Macro and Flows Update: April 2022 - e04

Summary

The video discusses the recent market dynamics, highlighting the significant backwardation in March Opex and the subsequent rally that failed to continue. It attributes this to major events like the 2020 election and Brexit, which typically lead to short squeezes and momentum moves. The script emphasizes the role of quantitative strategies and the impact of record corporate buybacks and individual demand. It also addresses the challenges posed by inflation and the Fed's slow response, the Russian invasion of Ukraine, and the potential for a Chinese invasion of Taiwan. The speaker suggests investing in long-dated options and skew, while recommending focus on domestic sectors like housing, energy, defense, and healthcare amidst geopolitical tensions and regime change.

Takeaways

• 📉 The March Opex showed significant backwardation, leading to a rally but not sustained, indicating a larger context of market behavior.
• 💹 Event-driven rallies like those from the 2020 election and Brexit have historically led to short squeezes and momentum trades, but the recent rally did not continue, hinting at market weakness.
• 📈 Despite record corporate buybacks and strong individual demand, the market has shown weak momentum after the March Opex and Fed meeting.
• 🇺🇸 Inflation and the Fed's slow response are major concerns; the Fed only raised rates by a quarter in March, lagging behind expectations and worsening inflation due to the Russia-Ukraine conflict.
• 🔄 The Fed's credibility is at stake, and they may need to be aggressive in addressing inflation and maintaining their image ahead of the midterm elections.
• 💰 The quantitative tightening of $95 billion per month likely to be announced in May will significantly impact capital market demand and liquidity.
• 🌾 Supply issues from the Russia-Ukraine conflict are pushing up inflation further, affecting commodities like wheat and oil, and contributing to secular deglobalization.
• 🏹 The possibility of a Chinese invasion of Taiwan is seen as a likelihood within the next year and a half, driven by strategic and technological needs.
• 🔫 Geopolitical trends and their impact on interest rates, inflation, and equity demand are shaping the macro landscape, with potential negative implications for the market.
• 💹 Long-term investment strategies should consider long-dated options and skew, as well as short-dated puts and skew, to navigate the current market environment.
• 🏠 Macro investments should focus on government-funded sectors like housing, domestic energy, defense spending, and healthcare, which are likely to benefit from policy shifts and deglobalization.

Q & A

What was the significant event in March that led to a rally in the markets?

The significant event in March was the Opex, which showed a dramatic positioning with significant backwardation on the VA surface, leading to a rally.

Why did the rally not continue despite the significant short interest in the markets?

The rally did not continue because of the broader context of other market and geopolitical events, such as the 2020 election and Brexit, which typically lead to a squeeze of short interest and momentum moves. However, the momentum generated from the 10% rally off the bottom was incredibly weak.

What are the two major factors causing slow movement towards a significant decline in liquidity?

The two major factors are inflation and the actions of the Federal Reserve. The Fed has been slow to respond to the inflationary pressures, and their actions, including a smaller than expected interest rate hike in March, have contributed to the decline in liquidity.

How does the Russian invasion of Ukraine affect the inflation situation?

The Russian invasion of Ukraine has led to significant increases in inflation due to oil supply shocks and disruptions in commodity supplies, particularly wheat and other food items from Ukraine and the Russian Republic, pushing inflation even higher.

What is the expected quantitative tightening measure by the Fed and its impact on capital market demand?

The expected quantitative tightening measure by the Fed is $95 billion per month, likely to be announced in May. This will have direct reductions to capital market demand and affect things very quickly.

What is the current state of liquidity in the US Equity Market?

Liquidity in the US Equity Market is very low. Although there is a $50 trillion domestic equity market with about $800 billion of equities changing hands on average per day, the actual liquidity driving price movement is as low as $40 to $50 billion per day.

How might the geopolitical trends and interest rate changes affect corporate buybacks and individual investment?

The changes in quantitative tightening and increasing interest rates will eventually filter through to corporate buybacks, reducing demand. This will also impact the buying demand from speculation and investment in passive flows from individual investors.

What is the likelihood of a Chinese invasion of Taiwan in the next year and a half according to the script?

The script suggests a 30 to 40% likelihood of a Chinese invasion of Taiwan in the next year and a half, due to strategic interests and the perceived existential threat to China's future.

What investment strategies are recommended in the current macro landscape?

The recommended investment strategies include long long-dated VA (volatility) and long-dated skew, as well as short-dated puts and short-dated skew to help fund a longer-dated VA. Calendar put spreads and calendar call spreads can also be used to fund low-cost hedges in the market.

What sectors are suggested for investment in the face of potential geopolitical challenges and regime change?

Suggested sectors for investment include housing, particularly residential and first-time home buyer tax credits, domestic energy, defense spending, and healthcare, as these are considered essential industries and are likely to receive government support and funding.

What is the importance of being 'like water' in the current investment environment?

Being 'like water' in the current investment environment means being adaptable and flexible, playing both sides of the markets, and taking advantage of opportunities in a time of regime change and shifting geopolitical landscapes.