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.

Outlines

00:00

📉 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.

05:03

💹 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.

10:06

🔄 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.

15:08

🏠 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.

Keywords

💡backwardation

Backwardation refers to a situation in futures markets where the price of a futures contract with a nearer delivery date is higher than one with a later delivery date. This is contrary to the usual contango situation where futures prices increase with time. In the video, significant backwardation led to a rally, indicating a strong demand for the asset in the present, rather than in the future.

💡quantitative strategies

Quantitative strategies are systematic investment approaches that use mathematical models and algorithms to make decisions. These strategies can include managed futures, trend following, and risk parity, among others. They aim to exploit certain market behaviors or anomalies by following predefined rules. In the context of the video, these strategies are activated by significant market movements and can contribute to momentum in the market.

💡short interest

Short interest refers to the total number of shares that have been sold short but have not yet been covered or closed out. High short interest can indicate that many investors are betting a stock's price will decline. In the video, a squeeze of short interest occurs when a significant rally challenges these bearish bets, forcing short sellers to buy back the shares they borrowed, further driving up the price.

💡inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Central banks attempt to limit inflation and avoid deflation to keep the economy running smoothly. In the video, inflation is a major concern for the Federal Reserve, and their actions to combat it can have significant impacts on financial markets and the economy.

💡FED

The Federal Reserve, often referred to as the FED, is the central banking system of the United States, responsible for implementing monetary policy. The FED's actions, such as adjusting interest rates and controlling the money supply, can influence economic conditions, including inflation, employment, and growth. In the video, the FED's potential actions to address inflation and maintain credibility are discussed as key factors affecting market dynamics.

💡quantitative tightening

Quantitative tightening is the process by which a central bank reduces the size of its balance sheet, typically by selling assets it has previously purchased. This is the reverse of quantitative easing, which involves buying assets to increase money supply. Quantitative tightening aims to reduce liquidity in the market, which can help control inflation. In the video, the impact of quantitative tightening on capital market demand and its effects on interest rates and corporate buybacks are discussed.

💡liquidity

Liquidity in financial markets refers to the ease with which assets can be bought or sold without affecting the asset's price. High liquidity means that there are many buyers and sellers, allowing for smooth and quick transactions. The video discusses how liquidity in the U.S. equity market is incredibly low, which can lead to significant price movements with relatively small trades.

💡geopolitical trends

Geopolitical trends refer to the patterns and shifts in international relations, political alliances, and conflicts that can influence global economics and markets. In the video, the geopolitical situation, particularly the Russian invasion of Ukraine and the potential Chinese invasion of Taiwan, is discussed as having significant implications for commodity prices, global supply chains, and market uncertainty.

💡deglobalization

Deglobalization is the process of reducing global interconnectedness, often characterized by a decrease in international trade, investment, and cooperation. This can be driven by various factors, including political tensions, protectionist policies, or economic crises. In the video, the concept of 'secular deglobalization' is introduced, suggesting a long-term trend away from global integration and towards more localized or regional economies.

💡hedging

Hedging is a risk management strategy used to offset potential losses in one investment by taking an opposite position in another. It is a way to protect against adverse price movements by investing in assets that are expected to move in the opposite direction. In the video, hedging is discussed in the context of options strategies, such as long-dated volatility and skew, which can be used to mitigate risks associated with market volatility.

💡macro investment

Macro investment refers to investment strategies that are based on the analysis of large-scale economic factors, such as interest rates, inflation, GDP growth, and geopolitical events. These strategies aim to capitalize on or protect against shifts in the broader economic environment. In the video, macro investment is discussed in the context of identifying sectors and areas that are likely to benefit from or be resilient to broader economic and geopolitical trends.

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

thanks this does not constitute an offer

to sell a solicitation of an offer to

buy or a recommendation of any security

or any other product or service by Kai

or any other third party regardless of

whether such security product or service

is referenced in this video furthermore

nothing in this video is intended to

provide tax legal or investment advice

and nothing in this video should be

construed as a recommendation to buy

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or to engage in any investment strategy

or transaction Kai does not represent

that the securi products or Services

discussed in this video are suitable for

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