Macro and Flows Update: April 2022 - e04
Summary
TLDRThe 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.
Outlines
📉 Market Dynamics and Event Impacts
This paragraph discusses the market's reaction to March Opex and the significant backwardation that occurred, akin to an event V. It highlights the rally that followed but emphasizes its failure to continue, which is crucial in the broader context. The paragraph compares this to other significant events like the 2020 election and Brexit, noting how these events led to short squeezes and momentum trades due to quantitative strategies like managed futures and risk parity. The paragraph also touches on record dollar speculative selling and corporate buybacks, suggesting a market susceptible to a squeeze. However, it questions the observed weakness, attributing it to two main factors: inflation and the Fed's slow response to it. The Fed's actions, influenced by the Russian invasion of Ukraine, are discussed, along with the anticipated increase in interest rates and their impact on liquidity and market demand.
💹 Market Liquidity and Geopolitical Tensions
The second paragraph delves into the current state of market liquidity, which is alarmingly low despite the size of the equity market. It provides specific figures to illustrate the discrepancy between the total market value and the actual volume driving price movement. The paragraph then connects this to the quantitative tightening initiated by the Fed, which is expected to reduce demand in the capital markets. The discussion extends to the effects of rising interest rates and inflation, which are exacerbating the liquidity issue. The paragraph also addresses the geopolitical tensions involving Russia and Ukraine, and their impact on commodities like wheat and oil, contributing to inflation. It then presents a scenario involving China and Taiwan, suggesting an increased likelihood of conflict based on recent events and China's strategic interests.
🔄 Positioning and Hedging Strategies
This paragraph focuses on the implications of the macro landscape on options positioning and hedging strategies. It suggests that the negative sentiment and increased hedging will not be able to offset the broader geopolitical issues affecting the market. The paragraph discusses the five-week cycle from April to May expiration, noting that this extended period results in less demand and continued weakness in the market. The upcoming Fed meeting in May is highlighted as a significant event that could influence market direction. The paragraph advises on various investment strategies, such as long-dated volatility and skew trades, to navigate the challenging market conditions. It emphasizes the importance of being versatile and leveraging both sides of the market in such an environment.
🏠 Macro Investments and Domestic Focus
The final paragraph shifts focus to macro investments and domestic opportunities in the face of global challenges. It posits that monetary policy will no longer fuel speculation and passive flows, with government at the center of funding future initiatives. The paragraph suggests sectors that are likely to benefit from this shift, such as housing, domestic energy, and defense spending, especially in anticipation of Republican midterm victories. It also discusses the potential for investment in essential industries as deglobalization occurs. The paragraph concludes by reiterating the importance of adaptability and strategic investment, even in a regime of contraction and geopolitical tension.
Mindmap
Keywords
💡backwardation
💡quantitative strategies
💡short interest
💡inflation
💡FED
💡quantitative tightening
💡liquidity
💡geopolitical trends
💡deglobalization
💡hedging
💡macro investment
Highlights
March Opex showed significant backwardation, leading to a rally.
The rally did not continue, which is significant in the grand context of market movements.
Event-driven market movements like the 2020 election and Brexit led to short interest squeezes and momentum.
Quantitative strategies such as managed futures, trend following, and risk parity can create significant market momentum.
Record dollar speculative selling and positive flows from corporate buybacks and individual demand.
The market's weakness despite positive flows indicates deeper issues.
Inflation and the Fed are major concerns, with the Fed being behind the curve in addressing inflation.
The Fed's actions have been influenced by the Russian invasion of Ukraine, leading to a delay in rate hikes.
There is increasing talk about more aggressive rate hikes, possibly up to 75 basis points.
Quantitative tightening of $95 billion per month is likely to be announced in May, affecting capital market demand.
Low market liquidity is a concern, with actual liquidity being much lower than total trading volume.
The impact of quantitative tightening and rising interest rates will eventually affect corporate buybacks and individual investment.
Geopolitical trends, including the situation in Ukraine and potential Chinese actions towards Taiwan, are shaping the macro landscape.
China's recent actions are seen as a move towards aligning with Russia for military and commodity support.
The potential for a Chinese invasion of Taiwan is seen as likely due to strategic and demographic reasons.
Investment strategies should consider long-dated volatility and fixed strike volatility as well as short-dated puts and skew.
Macro investments should focus on government funding, housing, domestic energy, defense spending, and essential industries.
Healthcare represents a significant portion of the US budget and is an area ripe for efficiency improvements.
Despite poor geopolitical news, there are always investment opportunities, especially in times of regime change.
Transcripts
hello and welcome back to our April Mac
flow's update video as mentioned last
month uh March Opex was uh dramatic in
terms of its positioning on the VA
surface we had significant backwardation
uh much like an event V and that led to
a significant
rally the interesting part about this
rally is not that that the rally
happened but that actually it did not
continue this means a lot in the grand
context of things at other such event BS
like the 2020 election brexit 2016
election these massive Von and charm
flows that kick off from these types of
moves ultimately lead to a squeeze of
short interest and an activation of
quantitative strategies into a momentum
move uh these quantitative strategies
include include manage Futures Trend
following VA targeting risk parity um
all of these strategies can really
create a lot of momentum and flows
particularly given the significant short
interest in the markets uh we've had
record dollar speculative selling and US
Equity Futures into the last
rally that uh makes the market
susceptible to a squeeze obviously we
also have have positive flows in the way
of record uh corporate
BuyBacks um as well as personal balance
sheets and demand from individuals
increasing as
well all this in the context of what has
been up until now a stimulative
said think about all those positive
flows and then think about how little
momentum we were able to ultimately
generate off of the 10% rally off the
bottom as after March Opex and the March
fed
meeting that is incredibly
weak so why is this weakness happening
you may
ask
inflation and the FED two major things
that are integrally
interconnected yet moving slowly towards
a
significant um decline in
liquidity the FED only raised a quarter
in March
uh most entities expected 25 to 50 basis
points they are significantly behind the
curve and they've expressed that but
because of the Russian invasion of
Ukraine they were unable to raise the 50
basis points um because they didn't
understand the risks that sat in front
of them since the invasion has led to
significant increases in inflation not
just from oil supply shocks but also for
Commodities like wheat um and other food
um that comes from Ukraine and the
Russian
Republic all of these
um supply issues ultimately um are
pushing inflation even more making the
FED even more behind the curve they
realize it you're starting to hear much
and more talk about 50 basis points at
every fed meeting we would not be
shocked to hear about 75 basis points
why are they having to be so aggressive
not just inflation but because they
don't want to be deemed as political
once we get into the midterm election so
you have a window here starting in May
till November where they have to be
incredibly aggressive in terms of
talking down inflation expectations and
trying to get out in front of
it the fed's very credibility is at
stake it is not just just to hem in
inflation but really to bolster their
their credibility in the short term the
quantitative tightening of
95 billion dollars per month that is
likely to be announced in
May uh will have
direct reductions to Capital market
demand it affects things very
quickly the longer term heading into the
fall effects of the rise in interest
rates which are already being priced
into the market um will also slowly um
eat away at Daily liquidity as I've
mentioned in the
past liquidity in markets is incredibly
low we have a $50 trillion domestic
Equity Market about $800 billion doll of
uh equities change hands hands on
average per day but the actual liquidity
that drives price movement is as low as
40 to 50 billion per day
that is
1% less than 1% of um of demand as I've
mentioned before liquidity in markets is
very low us Equity markets are about 50
trillion dollar uh daily trading volume
is closer to
8900
billion that said the actual amount of
trading that moves equity ities the
fundamental
moving pressure is closer to only $50
billion most of the trading is high
frequency or hedging
volume ultimately $50 billion in the
context per day in the context of 95
billion being removed per month you get
a sense for how much demand is coming
off the table this change in
quantitative tightening has significant
effects not to mention in the context of
what is in incredibly quickly increasing
interest rates which are adding to that
quantitative tightening lack of demand
this will filter through to corporate
BuyBacks eventually it will filter
through obviously into the buying uh
demand from from speculation and
investment in passive flows from
Individual
investors and we believe this inflation
push is just getting started
um policy makers come in the midterms
will will try and do um AFF policy that
will in the short term try to remedy
some of this inflation which has become
part of the Zeitgeist it will be talked
about at nauseum But ultimately most of
this will be fiscal demand driven tax
holidays
um firsttime home buyer credits things
of that nature that will ultimately in
the short term reduce inflation for the
uh individual but will increase
inflation secularly going
forward Russia is facing in their view
an existential threat they are not going
to stop or give up in Ukraine or
negotiate um ultimately that will lead
the west and the Allies to
take5 billion doll of oil
offline um that is dramatic those
effects will filter through in the next
9
months Ukraine and Russian wheat Supply
um will all but be taken off the
market we are witnessing the beginning
of secular deglobalization
and this will continue regardless of
whether or not what we fear is the worst
case happens that worst case is a China
invasion of
Taiwan the Chinese invasion of Taiwan we
see as a 30 to 40% likelihood in the
next year and a half why well China
actually did something incredibly
uncharacteristic on February 7th
enjoining and publicly um dismissing the
west and Western democracy it stopped
walking what had been a 40-year line um
between autocracy and capital markets it
had faced the West
and turned East equally in
tow this was a denouncement of the West
and Western ideals the only
reason in terms of long-term benefit
that we can see that China would have
done this is to side with Russia for
military
support and commodity
support that said commodity support can
be gained from other countries it truly
is a
military Arrangement and as we see it
the only reason that China sees a
military alliance with Russia as
necessaries because of their designs on
Taiwan now they did leave themselves
optionality ultimately and the big
question is now that Russia has had
problems
militarily now that we have seen uh the
negative uh outcomes for Russia in terms
of global coordination against them uh
financially does China walk back their
designs on
Taiwan we would argue that the odds are
increasingly unlikely the reason that
China saw this as the time to need to
move in Taiwan we believe is because of
the increasing encirclement by the Quant
Alliance as well as the need uh uh to
secure semi semiconductors in
Taiwan those semiconductors and the flow
of capital between Taiwan and China has
been decreasing in The Last 5 Years
secularly um this is unacceptable and is
an existential threat to China which has
incredibly negative demographic Trends
and is in completely reliant on
technological solutions going
forward this encirclement is only
accelerating with what has happened in
Russia and the alliances that we have
seen we believe that China has already
started taking the steps
towards um Taiwan and will be unable to
move away from it given how important
and existential they see that for their
future so given this macro landscape
these um these awful geopolitical Trends
and most importantly what it means for
interest rates inflation and demand for
equity
um we have secular issues at hand so the
real question is will the negative
positioning that we've seen Theon and
charm flows coming from increased
hedging Etc be able to offset these
geopolitical issues much
longer right now we enter a five-week
cycle from April to May expiration five
week Cycles mean as we've talked about
very vocally less
demand um because it is a 20% 25% longer
time period under which these Von and
charm flows operate so instead of a
onewe window of weakness where there's
less uh Von and charm positive flows
coming from index
markets it has extended over two weeks a
much longer period um because of that we
have seen the weakness we have recently
it was front run as people have become
much more cognizant of its existence um
but as we saw on Friday a really
increased continued weakness
here importantly May 4th is the big fed
meeting that fed meeting is already
developing its own event B that is
increasing given the increases inflation
there are bigger question marks about
what will be announced during this may
meeting we believe that increase and
event volume will ultimately lead to a
continued push into the FED which is
what we often see in the weeks prior um
and uh ultimately after it a bit of a
spike again um unfortunately we don't
believe the event V will be as big as
March and the Von and charm flows will
be in a position of much poor
seasonality and much poor uh demand from
the
Fed so this should we Bel begin to kick
off more negative uh balance of supply
and demand as we head out of May uh this
sell and may Mantra will be particularly
strong this year this fall will see
significant um removal of that liquidity
as we've mentioned from the fed and that
as it works its way through the market
will likely allow the market to succumb
to the demand uh the dir of demand uh
with excess
Supply so given this incredibly negative
outlook which I uh I'm sad to bring our
investors um where do you invest what do
you do from a VA perspective um the
answer tends to be long long dated V and
long dated skew skew has come down
dramatically in the last six months
whereas we had a historic demand for
skew and historically High skew going
into the end of last year and the
beginning of this year it has definitely
uh come down in the indexes
significantly um so long-term skew
andall um is also with the
underperformance of fixed strike VA is
also not a bad thing to invest in at
this juncture short dated puts and short
dated skew can help to fund a longer
dated VA given the short interest that
we see out there and then General still
hedging that happens calendar put
spreads should be a place to look
funding these with calendar call spreads
short or longer dated calls um could be
a very um good way to ultimately fund um
low cost hedges in this
market from a more fundamental basis
where should we be investing on a macro
uh basis
um no longer do we have monetary policy
fueling speculation and passive flows
instead government will sit at the core
of funding um the Future IT Federal
Reserve would likely buy our debt and
manage um you know fiscal policy um and
make sure that um that the exorbitant
privilege of the dollar is not wasted
but money will be flowing to demand not
supply and ultimately it will be flowing
to government through government funding
what does that mean you want to seat
yourself at the seat of that uh monetary
Supply coming from uh the the
treasury likely housing is will continue
particularly
residential um housing uh firsttime home
buyer tax credits are likely on the way
in the coming years um domestic energy
um is likely a good place to sit uh and
invest in the face of of Republican uh
midterm victories that are likely coming
um defense spending um is obviously
likely to get an uptick particularly
with more Republican um uh seats uh in
the
Congress any essential industry as we de
globalize um will be a place for
investment here domestically we believe
you should be on the strongest biggest
ship which is here in the US we have our
own resource
energy is no longer concern for us
domestically um the dollar should
continue to be strong Ironically in the
face of increased spending here because
it is simply the best uh house in a poor
neighborhood lastly Healthcare
Healthcare represents uh in total almost
30% of the US budget it is ripe within
efficiency and a great place for there
to be targeted Dem domestic policy um
for
improvements so just like anything poor
geopolitical news poor trends at the
index level doesn't necessarily mean uh
there are no places to invest um
secularly there'll be multiple
contraction yes but there are always
opportunities particularly in a time of
regime change it is important to be
water and to play um both sides of
markets in this type of environment
so as always thank you I wish that you
be water until next month
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