Macro and Flows Update: December 2022 - e12

Summary

The video discusses the macroeconomic landscape of 2022, highlighting the persistence of inflation and its impact on the economy, similar to the 60s and 70s. It predicts a mild recession in 2023 due to continued inflation and fiscal stimulus, which could lead to more populism. The script also touches on the potential for increased market volatility and the significance of the first half of 2023 for investment strategies, suggesting a period of potential decline followed by a resurgence in the market.

Takeaways

• 🌪️ Inflation has been a significant and persistent issue, mirroring patterns seen in the 60s and 70s.
• 💡 The war in Ukraine has exacerbated inflation, along with OPEC plus restrictions on oil.
• 📈 Despite frequent recessions from 1968 to 1982, real GDP growth remained strong over longer periods.
• 🏦 The Federal Reserve's actions to control inflation with potentially unsuitable tools may lead to a mild recession.
• 🔄 The market is currently experiencing a period of lower volatility and cheaper skew, which could change rapidly.
• 📉 The potential energy in the market is significant, with supply still well supplied into the end of the year.
• 🔄 Expect a second leg down in the market, with Q1 of the coming year being particularly critical.
• 📊 Lagged portfolios like private equity and real estate will likely cause a reduction in collateral and slow economic activity.
• 🌐 Positive news on inflation and dollar strength may reverse, leading to increased commodity demand and inflationary pressures.
• 📈 A mild recession could lead to more populism and fiscal stimulus, which may not be beneficial for equities in the long term.
• 🚀 The potential for a significant market downturn is building, with low long volatility and increasing risk premia indicating a possible major event on the horizon.

Q & A

What macroeconomic trends were discussed as having occurred over the past year?

The video discusses sticky inflation, an increase in populism, and a shift from cooperation to competition in global politics, exacerbated by the war in Ukraine and OPEC+ oil restrictions.

How does the current inflationary period compare to historical periods of inflation?

The current inflationary period is compared to the 1960s and 1970s, noting similar patterns of more frequent recessions but also periods of strong real inflation-adjusted GDP growth.

What is the predicted economic outlook in terms of recession and inflation?

The outlook predicts a mild recession, which is seen as worse than a deep recession due to its potential to increase populism and demand for fiscal stimulus, thereby exacerbating stagflationary pressures.

How does the Federal Reserve's approach to controlling inflation potentially affect the economic outcome?

The Federal Reserve's use of what are considered the wrong tools to control inflation is expected to contribute to a mild recession rather than mitigating economic downturns effectively.

What are the implications of the current economic situation for equities and market pricing?

The economic situation, marked by stagflation and a shift in market pricing, is deemed bad for equities. A notable decrease in market skew is mentioned, indicating a significant change in market sentiment.

What role does the performance of the dollar and Chinese economic policies play in the global inflationary landscape?

Dollar strength has exported inflation from the US, while China's economic policies, including its response to COVID-19, are expected to influence commodity demand and global inflation as the country reopens.

What is the significance of the new year in the context of the economic and market analysis presented?

The new year is significant due to the expected remarking of assets like private equity and real estate, which will influence collateral levels and potentially reverse some of the previous year's market trends.

What is the expected impact of a mild recession on stock buybacks and overall market activity?

A mild recession is expected to slow stock buybacks and overall market activity, contributing to a challenging environment for equities.

How does the video describe the potential for market volatility and investment strategy in the coming year?

The video predicts increased market volatility and suggests cautious investment in long volatility positions, anticipating significant market movements and opportunities for strategic investment.

What cautionary advice does the video offer to investors for the upcoming year?

Investors are advised to be cautious due to the potential for increased volatility and market downturns, with an emphasis on being prepared for significant economic and market shifts.

Outlines

00:00

🌪️ Economic Challenges and Recession Predictions

The first paragraph discusses the current economic climate, highlighting the persistence of inflation and the impact of macro forces that have been anticipated for over a year. It mentions the shift from a period of operation to increasing competition, exacerbated by the war in Ukraine and OPEC plus restrictions. The speaker compares the current situation to the 60s and 70s, predicting more frequent recessions similar to the 1968-1982 period. Despite frequent downturns, real GDP growth is noted to be stronger than the last 20-30 years, indicating a demand-driven economy. The paragraph concludes by forecasting a mild recession, which is considered worse than a deep one due to its potential to cause more populism and fiscal stimulus without the benefits of lower interest rates in a deeper recession.

05:04

📉 Market Dynamics and Flows Analysis

The second paragraph delves into market dynamics, specifically the strength of buybacks and the impact of a mild recession on these financial flows. It discusses the positive news of dollar strength and oil weakness due to Chinese slowdowns, but warns of potential reversals in these trends. The paragraph anticipates dollar weakness and a reopening of the Chinese economy, leading to increased commodity demand. It also touches on the macro perspective of a mild recession and its implications for market flows, particularly during the five-week cycle of lower volume and V supply. The speaker warns of potential dangers from a flows perspective, especially around the February period, and suggests a market downturn (B down) scenario with increased volatility (Vault pinning).

10:05

🚨 Cautionary Outlook and Investment Guidance

The final paragraph offers a cautionary outlook on the investment landscape, discussing the potential for realized volatility and the risks associated with decreasing buybacks and higher long-term rates. It mentions the possibility of a steepening yield curve and the lack of hedging, which could lead to a liquidation event. The speaker suggests that a significant market event is likely to occur within the first six-month period, but emphasizes that secular periods are typically good for volatility compression. The paragraph concludes with a positive note on the potential reemergence of trends seen earlier in the year and advises investors to manage their wealth carefully through the upcoming tumultuous times. The speaker also reminds viewers that the content does not constitute investment advice and that individuals are responsible for their own investment decisions.

Keywords

💡macro forces

The term 'macro forces' refers to large-scale economic factors that influence the overall performance and direction of economies and financial markets. In the video, it is mentioned that these forces, which have been discussed for over a year, have materialized in the current year, affecting inflation and competition.

💡inflationary picture

The 'inflationary picture' describes the current state and trends of inflation within an economy, including the rate at which prices for goods and services are increasing. In the video, the speaker notes that the inflationary picture has been 'sticky', meaning that inflation has been persistent and difficult to control.

💡populism

Populism is a political approach that seeks to appeal to the interests and concerns of ordinary people, often by opposing the elite or establishment. In the context of the video, populism is mentioned as one of the driving forces that have shifted the economic landscape from a period of cooperation to one of increasing competition.

💡OPEC plus restrictions

OPEC plus restrictions refer to the collective decision-making and production limits set by the Organization of the Petroleum Exporting Countries (OPEC) and its allies, often referred to as 'OPEC+'. These restrictions can impact global oil prices and contribute to inflationary pressures. In the video, it is mentioned that such restrictions have exacerbated inflation.

💡recessions

Recessions are periods of negative economic growth and are typically characterized by a decline in business activity, increased unemployment, and a decrease in production. The video discusses the historical frequency of recessions during the 1968 to 1982 period and draws parallels to the current economic situation, suggesting a potential for more frequent recessions.

💡real GDP growth

Real GDP growth refers to the increase in a country's gross domestic product (GDP) after adjusting for inflation. It reflects the true growth in the economy by eliminating the effects of price changes. In the video, it is noted that despite more frequent downturns, the historical period mentioned saw strong real GDP growth over longer periods.

💡equities

Equities, also known as stocks or shares, represent ownership interests in a company. The performance of equities is influenced by a variety of factors, including economic conditions, corporate performance, and market sentiment. In the video, the speaker suggests that the current inflationary environment is particularly challenging for equities.

💡VIX

The VIX, or Volatility Index, is a measure of market expectations for near-term volatility in the S&P 500 Index options. It is often referred to as the 'fear index' because it reflects investor sentiment about the likelihood of large price swings. In the video, the VIX is mentioned in the context of market conditions and investor sentiment.

💡fiscal stimulus

Fiscal stimulus refers to government spending and tax policies designed to boost economic activity, typically during periods of economic slowdown or recession. In the video, the speaker suggests that the consequences of a mild recession could lead to increased demands for fiscal stimulus, potentially exacerbating economic challenges.

💡dollar strength

Dollar strength refers to the value of the U.S. dollar relative to other currencies. A strong dollar can have various effects on the economy, including influencing trade balances and the cost of imported goods. In the video, the speaker notes that recent dollar strength has helped to export inflation from the developed world, particularly the U.S.

💡Chinese economy

The Chinese economy is the world's second-largest economy, and its performance can significantly impact global economic conditions. In the video, the speaker discusses the potential for China's economy to reopen and stimulate growth, which could increase demand for commodities and contribute to inflationary pressures.

💡collateralization

Collateralization in a financial context refers to the process of providing an asset, such as securities, to back a loan or other financial obligation. The value of these assets can affect the terms of the financial arrangement and the risk involved for both parties. In the video, the speaker discusses a reduction in collateralization as a potential economic challenge.

Highlights

Inflationary picture has been sticky, consistent with predictions made over a year ago.

Populism and increasing competition have driven changes, exacerbated by the war in Ukraine and OPEC plus restrictions.

The current economic situation mirrors periods in the 60s and 70s, with frequent recessions seen between 1968 and 1982.

Despite frequent downturns, the real, inflation-adjusted GDP growth was stronger in the past than in the last 20-30 years.

The first recession of the 1968-1982 period was mild but long, similar to what is anticipated now.

An activist Fed attempting to control inflation with potentially the wrong tools may lead to a mild recession.

A mild recession could lead to more populism and fiscal stimulus, which is counterproductive compared to a deep recession.

Markets are experiencing a period of lower volatility and cheaper skew, with potential for significant energy.

The strong economy and activist Fed policies may lead to a demand push economy with strong GDP over longer periods.

Lagging portfolios like private equity and real estate will likely cause a reduction in collateral and slow economic activity.

The market is expected to see a slowdown in buybacks and a mild recession, which will further slow economic activity.

Positive news on inflation this year included dollar strength and some oil weakness due to China's reduced stimulus.

Trends of dollar weakness and China's reopening are expected to reverse, leading to increased commodity demand and inflationary pressures.

The first quarter of the coming year is seen as particularly dangerous from a flows perspective due to lower V and charm flows.

The period from January 10th to the January Opex is expected to be strong from a flows perspective, presenting a buying opportunity.

The market is anticipated to experience a period of higher volatility and potential selling opportunities after the January Opex.

Long vol is considered a cautious position as we move forward, with the potential for realized volatility and a steepening yield curve.

The decline expected in the coming year will ultimately lead to one of the better volatility compression moments seen in secularly inflationary periods.

After the anticipated decline, there is potential for a reemergence of the trend seen early this year, with risk premia increasing and realized volatility decreasing.

Investors are advised to consult with professionals for personalized advice as the market navigates these tumultuous times.

Transcripts

hello and welcome to the final macro and

flows update video

of the year uh it's been a wild ride um

a lot of the macro forces that we've

been talking about for over a year now

have come to pass this year um the

inflationary picture which we clearly

laid out uh over a year ago now um has

really been sticky and uh you know a lot

of of what we've seen in terms of the

populism and the driving forces that

have taken us from a period of operation

um into a time of increasing competition

has also come to pass clearly uh with

the war in Ukraine uh inflation has been

exacerbated by by those forces by the

OPEC plus um you know restrictions and

uh and supporting of oil um we've seen a

lot of things that mimic what we saw

during periods like this in the 60s and

70s already and this is just the

beginning yes in the short term we are

seeing what we saw during the 60s and

70s uh a a beginning of of one of many

recessions more frequent recessions

during this period uh in the 68 to 82

period uh of inflation the last

inflationary period we had uh we had

four recessions in a very short period

of time yet this is somewhat

counterintuitive real inflation adjusted

GDP growth was above Trend much stronger

than it's been in the last 20 30 years

so more frequent downturns in the market

in the economy yet more of a demand push

economy with strong GDP um over longer

periods of time the first recession of

the 68 to 82 period was a long but mild

recession from uh you know in the six

late 69

7071 period um our belief is that's what

we're likely to see here a very very

strong economy for the most part with a

fed that's being activist and trying to

control inflation trying to uh slow um

inflation with what are the wrong Tools

in our view that's probably the worst

case so everybody's talking about

recession not recession strong big deep

recession uh or or or not we believe all

of that is is quite irrelevant we will

have a recession likely a mild recession

um and ironically that's much worse than

a deep recession why because will cause

more populism and more fiscal stimulus

uh which is what recessions do they will

cause uh people to to demand more

stimulus yet we won't get uh the higher

uh you know the the the decrease in

interest rates that would necessarily

come uh if we were going into a much

deeper recession so instead will uh

muddle through on on the economy while

still having uh some aary pressure so a

stack inflationary environment um really

really bad uh for

equities all of this um is happening uh

during a time of uh you know pricing in

in markets becoming much more uh from

AOL perspective much much cheaper skew

has gone from a 98th 99th percentile in

uh January of this year all the way to

the zeroth percentile um the potential

energy of that is is

significant V is still well supplied uh

we believe here into the end of the year

that uh that there'll be some uh you

know support from that V Supply But

ultimately um there is a a coming second

leg down we still believe um in the next

uh first two quarters of the coming

year um importantly the in the new year

uh the new year is a big marker this

year than most years uh and and why is

that well one there's 's a lot of

lagging portfolios like private Equity

Venture Capital real estate that remark

uh quite slowly and that have to remark

on the first of the year this this will

cause a reduction in collateral um much

like the Santa Claus period in the Jor

generally strong because of all of the

uh reinvestment of of of gains uh the

decreasing of of the value of

overwhelming the majority of assets this

year will lead to um a a reverse effect

this year you'll get a Slowdown in

BuyBacks this year BuyBacks continue to

be quite strong and those lag again um

for many reasons a mild recession of SL

economy will slow those um as

well now all of this is happening at a

time when uh you know the inflation this

year we actually had some positive news

on uh we had dollar strength which

exported inflation uh from the developed

World particularly the US um we've had

uh you know uh some form um of of oil uh

weakness due to Chinese uh closing down

uh not a lot of stimulus coming from

China during this period we believe a

lot of those Trends will actually start

to reverse we're starting to see dollar

weakness um we're starting to see China

reopening yes uh you're getting more

covid cases Etc in the short term but

that will eventually lead to later in

the year a reopening and a stimulation

of of of CH the Chinese economy that

will lead to more commodity demand

despite in the short term that not being

the case a refilling of of the spr spr

ETC will also uh support some of these

inflationary pressures so from a macro

perspective um you know this mild

recessionary case which we're likely to

see which a lot of people will become

more and more positive about a lot of

people might even call for a goldilock

situation oh the econom is not too bad

and look the FED is now pausing uh we

believe that's actually the worst of of

all cases um so all of those effects uh

really we really believe in q1

particularly as we get into um the

February uh period through you know past

this January expiration into February

become a lot more um dangerous from a

flows perspective uh we're currently in

a five-week cycle so uh lower V and

charm flows but

uh you know

more uh low volum weighted time in this

period due to to regular vacations Etc

so these two things will be

counteracting each other right at a time

when uh the JP Morgan hedged Equity you

know big S SPX uh trade is right near

strike so we've this has been a bit of a

magnet we've come down into this area as

we have called for in the last couple

weeks but uh but that low volume

weighted time that V Supply not to

mention all of that holiday V that is

low behind what was a de Opex something

that's very highly demanded has led

people to have a lot of downside uh Vall

protection uh in this window so broadly

we believe and we've seen this what

we've called for the last couple weeks

say um a a poorer uh seasonality on the

back half of this uh period despite

November December being quite strong and

a ball compression into that so Market

down B down scenario um and much more

Vault pinning we do believe after uh the

first week in change of January that

that uh that we begin to move out of

that V compression period right at the

same time where Vana and charm flows

actually happen to come back um for this

kind of January Opex period so we

broadly expect January 10th um through

uh CPI um and the January Opex uh third

week third Friday of January should be a

strong period and a period from a flows

perspective to to really kind of buy

into um after this kind of early earlier

kind of uh week period that rally

whatever comes out of that rally whether

it's extends throughout Feb Opex which

you very well might um uh you know

that's our kind of base case will

eventually lead to a bigger selling

opportunity um again we are targeting

mentioned this date before but but watch

for it feed 14th from 15th um as a kind

of a CPI print that will begin to not

look as favorable as the last couple

have um also an economy that starts to

um to weaken considerably more with less

collateralization as well as we

mentioned um and a period of uh you know

real potential weakness um the more the

rubber band stretches and the more we're

able to Rally starting in that J 10th

period through the Feb Opex about that

month and a month and a half or month

and a quarter the more danger there is

in Market markets the case for longval

which we have been cautiously saying is

is coming is building and building as we

move forward this will be my kind of

final Point here for the year I we'll

end with with a with a

cautionary comment here um if you think

about

longall we are now at the zero

percentile and we're there with at the

Money Ball significantly low so as of

the money puts are very very inexpensive

if we get a rally as we're talking about

a stretching of that rubber band we

begin to build this kind of realized VA

potential right as BuyBacks begin to

decrease right right as uh we start to

see uh kind of lot higher long-term

rates um and maybe a steepening in the

yield curve um these these types of

things could really really begin to um

exacerbate not only realize potential

vola ility higher implied ball higher

skew ball not to mention a total lack of

hedging um that's happening now with the

with skew at the zero percentile that

can really lead to a liquidation of that

um it's something that the window again

it opens for we've talked about how

there's now no longer cushions on the

floor but gasoline uh we really do feel

like a spark um is likely to come uh

either in February at those dates we

mentioned if not pushing probably to may

but sometime in this first

six-month uh period um all of the items

uh are there at this point all we need

is time and a bit of a a catching of of

of U of bigger entities by surprise

which we believe will come uh sometime

in these in this first six-month period

so um there is uh there's a reason to

believe that this decline that

eventually happens however um will be

ultimately after it's done one of the

better um V compression uh moments uh

that we've seen sometime inflationary

periods secularly are are good times um

for V compression and so a big b event

coming but after that really a potential

in the b space um with risk Premia

increasing realiz B slowly decreasing uh

generally to the downside uh we do

believe we'll have a reemergence of the

trend we've had early this year um more

secularly going forward after the VA

event that we eventually have here in

the coming

year thank you all uh for a wonderful

year uh it's been wonderful getting to

know all of you as uh investors many of

you friends um we look forward to

helping you manage your wealth and

helping guide you through these

tumultuous times uh in the year ahead uh

happy holidays and a happy

2023

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