Macro and Flows Update: November 2022 - e11

Summary

The video discusses the recent market rally driven by event fall and seasonality, highlighting the importance of understanding market microstructure and structural underpinnings. It emphasizes the potential risks associated with low volatility and skew, suggesting that the current market optimism could be leading to a 'sell the news' scenario. The speaker advises viewers to be cautious, noting that despite positive short-term trends, structural inflation and macroeconomic challenges may persist, recommending a strategic approach to investing in assets like energy and commodities for the long term.

Takeaways

• 📉 Event Falls and their impact on market rallies, as seen with past political events and the recent CPI report, show that positive flows can occur regardless of the actual outcome.
• 📈 The market experienced a significant rally due to event V compression, which has since been decimated, but lower CPI figures contributed to the positive sentiment.
• 🎉 Seasonality plays a crucial role in market behavior, especially during the November to December period, where holiday-induced shortened trading days and lower volumes can accelerate structural flows.
• 🚫 The skew is currently at the zero percentile in the S&P, indicating a lack of hedging and potential vulnerability to shocks, unlike earlier in the year when skew was high and the market was well-cushioned.
• 💸 The potential energy for volatility to increase is significant given the current low skew and implied volatility levels, especially in a higher volatility regime.
• 🔄 Market participants have shifted from a hedged position earlier in the year to a less protected stance now, increasing crowding and the potential for a more significant downturn if issues arise.
• 🌐 Macro landscape suggests a potentially treacherous future despite recent positive news, with factors like dollar weakness and China's reopening potentially supporting structural inflation.
• 📊 Inflation expectations remain sticky, and despite some optimism around CPI declines, the structural factors contributing to inflation are likely to persist and may worsen.
• 🛒 The advice for investors is to be mindful of the potential risks and consider strategic hedging, especially given the potential for increased volatility and market shocks.
• 📈 Despite short-term optimism, the medium to long-term outlook suggests a need for caution, as structural issues and potential sell-the-news events could lead to market downturns.

Q & A

What is the main theme of the November episode of the Macro and Flows update?

The main theme of the November episode is the discussion of event falls, market rallies, and the impact of seasonality on market behavior, particularly in the context of holidays and the end of the year.

What does the term 'event fall' refer to in the context of the script?

In the context of the script, 'event fall' refers to the phenomenon where the worst-case scenarios expected by the markets are priced too high, leading to a market rally once the event gets compressed and the outcome becomes irrelevant.

How does the script explain the role of seasonality in market behavior?

The script explains that seasonality is not a magical construct but has real structural underpinnings related to market microstructure. It mentions that during the November to December period, the market experiences shortened time due to holidays, leading to lower volume and the potential for positive flows driving market behavior.

What is the significance of the skew being at the zero percentile in the S&P?

The skew being at the zero percentile in the S&P indicates that implied volatility skew is low, which generally points to entities not buying that skew and more sellers. This situation is considered risky as it means the market is not well-h hedged and a shock could lead to significant market movement.

What does the script suggest about the relationship between low skew and market behavior?

The script suggests that low skew is akin to having gasoline on the floor, indicating a high potential for a market shock to accelerate and cause significant changes. It also implies that when skew is low, market participants are not hedged, making the market more vulnerable to downturns.

How does the script discuss the potential impact of the US-China meeting on the market?

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What does the script suggest about the structural move in inflation?

The script suggests that there is a secular move in inflation driven by factors such as demographics, populism, and monetary policy cycles. Despite short-term fluctuations and potential declines in CPI, the structural inflation is expected to remain sticky and continue to increase in the long term.

What are the implications of a low implied volatility environment according to the script?

In a low implied volatility environment, the script suggests that there is significant potential energy for volatility to increase, especially in situations where markets become unpinned. This environment is likened to buying something very low, with the potential for substantial gains if markets move higher.

How does the script describe the impact of the Fed's actions on inflation and the market?

The script describes that despite the Fed's actions to raise rates and strengthen the dollar, significant inflation has occurred. It suggests that the structural factors supporting inflation are likely to continue and even get worse, leading to a sticky inflation environment in the long term.

What advice does the script give regarding investment strategy in the context of the current market conditions?

The script advises investors to be mindful of the potential risks and to consider hedging strategies, especially given the low skew and the potential for market shocks. It also suggests that investors should continue to add to their positions in energy and commodities on dips, as these are seen as secular moves that will outperform in the long term.

What is the script's outlook on equities and commodities in the next decade?

The script's outlook is that equities and commodities will face a challenging decade, with a focus on structural inflation and the impact of factors such as demographics and resource scarcity. It suggests that investors should approach equities with caution and consider commodities as a strong long-term investment.