Macro and Flows Update: March 2023 - e15
Summary
TLDRIn this episode of Macro and Flows, Kai discusses the market's reaction to recent events, including the February Opex and the anticipated 5-week cycle leading to March Opex. He highlights the Fed's role in managing market expectations and inflation, emphasizing the importance of not fighting the Fed's policy direction. Kai also touches on the potential impact of the upcoming election cycle and geopolitical tensions with China on the economy and markets, advising viewers to be aware of structural macro flows and to manage their investments actively.
Takeaways
- 📉 The recent market decline following the February Opex is attributed to a reduction in positive flows and a shift in market dynamics.
- 🔄 March Opex is expected to enter a 5-week cycle, historically associated with weaker market performance and reduced positive flows.
- 💹 Despite market decline, it has been relatively calm due to buybacks and structured product flows, which are expected to decrease in the upcoming weeks.
- 🏦 The lack of buybacks during the earnings season, starting around March 16th, may contribute to a lack of demand in the market, potentially exacerbating the downturn.
- 📈 The Federal Reserve (Fed) is likely to address the drop in long-end yields, which have fallen dramatically, as it does not align with their goals to combat inflation.
- 🚫 The Fed's actions suggest they are not aiming for a 2008-style banking crisis, but rather a controlled reduction in market speculation and valuations.
- 🛠️ The Fed's quick response to the Silicon Valley Bank and Signature Bank issues indicates a desire for controlled liquidation in speculative sectors.
- 📊 The banking sector's inherent leverage makes it vulnerable to crises of confidence, which can lead to a chain reaction of liquidation events.
- 🌐 Geopolitical tensions, particularly with China, may escalate during the political season, influencing market sentiment and Fed policy.
- 🏆 The upcoming election cycle may lead to increased fiscal stimulus, potentially driving further inflation and impacting long-term market trends.
- 📝 This transcript is for informational purposes only and should not be construed as investment advice; individuals should consult with professionals for personalized guidance.
Q & A
What is the significance of the February 15th to 17th February Opex mentioned in the script?
-The February Opex mentioned in the script is significant because it represents a time when investors may choose to take beta off the table, potentially leading to market adjustments or liquidations. It is a period of interest for those following market trends and making investment decisions based on options expiration dates.
What does the term 'liquidation' refer to in the context of the script?
-In the context of the script, 'liquidation' refers to the process of converting assets into cash, often due to market downturns or the need to meet margin calls. It is a selling of assets, which can contribute to a decline in market prices.
What is a 5WE cycle as mentioned in the script?
-A 5WE cycle, as mentioned in the script, refers to a five-week options cycle. This cycle indicates a period where there is typically less positive flow under the market, and it is characterized by a longer duration of about two weeks instead of the usual one week. During this time, the market may experience a calmer decline due to less buying activity and buyback support.
Why is the buyback window closing from March 16th to April 28th?
-The buyback window is closing during this period because approximately 40% of buybacks are put on hold starting March 16th. This is typically due to the earnings season, during which companies are not allowed to buy back their own stock as part of regulatory restrictions to prevent insider trading and maintain fair market practices.
What is the Fed's stance on the long end of the curve and yields according to the script?
-According to the script, the Fed is likely to maintain a less accommodative stance on the long end of the curve and yields. They aim to talk back up the yields to prevent more speculation and market demand from investors, as they believe the recent dramatic drop in the bond market is not in line with their goals, given the ongoing inflationary and stagflationary problems.
What does the script imply about the Fed's actions during a market decline?
-The script implies that the Fed has been actively managing the market decline by selling calls and attempting to reduce speculation and negative wealth effects. They aim for a controlled liquidation and lower market levels to achieve their economic outcomes, but they also move quickly to secure depositors and prevent a full-blown crisis, as seen with Silicon Valley Bank and Signature Bank.
What is the expected impact of the election cycle on the economy and markets?
-The script suggests that the upcoming election cycle, about a year away, will likely lead to more fiscal stimulus. As the market comes down and the economy slows, politicians may use this as an opportunity to introduce more fiscal stimulus measures, particularly targeting younger generations and those in need of financial support. This could potentially lead to more inflationary pressures and continue the secular problem of high market valuations.
How does the script describe the current state of the banking sector?
-The script describes the banking sector as leveraged and potentially vulnerable to crises of confidence. It suggests that banks, especially those without an implicit guarantee from the federal government, could face significant challenges if deposits or capital are withdrawn on a large scale. The sector is characterized as a 'leverage shell game' that requires confidence and support to function properly.
What is the script's outlook on the structural positioning of rates?
-The script suggests that structurally, rates are expected to continue rising, albeit not necessarily in the immediate future. The Fed's actions to combat inflation and maintain price stability will likely require higher rates in the long term, which could pose challenges for market valuations that are currently high relative to the higher interest rates in the back of the curve.
What geopolitical factor is mentioned in the script that could impact markets?
-The script mentions the geopolitical tensions between China and the US as a factor that could impact markets. It suggests that political seasons may lead to tougher rhetoric against China and more reactionary policies, which could escalate into bigger problems. The script advises not to lose sight of this issue as it could have significant implications for the market and the global economic landscape.
What advice does the script give to investors regarding market positioning and management?
-The script advises investors to be aware of the structural macro flows and to manage their positions actively during different market windows. It emphasizes the importance of being cognizant of structural positioning and being prepared to adapt to changing market conditions. The advice is to 'be water', suggesting flexibility and adaptability in investment strategies.
Outlines
📉 Market Volatility and Beta Reduction
The paragraph discusses the recent market trends and the significance of February Opex, which was a key period for investors to reduce their market exposure. It highlights the liquidation from the market's recent highs and the anticipation of a different outcome for March Opex. The narrative touches on structural flows and their similarities to past market behaviors, emphasizing the importance of understanding these patterns. The speaker also introduces the concept of a 5-week cycle, which is expected to be challenging due to reduced positive flows and the calming effect of buybacks against market decline. The paragraph ends with a cautionary note about the potential dangers in the upcoming two weeks as the buyback window closes and the market enters a traditionally weaker phase.
🏦 Fed's Actions and Market Implications
This paragraph delves into the Federal Reserve's role in shaping market outcomes, particularly through their actions during the market rally and their intentions to curb speculation. The speaker explains that the Fed's 'selling calls' strategy aimed to create a negative wealth effect and reduce market speculation. The paragraph also discusses the Fed's communication strategy, emphasizing the importance of not fighting against the central bank's policies. It further explores the Fed's stance on market decline versus liquidation and the response to banking sector issues, specifically Silicon Valley Bank and Signature Bank. The speaker suggests that the Fed's actions were well-timed and managed, and that the market should expect a pause in the Fed's policy, with a focus on managing inflation and maintaining economic stability.
📈 Market Outlook and Structural Flows
The paragraph provides an outlook on the market's structural flows and the Fed's potential actions to manage long-term interest rates. It discusses the likelihood of the Fed attempting to increase long-term yields despite short-term liquidity provisions. The speaker highlights the delicate balance the Fed must maintain between controlling inflation and not harming the economy. The paragraph also touches on the potential for a recession and the Fed's response to structural inflation. Additionally, it raises two important considerations for the future: the upcoming election cycle and its potential for increased fiscal stimulus, and the ongoing geopolitical tensions with China, which could lead to more reactive policies and increased risks.
📝 Final Thoughts and Advisories
In the final paragraph, the speaker concludes with a reminder of the importance of understanding and managing structural macro flows for long-term investment success. The speaker advises investors to be active in their management and to be aware of the different positioning required during various market conditions. The paragraph ends with a disclaimer, emphasizing that the content is not intended to provide tax, legal, or investment advice, and that viewers are responsible for determining the suitability of any investment strategy based on their personal circumstances. It also advises consulting with professionals for specific business, legal, or tax situations.
Mindmap
Keywords
💡Macro and Flows
💡Volatility
💡Beta
💡Liquidation
💡Opex
💡Buyback
💡FED
💡Inflation
💡Wealth Effect
💡Silicon Valley Bank
💡Geopolitics
💡Election Cycle
Highlights
February 15th to 17th February Opex was a key time to take beta off the table, which could have been beneficial for those who heeded the advice.
There has been a liquidation from recent highs starting at February Opex, leading into a different scenario for March Opex compared to February-March 2020.
Structural flows have similarities, but there is a dampening of knowledge to an extent, which has been verbally communicated in advance.
Approaching March Opex, a 5-week cycle is anticipated, which typically indicates a longer period of less positive flows.
The decline in the markets has been relatively calm due to well-understood factors, such as buyback and charm flows.
The 5-week cycle sees a reduction in these supportive flows, making the next two weeks a potentially dangerous period for the market.
The buyback window is closing, with about 40% of buybacks on hold starting March 16th, affecting demand in the context of a declining market.
The Federal Reserve is expected to address the long end of the curve and yields, as they have recently decreased dramatically.
The bond market reaction has been too fast and too far, especially considering the current situation is not a 2008 banking crisis.
The Fed's actions are aimed at controlling speculation and achieving economic outcomes without overtly targeting market outcomes.
The Fed's strategy involves selling calls to reduce speculation and managing a controlled liquidation without wanting a full market collapse.
The Fed's quick response to the Silicon Valley Bank and Signature Bank issues indicates a managed situation to avoid a crisis of confidence.
The banking sector's inherent leverage makes it vulnerable to crises of confidence, which can lead to a liquidity crunch and potential failure.
The Fed is expected to continue providing short-term liquidity and support, but not to the extent of broad QE or a significant reversal of the current market trend.
The long-term challenge for the Fed is balancing inflation control with economic stability, as structural inflation is expected to be stickier than anticipated.
An election cycle about a year away could lead to more fiscal stimulus, potentially exacerbating inflationary pressures.
Geopolitical tensions, particularly with China, may escalate due to the political season and could have significant implications for the market.
Despite short-term risks and a potential downtrend, there will be opportunities for counter-trend rallies, and investors should be active in managing their positions.
Transcripts
hello and welcome back to another
episode of the macro and flows monthly
update from Kai
volatility um it's been an interesting
month uh as we've talked about
throughout the last several months um
February 15th to 17th February Opex
represented a particularly interesting
time to take beta off the table
hopefully those that have tuned in uh
benefited from from that
conversation uh we have seen uh a
liquidation from the recent highs
starting at Feb Opex uh and not
surprisingly here we sit going into
March Opex a kind of a different outcome
than we saw Feb March 2020 but but
similarly related despite the narrative
that you hear behind the scenes these
structural flows have um some
similarities a slight difference is U
knowledge is all dampening to an extent
we have been out in front of this very
verbally and this is not Co you know
this is not the same crisis uh that set
in front of us but nevertheless uh
interesting coincidence right obviously
not a coincidence um what's going on uh
as we currently stand here approaching
March Opex um we will be heading into a
5we cycle which uh we think is
particularly interesting uh you know
generally five we opcs mean those Cycles
mean that there's a longer amount of
time usually instead of one week about
two where there's less positive flows
underneath the market despite the
liquidation
this decline in the markets has been
relatively calm because uh a calm well
understood uh decline uh comes with a
bunch of buyback uh against you know Von
and charm flows relative to the decaying
put and structured product Deltas in
this 5we cycle uh you start to get less
of that so it's still a very kind of
dangerous period here for the next two
weeks um a little bit longer than the
usual uh window of weakness or window of
non-st strength um the buyback window is
closing here uh March 16th to April 28th
or so uh BuyBacks will largely be going
offline as we get into into the earning
season uh about 40% of BuyBacks are on
hold starting March 16th and I only get
more from there um so important kind of
lack of demand there that you may
normally see that otherwise in the
context of a declining Market um you
know may may exacerbate things in the
short term um in the midterm uh you know
from a flows
perspective um we're likely uh to to
hear the FED uh come back in and try and
talk back up uh the high the long end of
the curve the yields the long end of the
curve they've come down dramatically
it's actually been historic in the last
week um and we don't believe that's what
the FED wants the inflationary
stagflationary problem is still very
much front and center and the bond
market reaction has been uh has been too
fast and too far especially given what
we think is not a uh you know a 2008
banking crisis situation uh we'll get
back into the macro here in a second but
in particular I think it's important to
note that it's not just the flows uh and
the lack of demand that we see during
this kind of next two week week and a
half period it really is um you know the
fact that the FED is like
to not be as accommodative from a a
yield perspective and a Fed policy
perspective yes they'll provide
liquidity to deposits like they have yes
they'll they'll prevent a Liquidation on
the tail but in terms of broad uh
liquidity and Supply from much longer
term and fighting inflation perspective
we do believe uh yes they're not going
to do 50 base points but they do still
want to talk back up the yields along
into the curve um to prevent more
speculation um and and Market kind of
uh demand from investors um at the end
of the day uh you know in the long term
however um we do see uh investors under
lovered a lot of this was broadly U well
telegraphed again we were out there very
clearly giving you dates months ahead of
time um there has been a bit more put
buying particularly lately skew uh in
the in the VA complex has come up and we
do believe this will allow the FED at
the very least to broadly work towards a
pause um which takes us to kind of some
of the macro effects um we were very
clear that the Fed was selling calls
there at the top not actually uh
physically selling call options but they
wanted speculation out of the market uh
they wanted uh a a negative wealth
effect to really take hold and to kind
of wash out specul from the market in
order to affect the economy uh they
won't outwardly tell you that that
they're out there trying to Target
Market kind of outcomes but but broadly
uh the market and the economy are
connected the feedback loop of the
wealth effect and taking out the
speculation after a 20% rally off the
lows of the market is very important for
the FED to to to do in order to achieve
its outcomes um so they were selling
calls don't fight the FED uh that didn't
mean they wanted a liquidation we were
clear there's a difference between a
decline in markets with relatively low
stair step kind of volume um and uh and
a pure liquidation now the FED doesn't
always you know control the outcome as
well as they would like but important to
note that they were very clear that they
wanted the market lower they were trying
to talk the market down Market didn't
listen for a while and eventually though
kind of uh when the window was right as
we explored um the the time was right
for uh for those to be
uh to to to work again don't fight the
FED now the question is does the FED
want to liquidation answer is no and and
I think this decline doesn't mean that a
liquidation or a um or a tail is
necessarily coming actually quite the
contrary I think the FED uh really very
much kind of telegraphed this understood
what was happening um in real time knew
about the Silicon Valley Bank and
Signature Bank issues um and it was very
quick obviously as soon as the decline
happened come in and and and secure
depositors um we believe that that's not
a coincidence um uh you know Silicon
Valley Bank represents uh you know a
large swath of the the technology sector
um uh Signature Bank was very much a
lendo and the crypto space these are
speculative spaces that for the most
part uh are exactly what the FED uh
wanted kind of some of the froth to come
out of um so this is uh kind of Ideal
for the FED in the sense that they've
been selling calls um and want a a
controlled liquidation now many here may
believe hey did you see what happened to
credit s the other day how is this a
controll liquidation some of these CDs
flouts are the are the worst things
we've ever seen in certain um sectors um
listen the banking sector by definition
is leveraged and always and I mean
always with a few exceptions that are
backed by the federal government at this
point are always uh a a without using
the word Ponzi a leverage shell game uh
at the end of the day if uh there is a
loss of confidence in a bank uh and the
deposits are withdrawn whether it's a
you know or or capital is withdrawn and
other means um there is just simply too
much leverage to support um you know in
its Investments without a
deleveraging and this structure you know
particularly as it related to S you know
uh both both entities both Silicon
Valley Bank and signature um these the
the actual uh hold to maturity
Securities having to be remarked
ultimately represent a a step down um
and and uh you know liquidation uh event
so yes there was some particularly bad
acting in in those parts some
irresponsible corporate governance um
but at the end of the day this is a bank
problem and uh it exists across Banks um
and if you have a crisis of confidence
at some point um all banks have to be
backstopped or there is a tale so there
is a always no matter what environment
you're in this reality that Banks um
especially those that aren't already
backed uh with an implicit guarantee
from the federal government um uh you
know can have a self-fulfilling prophecy
of of a tale so um within that context
and the reality that the truth that that
can always happen again we believe this
was broadly telegraphed and well managed
by the FED beforehand um and do believe
that that there's a bit of a overblown
nature to that macro narrative which has
really followed price more than anything
that said that does not mean markets are
going to bounce back and rally because
again as we mentioned in the flows piece
we do believe the FED um is not going to
provide the liquidity and Broad QE that
some people are calling for the market
has been too fast to price in a reversal
by the FED uh we do think but they'll
continue to provide short-term liquidity
markets open the discount window as they
have and continue to keep it open back
stop depositors as they've done we also
believe the same will happen in Europe
with credit S as as Swiss bank has said
so broad liquidity will be provided to
help protect against the tail that said
we do believe the FED will be coming
back in and trying to talk back up that
long in of the curve and that is really
where the real risk lies it's less of a
tail outcome broadly for markets and the
banking sector and more of the
actualization of this reality that we
are broadly in a a spot where the FED is
stuck between a rock and a hard place
they are um trying to take out the
leverage and the speculation and take
down markets from uh you know to a place
so they can slow down inflation and they
have to uh to to meet their Mandate of
of price stability while trying not to
hurt the economy too much and that is a
very delicate balance that is a
different situation with the inflation
at hand than they have ever they've seen
the last 40
years um ultimately uh this raising of
expectations of the long and the curve
we which we believe will happen uh
before too long again once things have
calm down a bit um is um is the ultimate
problem for Val markets valuations are
high relative to higher interest rates
in the back in the curve and
structurally we believe rates are still
going higher maybe not this month maybe
not next month but broadly the FED will
have to come back in and start um uh
fighting inflation again after a short
pullback here um this pause that we're
going to get is a chance for the FED to
stop and look around and see uh what's
going on with the lag and we do believe
that that structural inflation will
continue to be much stickier Than People
expect we may get a recession we don't
believe it'll be a deep one um
ultimately that will force the fed's
hand um again lastly um not many people
are looking at two things which are very
important in office in the distance and
I want our our listeners to to start
thinking about that we're heading into
an election cycle in about a year excuse
me and that election cycle means more
fiscal stimulus the more this Market
comes down the more the economy slows
even if we get a mild recession that
will be all the excuse that politicians
need left or right to talk more fiscal
stimulus into the hands of the voting
public particularly Millennials and the
generation that cannot uh you know fund
their homes cannot um get some of the
you know fund their
educations expect stimulus to the people
and that ultimately is more inflationary
again and will continue to drive this
secular problem that's one uh two uh
China and geopolitics we haven't talked
about in a while it's kind of gone to
the back burner there was a moment of of
appearing approachment between China and
the US that faded very quickly political
season also means more tough talk
against China um it also means more
reactionary policy the more hemmed in
China feels um the more likely we are to
see um bigger problems do not take your
eye off that ball um the FED is likely
happy with this outcome don't fight the
FED um that said understand that
positioning is still
relatively um uh you know short uh fed
paw is broadly good uh and the B that
balance um for things and so after a a
bit of a window here of of weakness and
potential risk um know that we'll
probably also still get our fair share
of counter Trend
rallies despite what is a secular U
downtrend um as well so uh as always a
lot of up down up or down up down in
this scenario um be water um do remember
that these structural macro flows matter
over the long term and that is the way
to to play this decade really not just
the next year or two um but uh you know
that has to be in real terms and we have
to be cognizant of the structural
positioning during different windows and
be active in our management be water I
wish you well this does not constitute
an offer to sell a solicitation of an
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