project boasts 185 megawatts of discharge capacity, providing crucial grid services like capacity, energy storage, and frequency stabilization. The battery’s integration aids in maintaining grid reliability while transitioning to renewable energy, marking a significant step in Hawaii’s commitment to a clean-energy grid. [Link]

Marketing

How Pop-Tarts pulled off its unforgettable mascot sacrifice (Marketing Brew)
Pop-Tarts made a bold marketing move just before the new year, ending 2023 with a bang. After Kansas State’s 29-19 win over North Carolina State in the Pop-Tarts Bowl game, a Strawberry Pop-Tarts mascot climbed into a massive toaster before spitting out an equally large and edible Pop-Tart for the victors to feast on. It was certainly an unconventional marketing tactic playing to its “crazy good” mantra. It ended up being a big success, as internet memes and discussion boosted viewership and turned the stunt into the brand’s biggest earned campaign. [Link]

Back to Work?

Offices Around America Hit a New Vacancy Record (WSJ)
Office vacancies in major US cities have reached their highest levels in over four decades, tracing back to overbuilding in the 1980s and 1990s, worsened by the shift towards remote work and smaller office spaces accelerated by the pandemic. Many of the vacancy trends have flipped too. For example, areas that were once booming like San Francisco and Texas cities are now facing high vacancy rates, while cities in Florida that once struggled now show lower rates. [Link]

Soccer Stumbles

Chinese Remains Terrible at Soccer. It Says This Is Why. (WSJ)
Corruption is Xi Jinping’s explanation of China’s soccer struggles. The Chinese government has revealed that high-profile figures in the country have been involved in bribery and match-fixing. Li Tie is one star player turned coach who admitted to manipulating the outcome of games in exchange for money. With such a large population, of which many are fans of the sport, it’s hard to imagine that a country of its size wouldn’t be able to put together a solid team.  The corruption involved sounds like it might be a smaller byproduct of larger issues like government policy and business models within the country and world of sport. [Link]

Government Programs & Policies

The Fed Launched a Bank Rescue Program Last Year. Now, Banks Are Gaming It. (WSJ)
The Federal Reserve’s emergency lending program, created during the 2023 banking crisis, has unexpectedly turned into a profitable opportunity for banks. With the market anticipating multiple Fed rate cuts, banks are able to borrow from the Fed’s program at lower rates and earn higher returns by depositing these funds with the central bank. Initially, the program provided costly loans due to expected higher rates, but the recent reversal in rate expectations made borrowing cheaper. [Link]

Maine renews effort to elect president by national popular vote (Daily Kos)
Maine is a state that divides its electoral votes: two for the statewide winner and one each for the winners in its congressional districts. Democrats in the state are now revisiting a bill to join the National Popular Vote Interstate Compact and allocate Maine’s four electoral college votes to the national popular vote winner. All member states would collectively award their electoral votes to the winner of the national popular vote and will only take effect when states representing a majority of the 538 electoral votes join, which means 270 or more votes. The goal would be to ensure that the winner of the popular vote becomes president. The popular vote winner has lost the Electoral College five times in US history, the most recent being Hillary Clinton vs Donald Trump. [Link]

IRS collects more than $500 million in back taxes from delinquent millionaires (MarketWatch)
Millionaires with outstanding tax debts have paid $520 million to the IRS following increased enforcement efforts geared toward wealthy businesses and individuals. Now that the IRS has received a big funding boost from the Inflation Reduction Act, the agency can enhance compliance which is already having success. The crackdown could be hindered by a deal to lift the debt ceiling or a potential deal to avert an upcoming government shutdown, both of which would redirect billions of dollars of funding elsewhere. [Link]

Secret Societies

Skull and Bones and Equity and Inclusion (The Atlantic)
In 2019, members of Yale’s secret society Skull and Bones, known for its elite and exclusive history, confronted its legacy of exclusion by replacing traditional portraits in their meeting place with signs criticizing the society’s lack of diversity. This act reflected broader changes within Yale’s secret societies, which historically have been symbols of privilege and exclusivity. To give you an idea of the exclusivity here, the Vanderbilts, Rockefellers, US presidents, and other high-profile figures have all been bonesmen. The societies now are increasingly diverse, with members advocating for social justice and inclusivity, which has raised tensions between those focused on progress and alumni who value tradition. [Link]

Tails Never Fails?

Scientists Destroy Illusion That Coin Toss Flips Are 50–50 (Scientific American)
After more than 350,000 coin flips, a study found that coins landed on the same side as they started 50.8% of the time, indicating a nearly 1% bias. This finding supports the theory that coins don’t rotate symmetrically in the air, meaning that they spend more time in the air with their initial side facing up. However, for everyday decisions, this bias is negligible, and standard coin flips can still be considered virtually random. If you can see the coin before it’s flipped, though, it sounds like the side facing up might be the one you should go with, instead of the favored “tails never fails” strategy. [Link]

Race Against Rats

A New York Professor Wages Epic Battle Against Rats Attacking His Car (WSJ)
A theater professor at the City University of New York has been unlucky enough to experience four rat invasions of his car in New York City, which is known for its large rat population. The professor has used some creative tactics to combat the rats, like wrapping ignition wires in minty tape and pouring a “garlic-scented potion” on his engine. It’s an issue many are having, with more than 91,700 car damage claims due to rodents in the US from July 2022 to the end of June 2023. The search for effective deterrents is ongoing, and many more interesting methods are being tested. [Link]

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Have a great weekend!

Even for a commodity like natural gas, the last three months have been incredibly volatile.  Think about this; over the last month, front-month natural gas futures are up over 40%, but over the last three months, they’re actually down.  A 40% rally and it’s still in the red over the last three months. Incredible.

Below we show the one-month rate of change in natural gas over time, and anything over the red line indicates a rally of more than 30%.  While there have been plenty of other periods where natural gas rallied a lot more than it has over the last month, the recent move ranks as the largest since late 2022. It’s also a far cry from where the market was a year ago when the commodity was in the middle of its largest ever one-month decline (-52.4%).

The scatter chart below compares rolling one-month moves in natural gas to rolling three-month returns. As you would expect, the relationship is positively correlated- if natural gas is up over the last three months, it’s probably also up over the last month and vice versa. That’s what makes the current performance stick out so much. In the chart below, we have drawn a red box around all the different occurrences where nat gas rallied at least 30% in a month but was down over the prior three months, and there weren’t many.

In the long-term chart of natural gas below, we have included red dots for each of those occurrences when it was up at least 30% in the prior month but down over the prior three months. While there were sporadic occurrences from the late 1990s through 2012, there was nearly a ten-year lull from May 2012 up until 2022 at which point there have been several additional occurrences.

In terms of performance following these periods of extreme divergences between one and three-month returns in natural gas, overall, there hasn’t been much of a clear trend.  Before the three most recent occurrences since the start of 2022, the commodity’s performance was generally positive going forward.  In the three most recent occurrences, though, natural gas experienced declines of over 40% each time.

Just to illustrate once again how volatile natural gas is, check out the performance following the January 2022 occurrence.  While natural gas was up nearly 70% after six months, a year later it was down 44.9% for an overall performance shift of over 110 percentage points!

Overshadowed by the hotter than expected CPI print, initial jobless claims at least came in healthier than expected this morning.  Initial claims came in at 202K, down 1K from last week’s upwardly revised level of 203K.  At current levels, initial claims are down near some of the lowest levels of the past year.  Zooming out, those are also some of the lowest levels since the late 1960s which could paint a historically rosy picture for the labor market.

Taking a look at claims before seasonal adjustment, one of the first couple weeks of the year have often marked the annual peak in claims.  Assuming this week does in fact mark that seasonal high, it would measure roughly inline with other years since 2018 save for 2021 when claims were working off extremely elevated pandemic levels.  Looking forward over the first half of the year, unadjusted claims face seasonal tailwinds.

In addition to initial jobless claims posting a strong reading, continuing claims came in below expectations falling to 1.834 million compared to expectations of an uptick to 1.87 million.  That also marks back-to-back weekly declines in continuing claims as current levels are now down 91K versus the mid November high of 1.925 million. That level is also back below last spring’s highs. That means there has been at least some respite in what more generally has been an upward trend in continuing claims over the past year and a quarter.

In all, both initial and continuing claims have come off their best levels put in place in the fall of 2022 but have each seen steady improvement in recent weeks after a lackluster 2023.  However, that does not exactly put the two in parity, and there is at least one way of chopping up the data which comes off as less optimistic than the historically strong levels.

Below we take the ratio of the four week moving averages of continuing claims versus initial claims.  While far from a perfect recessionary indicator, it has generally spiked during, albeit particularly in the later stages of, past recessions.  Given initial claims have returned to historically low levels while the pivot lower in continuing claims has been less pronounced and more recent, this ratio has rocketed higher over the past six months.  In fact, it has risen 31% in that span. Prior to 2020, each instance of an increase of that size occurred at the tail ends of recessions, namely those of the 1970s and early 1980s.  However, in the post pandemic period, swings of that size have greater precedence with three other even larger increases occurring over the past few years.

Since the bond market peaked in late 2021 just before the Fed embarked on its attempt to tame inflation by hiking rates, it has been painful to be an investor in “risk-free” Treasuries at nearly all points on the curve.  The most pain has been felt at the long-end of the Treasury curve on notes expiring in 10-20+ years.

While the 20+ year Treasury ETF (TLT) is down 28% on a total return basis over the last two years, you may be surprised to see that the high-yield (junk) bond ETF (HYG) is actually now up on a total return basis over the same time frame.  HYG has also easily outperformed the aggregate bond market ETF (BND), which is down 7.4% over the last two years.

Going back five years instead of two, had you decided to go with the “safety” of long-term Treasuries (TLT) over the higher-risk junk bond space (HYG) back in early 2019, you’re still kicking yourself as HYG is up 18.3% over the last five years compared to a 10.6% decline for TLT over the same time frame.

As shown below, TLT was actually up nearly 50% YoY versus a decline of more than 10% for HYG at the time of the COVID Crash in early 2020 when the Fed cut rates to zero while riskier assets like stocks and junk bonds were tanking.  But ever since the COVID Crash lows, long-term Treasury yields have been trending higher (meaning lower bond prices).

Because the high-yield bond ETF has a lower average duration than TLT, it has been spared the massive drop in price that long-term Treasury bonds have experienced.  Couple that with high yield spreads being in a relatively good place, and HYG is currently trading close to a five-year high on a total return basis.  TLT investors are jealous.

Just as longer duration worked against TLT as rates were rising, it reaps the rewards during periods when rates decline. Since the 10/19/23 peak in the 10-year yield, for example, TLT has rallied 16.3% while HYG is up less than half that (7.8%).