Macro and Flows Update: March 2023 - e15

Summary

In this episode of Macro and Flows, Kai discusses the market's reaction to recent events, including the February Opex and the anticipated 5-week cycle leading to March Opex. He highlights the Fed's role in managing market expectations and inflation, emphasizing the importance of not fighting the Fed's policy direction. Kai also touches on the potential impact of the upcoming election cycle and geopolitical tensions with China on the economy and markets, advising viewers to be aware of structural macro flows and to manage their investments actively.

Takeaways

• 📉 The recent market decline following the February Opex is attributed to a reduction in positive flows and a shift in market dynamics.
• 🔄 March Opex is expected to enter a 5-week cycle, historically associated with weaker market performance and reduced positive flows.
• 💹 Despite market decline, it has been relatively calm due to buybacks and structured product flows, which are expected to decrease in the upcoming weeks.
• 🏦 The lack of buybacks during the earnings season, starting around March 16th, may contribute to a lack of demand in the market, potentially exacerbating the downturn.
• 📈 The Federal Reserve (Fed) is likely to address the drop in long-end yields, which have fallen dramatically, as it does not align with their goals to combat inflation.
• 🚫 The Fed's actions suggest they are not aiming for a 2008-style banking crisis, but rather a controlled reduction in market speculation and valuations.
• 🛠️ The Fed's quick response to the Silicon Valley Bank and Signature Bank issues indicates a desire for controlled liquidation in speculative sectors.
• 📊 The banking sector's inherent leverage makes it vulnerable to crises of confidence, which can lead to a chain reaction of liquidation events.
• 🌐 Geopolitical tensions, particularly with China, may escalate during the political season, influencing market sentiment and Fed policy.
• 🏆 The upcoming election cycle may lead to increased fiscal stimulus, potentially driving further inflation and impacting long-term market trends.
• 📝 This transcript is for informational purposes only and should not be construed as investment advice; individuals should consult with professionals for personalized guidance.

Q & A

What is the significance of the February 15th to 17th February Opex mentioned in the script?

The February Opex mentioned in the script is significant because it represents a time when investors may choose to take beta off the table, potentially leading to market adjustments or liquidations. It is a period of interest for those following market trends and making investment decisions based on options expiration dates.

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

In the context of the script, 'liquidation' refers to the process of converting assets into cash, often due to market downturns or the need to meet margin calls. It is a selling of assets, which can contribute to a decline in market prices.

What is a 5WE cycle as mentioned in the script?

A 5WE cycle, as mentioned in the script, refers to a five-week options cycle. This cycle indicates a period where there is typically less positive flow under the market, and it is characterized by a longer duration of about two weeks instead of the usual one week. During this time, the market may experience a calmer decline due to less buying activity and buyback support.

Why is the buyback window closing from March 16th to April 28th?

The buyback window is closing during this period because approximately 40% of buybacks are put on hold starting March 16th. This is typically due to the earnings season, during which companies are not allowed to buy back their own stock as part of regulatory restrictions to prevent insider trading and maintain fair market practices.

What is the Fed's stance on the long end of the curve and yields according to the script?

According to the script, the Fed is likely to maintain a less accommodative stance on the long end of the curve and yields. They aim to talk back up the yields to prevent more speculation and market demand from investors, as they believe the recent dramatic drop in the bond market is not in line with their goals, given the ongoing inflationary and stagflationary problems.

What does the script imply about the Fed's actions during a market decline?

The script implies that the Fed has been actively managing the market decline by selling calls and attempting to reduce speculation and negative wealth effects. They aim for a controlled liquidation and lower market levels to achieve their economic outcomes, but they also move quickly to secure depositors and prevent a full-blown crisis, as seen with Silicon Valley Bank and Signature Bank.

What is the expected impact of the election cycle on the economy and markets?

The script suggests that the upcoming election cycle, about a year away, will likely lead to more fiscal stimulus. As the market comes down and the economy slows, politicians may use this as an opportunity to introduce more fiscal stimulus measures, particularly targeting younger generations and those in need of financial support. This could potentially lead to more inflationary pressures and continue the secular problem of high market valuations.

How does the script describe the current state of the banking sector?

The script describes the banking sector as leveraged and potentially vulnerable to crises of confidence. It suggests that banks, especially those without an implicit guarantee from the federal government, could face significant challenges if deposits or capital are withdrawn on a large scale. The sector is characterized as a 'leverage shell game' that requires confidence and support to function properly.

What is the script's outlook on the structural positioning of rates?

The script suggests that structurally, rates are expected to continue rising, albeit not necessarily in the immediate future. The Fed's actions to combat inflation and maintain price stability will likely require higher rates in the long term, which could pose challenges for market valuations that are currently high relative to the higher interest rates in the back of the curve.

What geopolitical factor is mentioned in the script that could impact markets?

The script mentions the geopolitical tensions between China and the US as a factor that could impact markets. It suggests that political seasons may lead to tougher rhetoric against China and more reactionary policies, which could escalate into bigger problems. The script advises not to lose sight of this issue as it could have significant implications for the market and the global economic landscape.

What advice does the script give to investors regarding market positioning and management?

The script advises investors to be aware of the structural macro flows and to manage their positions actively during different market windows. It emphasizes the importance of being cognizant of structural positioning and being prepared to adapt to changing market conditions. The advice is to 'be water', suggesting flexibility and adaptability in investment strategies.

Outlines

00:00

📉 Market Volatility and Beta Reduction

The paragraph discusses the recent market trends and the significance of February Opex, which was a key period for investors to reduce their market exposure. It highlights the liquidation from the market's recent highs and the anticipation of a different outcome for March Opex. The narrative touches on structural flows and their similarities to past market behaviors, emphasizing the importance of understanding these patterns. The speaker also introduces the concept of a 5-week cycle, which is expected to be challenging due to reduced positive flows and the calming effect of buybacks against market decline. The paragraph ends with a cautionary note about the potential dangers in the upcoming two weeks as the buyback window closes and the market enters a traditionally weaker phase.

05:01

🏦 Fed's Actions and Market Implications

This paragraph delves into the Federal Reserve's role in shaping market outcomes, particularly through their actions during the market rally and their intentions to curb speculation. The speaker explains that the Fed's 'selling calls' strategy aimed to create a negative wealth effect and reduce market speculation. The paragraph also discusses the Fed's communication strategy, emphasizing the importance of not fighting against the central bank's policies. It further explores the Fed's stance on market decline versus liquidation and the response to banking sector issues, specifically Silicon Valley Bank and Signature Bank. The speaker suggests that the Fed's actions were well-timed and managed, and that the market should expect a pause in the Fed's policy, with a focus on managing inflation and maintaining economic stability.

10:01

📈 Market Outlook and Structural Flows

The paragraph provides an outlook on the market's structural flows and the Fed's potential actions to manage long-term interest rates. It discusses the likelihood of the Fed attempting to increase long-term yields despite short-term liquidity provisions. The speaker highlights the delicate balance the Fed must maintain between controlling inflation and not harming the economy. The paragraph also touches on the potential for a recession and the Fed's response to structural inflation. Additionally, it raises two important considerations for the future: the upcoming election cycle and its potential for increased fiscal stimulus, and the ongoing geopolitical tensions with China, which could lead to more reactive policies and increased risks.

15:02

📝 Final Thoughts and Advisories

In the final paragraph, the speaker concludes with a reminder of the importance of understanding and managing structural macro flows for long-term investment success. The speaker advises investors to be active in their management and to be aware of the different positioning required during various market conditions. The paragraph ends with a disclaimer, emphasizing that the content is not intended to provide tax, legal, or investment advice, and that viewers are responsible for determining the suitability of any investment strategy based on their personal circumstances. It also advises consulting with professionals for specific business, legal, or tax situations.

Keywords

💡Macro and Flows

The term 'Macro and Flows' refers to the analysis of large-scale economic factors and the movement of funds in financial markets. In the context of the video, it is used to discuss the overarching trends and events that influence market behavior, such as the Federal Reserve's policies and market reactions to economic data.

💡Volatility

Volatility is a measure of the variation in the price of a security over time. High volatility indicates a high degree of risk due to large fluctuations in price. In the video, volatility is discussed as a key factor that investors and traders must consider, especially during periods of market uncertainty.

💡Beta

Beta is a measure of a stock's or security's volatility in relation to the overall market. A beta greater than 1 indicates that the security is more volatile than the market, while a beta less than 1 suggests the opposite. In the context of the video, taking beta off the table refers to reducing exposure to market risk.

💡Liquidation

Liquidation in a financial context refers to the process of converting assets into cash to settle debts or to realize gains or losses. It often occurs when market conditions lead to forced selling. In the video, liquidation is mentioned in relation to the decline from recent market highs.

💡Opex

Opex, short for options expiration, is the date on which an options contract becomes void. It is a critical time for market participants as options contracts are settled, potentially leading to increased market volatility. The video references specific dates around Opex as times of interest for market activity.

💡Buyback

A buyback, or share repurchase, is when a company buys back its own shares from the open market, often to return value to shareholders or to support the stock price. In the video, the speaker discusses the impact of buybacks on market demand, particularly during the earnings season.

💡FED

The FED, or Federal Reserve, is the central banking system of the United States, responsible for implementing monetary policy to maintain economic stability. The FED's actions, such as adjusting interest rates and conducting quantitative easing, have significant impacts on financial markets and the economy.

💡Inflation

Inflation refers to the rate at which the general level of prices for goods and services is rising, leading to a decrease in purchasing power over time. Central banks like the FED aim to maintain price stability, and managing inflation is a key part of their mandate.

💡Wealth Effect

The wealth effect is a psychological and economic phenomenon where an increase in perceived wealth, such as from rising asset prices, influences economic behavior, leading to increased spending and investment. Conversely, a decline in wealth can lead to reduced spending and a potential economic slowdown.

💡Silicon Valley Bank

Silicon Valley Bank is a financial institution that primarily serves technology and life science companies. In the context of the video, it is mentioned as an example of a bank that faced issues, which the FED was quick to address to secure depositors, illustrating the FED's role in managing financial stability.

💡Geopolitics

Geopolitics is the study of international relations and political geography, focusing on how economic, cultural, and political factors interact with geographic considerations. In the video, it is discussed in relation to the impact of political tensions, particularly between China and the US, on global markets.

💡Election Cycle

An election cycle refers to the series of events surrounding national or regional elections, including campaigning, voting, and the formation of new governments. The video discusses the upcoming election cycle and its potential to influence fiscal policy and market conditions.

Highlights

February 15th to 17th February Opex was a key time to take beta off the table, which could have been beneficial for those who heeded the advice.

There has been a liquidation from recent highs starting at February Opex, leading into a different scenario for March Opex compared to February-March 2020.

Structural flows have similarities, but there is a dampening of knowledge to an extent, which has been verbally communicated in advance.

Approaching March Opex, a 5-week cycle is anticipated, which typically indicates a longer period of less positive flows.

The decline in the markets has been relatively calm due to well-understood factors, such as buyback and charm flows.

The 5-week cycle sees a reduction in these supportive flows, making the next two weeks a potentially dangerous period for the market.

The buyback window is closing, with about 40% of buybacks on hold starting March 16th, affecting demand in the context of a declining market.

The Federal Reserve is expected to address the long end of the curve and yields, as they have recently decreased dramatically.

The bond market reaction has been too fast and too far, especially considering the current situation is not a 2008 banking crisis.

The Fed's actions are aimed at controlling speculation and achieving economic outcomes without overtly targeting market outcomes.

The Fed's strategy involves selling calls to reduce speculation and managing a controlled liquidation without wanting a full market collapse.

The Fed's quick response to the Silicon Valley Bank and Signature Bank issues indicates a managed situation to avoid a crisis of confidence.

The banking sector's inherent leverage makes it vulnerable to crises of confidence, which can lead to a liquidity crunch and potential failure.

The Fed is expected to continue providing short-term liquidity and support, but not to the extent of broad QE or a significant reversal of the current market trend.

The long-term challenge for the Fed is balancing inflation control with economic stability, as structural inflation is expected to be stickier than anticipated.

An election cycle about a year away could lead to more fiscal stimulus, potentially exacerbating inflationary pressures.

Geopolitical tensions, particularly with China, may escalate due to the political season and could have significant implications for the market.

Despite short-term risks and a potential downtrend, there will be opportunities for counter-trend rallies, and investors should be active in managing their positions.

Transcripts

hello and welcome back to another

episode of the macro and flows monthly

update from Kai

volatility um it's been an interesting

month uh as we've talked about

throughout the last several months um

February 15th to 17th February Opex

represented a particularly interesting

time to take beta off the table

hopefully those that have tuned in uh

benefited from from that

conversation uh we have seen uh a

liquidation from the recent highs

starting at Feb Opex uh and not

surprisingly here we sit going into

March Opex a kind of a different outcome

than we saw Feb March 2020 but but

similarly related despite the narrative

that you hear behind the scenes these

structural flows have um some

similarities a slight difference is U

knowledge is all dampening to an extent

we have been out in front of this very

verbally and this is not Co you know

this is not the same crisis uh that set

in front of us but nevertheless uh

interesting coincidence right obviously

not a coincidence um what's going on uh

as we currently stand here approaching

March Opex um we will be heading into a

5we cycle which uh we think is

particularly interesting uh you know

generally five we opcs mean those Cycles

mean that there's a longer amount of

time usually instead of one week about

two where there's less positive flows

underneath the market despite the

liquidation

this decline in the markets has been

relatively calm because uh a calm well

understood uh decline uh comes with a

bunch of buyback uh against you know Von

and charm flows relative to the decaying

put and structured product Deltas in

this 5we cycle uh you start to get less

of that so it's still a very kind of

dangerous period here for the next two

weeks um a little bit longer than the

usual uh window of weakness or window of

non-st strength um the buyback window is

closing here uh March 16th to April 28th

or so uh BuyBacks will largely be going

offline as we get into into the earning

season uh about 40% of BuyBacks are on

hold starting March 16th and I only get

more from there um so important kind of

lack of demand there that you may

normally see that otherwise in the

context of a declining Market um you

know may may exacerbate things in the

short term um in the midterm uh you know

from a flows

perspective um we're likely uh to to

hear the FED uh come back in and try and

talk back up uh the high the long end of

the curve the yields the long end of the

curve they've come down dramatically

it's actually been historic in the last

week um and we don't believe that's what

the FED wants the inflationary

stagflationary problem is still very

much front and center and the bond

market reaction has been uh has been too

fast and too far especially given what

we think is not a uh you know a 2008

banking crisis situation uh we'll get

back into the macro here in a second but

in particular I think it's important to

note that it's not just the flows uh and

the lack of demand that we see during

this kind of next two week week and a

half period it really is um you know the

fact that the FED is like

to not be as accommodative from a a

yield perspective and a Fed policy

perspective yes they'll provide

liquidity to deposits like they have yes

they'll they'll prevent a Liquidation on

the tail but in terms of broad uh

liquidity and Supply from much longer

term and fighting inflation perspective

we do believe uh yes they're not going

to do 50 base points but they do still

want to talk back up the yields along

into the curve um to prevent more

speculation um and and Market kind of

uh demand from investors um at the end

of the day uh you know in the long term

however um we do see uh investors under

lovered a lot of this was broadly U well

telegraphed again we were out there very

clearly giving you dates months ahead of

time um there has been a bit more put

buying particularly lately skew uh in

the in the VA complex has come up and we

do believe this will allow the FED at

the very least to broadly work towards a

pause um which takes us to kind of some

of the macro effects um we were very

clear that the Fed was selling calls

there at the top not actually uh

physically selling call options but they

wanted speculation out of the market uh

they wanted uh a a negative wealth

effect to really take hold and to kind

of wash out specul from the market in

order to affect the economy uh they

won't outwardly tell you that that

they're out there trying to Target

Market kind of outcomes but but broadly

uh the market and the economy are

connected the feedback loop of the

wealth effect and taking out the

speculation after a 20% rally off the

lows of the market is very important for

the FED to to to do in order to achieve

its outcomes um so they were selling

calls don't fight the FED uh that didn't

mean they wanted a liquidation we were

clear there's a difference between a

decline in markets with relatively low

stair step kind of volume um and uh and

a pure liquidation now the FED doesn't

always you know control the outcome as

well as they would like but important to

note that they were very clear that they

wanted the market lower they were trying

to talk the market down Market didn't

listen for a while and eventually though

kind of uh when the window was right as

we explored um the the time was right

for uh for those to be

uh to to to work again don't fight the

FED now the question is does the FED

want to liquidation answer is no and and

I think this decline doesn't mean that a

liquidation or a um or a tail is

necessarily coming actually quite the

contrary I think the FED uh really very

much kind of telegraphed this understood

what was happening um in real time knew

about the Silicon Valley Bank and

Signature Bank issues um and it was very

quick obviously as soon as the decline

happened come in and and and secure

depositors um we believe that that's not

a coincidence um uh you know Silicon

Valley Bank represents uh you know a

large swath of the the technology sector

um uh Signature Bank was very much a

lendo and the crypto space these are

speculative spaces that for the most

part uh are exactly what the FED uh

wanted kind of some of the froth to come

out of um so this is uh kind of Ideal

for the FED in the sense that they've

been selling calls um and want a a

controlled liquidation now many here may

believe hey did you see what happened to

credit s the other day how is this a

controll liquidation some of these CDs

flouts are the are the worst things

we've ever seen in certain um sectors um

listen the banking sector by definition

is leveraged and always and I mean

always with a few exceptions that are

backed by the federal government at this

point are always uh a a without using

the word Ponzi a leverage shell game uh

at the end of the day if uh there is a

loss of confidence in a bank uh and the

deposits are withdrawn whether it's a

you know or or capital is withdrawn and

other means um there is just simply too

much leverage to support um you know in

its Investments without a

deleveraging and this structure you know

particularly as it related to S you know

uh both both entities both Silicon

Valley Bank and signature um these the

the actual uh hold to maturity

Securities having to be remarked

ultimately represent a a step down um

and and uh you know liquidation uh event

so yes there was some particularly bad

acting in in those parts some

irresponsible corporate governance um

but at the end of the day this is a bank

problem and uh it exists across Banks um

and if you have a crisis of confidence

at some point um all banks have to be

backstopped or there is a tale so there

is a always no matter what environment

you're in this reality that Banks um

especially those that aren't already

backed uh with an implicit guarantee

from the federal government um uh you

know can have a self-fulfilling prophecy

of of a tale so um within that context

and the reality that the truth that that

can always happen again we believe this

was broadly telegraphed and well managed

by the FED beforehand um and do believe

that that there's a bit of a overblown

nature to that macro narrative which has

really followed price more than anything

that said that does not mean markets are

going to bounce back and rally because

again as we mentioned in the flows piece

we do believe the FED um is not going to

provide the liquidity and Broad QE that

some people are calling for the market

has been too fast to price in a reversal

by the FED uh we do think but they'll

continue to provide short-term liquidity

markets open the discount window as they

have and continue to keep it open back

stop depositors as they've done we also

believe the same will happen in Europe

with credit S as as Swiss bank has said

so broad liquidity will be provided to

help protect against the tail that said

we do believe the FED will be coming

back in and trying to talk back up that

long in of the curve and that is really

where the real risk lies it's less of a

tail outcome broadly for markets and the

banking sector and more of the

actualization of this reality that we

are broadly in a a spot where the FED is

stuck between a rock and a hard place

they are um trying to take out the

leverage and the speculation and take

down markets from uh you know to a place

so they can slow down inflation and they

have to uh to to meet their Mandate of

of price stability while trying not to

hurt the economy too much and that is a

very delicate balance that is a

different situation with the inflation

at hand than they have ever they've seen

the last 40

years um ultimately uh this raising of

expectations of the long and the curve

we which we believe will happen uh

before too long again once things have

calm down a bit um is um is the ultimate

problem for Val markets valuations are

high relative to higher interest rates

in the back in the curve and

structurally we believe rates are still

going higher maybe not this month maybe

not next month but broadly the FED will

have to come back in and start um uh

fighting inflation again after a short

pullback here um this pause that we're

going to get is a chance for the FED to

stop and look around and see uh what's

going on with the lag and we do believe

that that structural inflation will

continue to be much stickier Than People

expect we may get a recession we don't

believe it'll be a deep one um

ultimately that will force the fed's

hand um again lastly um not many people

are looking at two things which are very

important in office in the distance and

I want our our listeners to to start

thinking about that we're heading into

an election cycle in about a year excuse

me and that election cycle means more

fiscal stimulus the more this Market

comes down the more the economy slows

even if we get a mild recession that

will be all the excuse that politicians

need left or right to talk more fiscal

stimulus into the hands of the voting

public particularly Millennials and the

generation that cannot uh you know fund

their homes cannot um get some of the

you know fund their

educations expect stimulus to the people

and that ultimately is more inflationary

again and will continue to drive this

secular problem that's one uh two uh

China and geopolitics we haven't talked

about in a while it's kind of gone to

the back burner there was a moment of of

appearing approachment between China and

the US that faded very quickly political

season also means more tough talk

against China um it also means more

reactionary policy the more hemmed in

China feels um the more likely we are to

see um bigger problems do not take your

eye off that ball um the FED is likely

happy with this outcome don't fight the

FED um that said understand that

positioning is still

relatively um uh you know short uh fed

paw is broadly good uh and the B that

balance um for things and so after a a

bit of a window here of of weakness and

potential risk um know that we'll

probably also still get our fair share

of counter Trend

rallies despite what is a secular U

downtrend um as well so uh as always a

lot of up down up or down up down in

this scenario um be water um do remember

that these structural macro flows matter

over the long term and that is the way

to to play this decade really not just

the next year or two um but uh you know

that has to be in real terms and we have

to be cognizant of the structural

positioning during different windows and

be active in our management be water I

wish you well 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 sub security

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video furthermore nothing in this video

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recommendation to buy sell or hold any

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Financial circumstances and risk

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