Macro and Flows Update: October 2023 - e22

Summary

The video script discusses ongoing geopolitical conflicts, particularly the war in Gaza, and their impact on global markets. It highlights the West's tensions with China and Russia, and how these conflicts can influence resource markets, such as oil and gold. The speaker anticipates increased global activity and conflict, drawing parallels with the 1970s. The script also covers the financial response to these tensions, including government spending and the issuance of bonds. It predicts a positive Q4 due to structural liquidity effects and seasonal factors. The speaker advises on investment strategies, suggesting a focus on tech and long-dated call positions, while cautioning about potential market volatility and a coming decline in late January.

Takeaways

• 🌍 Increased global conflicts, such as the war in Gaza and tensions between the West, China, and Russia, are seen as ongoing issues rather than isolated events.
• 📈 The geopolitical situation affects financial markets, with potential impacts on oil and gold prices, and is considered a factor in the current competitive global landscape.
• 💰 Government spending, particularly in response to conflicts and economic needs, contributes to the issuance of bonds, affecting liquidity in the financial system.
• 📉 The liquidity pull from bond issuance and higher interest rates can lead to a decrease in stock market liquidity and affect risk assets.
• 🔄 Despite negative sentiments, structural flows in the market remain strong and can counterbalance negative trends during specific periods.
• 📅 A specific date, October 6, was highlighted as expected to mark a market rally, which aligns with structural support periods in the market.
• 💹 Q4 is expected to be positive due to major liquidity effects at the year's end, with significant reinvestment of collateral and a potential 'Santa Claus rally'.
• 🛒 Seasonal factors like holidays contribute to market dynamics, with expectations of increased market activity and potential short-term challenges for bears.
• 📈 The issuance of structured products has helped stabilize the market, providing support despite global risks and seasonal liquidity weaknesses.
• 🔮 The market is anticipated to be volatile, with a potential blowoff top situation setting up for a larger decline in late January or early February.
• 🎯 Focus on tech and low-quality rallies are advised for the upcoming market movement, with a predicted rotation back to value as yields may initially decrease.

Q & A

What major global conflict is being discussed at the beginning of the script?

The major global conflict being discussed is the war in Gaza, with Hamas attacking Israel.

How does the speaker view the conflict in Gaza in the context of broader global tensions?

The speaker views the conflict in Gaza as another front in the ongoing war that already exists between the West, China, and Russia, with Iran and entities like Hamas being involved due to perceived opportunities in a more competitive world.

What impact do global conflicts and tensions have on the oil and resource markets?

Global conflicts and tensions put a put option under the oil market and other resource markets globally, as well as under assets like gold and safe havens like the dollar, leading to increased market volatility and shifts in investment strategies.

What historical parallels does the speaker draw with the current economic situation?

The speaker draws parallels with the 1970s, highlighting the OPEC crisis, the Vietnam War, the active Cold War, and the Great Society program, all of which involved significant fiscal spending and had an impact on the economy and markets.

How does the speaker describe the effect of government spending on the economy and markets?

The speaker describes the need for more issuance to meet spending, both domestically and internationally, as similar to the 1970s. This issuance pulls liquidity out of the system, affecting stock markets and risk assets, and leading to a reverse 'TINA' effect where money is drawn out of risk assets.

What specific date was given for a market rally to begin?

October 6th was the specific date given for the market rally to begin.

What are the two major liquidity effects expected at the end of the year?

The two major liquidity effects expected at the end of the year are the reinvestment of gains from the equity market at the beginning of January and the increased volume of trading around the holidays, particularly Thanksgiving, Christmas, and New Year's Day.

What is the significance of the January 17th expiration in the script's analysis?

January 17th is significant as it marks the Wednesday of January expiration, which the speaker believes could be a turning point for a coming larger decline in the market.

How does the speaker describe the role of structured products in the current market?

The speaker describes the role of structured products as significant in pinning the market and providing support, despite the drawn liquidity and global risks, by leaving banks and market makers long ball and well hedged.

What advice does the speaker give for playing the anticipated market rally?

The speaker advises using long-dated call positions and calendar call spreads for playing the anticipated market rally with some protection, as they believe this could be a decently large rally with a significant amount of convexity.

What sector does the speaker believe will perform better during the rally and subsequently lead the decline?

The speaker believes that the tech sector will perform better during the rally but will also lead the decline as it begins its second leg down after the rally ends, with a dramatic rotation back to value from growth.

Outlines

00:00

🌍 Global Conflicts and Macroeconomic Impact

This paragraph discusses the ongoing global conflicts, particularly the war in Gaza between Hamas and Israel, and how they fit into the broader context of geopolitical tensions involving the West, China, and Russia. It highlights the resurgence of old conflicts and the emergence of new ones in an increasingly competitive world. The speaker suggests that these conflicts, along with the need for more government spending to support economies, are reminiscent of the 1970s, with an OPEC crisis, the Vietnam War, and the Cold War. The issuance of bonds to meet spending is drawing liquidity out of the system, impacting stock markets and risk assets. Despite these challenges, the speaker does not view the current situation as surprising, but rather as a continuation of expected global activity.

05:02

📈 Market Analysis and Expected Rally

The speaker provides a market analysis, predicting a specific date, October 6, for a market rally following the September declines. The expectation is based on structural support in the market during November and December. The S&P is said to have rallied significantly since that date, and the speaker anticipates this positive trend to continue despite temporary weakness. A positive Q4 is expected due to major liquidity effects at the year's end, with a significant reinvestment of capital and a Santa Claus rally anticipated. However, the speaker warns that the issuance of bonds continues to pose problems, though it may slow towards the year's end.

10:04

💹 Role of Structured Products and Market Support

This paragraph examines the role of structured product issuance in the market, noting that it has left banks and market makers well-hedged and able to prevent excessive market fluctuations despite the risks and liquidity shortages. The speaker suggests that there will be substantial support in the upcoming period, especially considering the cash crunch at the end of the year. The Fed, Treasury, and other entities are expected to be cautious and potentially supportive of liquidity. The speaker advises watching the market closely in the days following the expiration week, as the market's performance during this time could indicate future trends.

15:05

📊 Investment Strategy and Market Outlook

The speaker concludes with an investment strategy and market outlook, suggesting that despite the expected rally, the market will remain volatile, especially as it heads into November and December. The speaker anticipates a market uptick in late December and early January, followed by a decline. Tech is expected to perform better than it has in recent weeks, but it is also expected to lead the next market decline, with a shift from growth to value stocks. The speaker advises that the dispersion in the market will continue, making it a great opportunity for certain trades. The speaker also provides a reminder that the information shared does not constitute investment advice and that individuals should consult with their advisors before making investment decisions.

Keywords

💡Macro

The term 'Macro' refers to the large-scale economic factors and events that influence the overall performance of the economy and financial markets. In the context of the video, it is used to discuss the broader geopolitical and economic issues such as wars, conflicts, and globalization that impact financial markets. The speaker uses 'Macro' to analyze the ongoing war between the West, China, and Russia, and how these events can affect market trends and investor behavior.

💡Expiration

Expiration refers to the end of a contract period for financial derivatives like options and futures. In the video, it is used to discuss how the expiration of financial instruments can influence market behavior, particularly around specific dates when many contracts are settled. The speaker talks about 'October expiration' and how it can create market volatility or provide support for certain market movements.

💡Conflict

Conflict, as used in the video, refers to geopolitical tensions and military confrontations between nations or groups. The speaker discusses the impact of conflicts, such as the war in Gaza and tensions between the West, China, and Russia, on global markets and investor sentiment. Conflicts can lead to uncertainty and volatility in financial markets, affecting asset prices and investment strategies.

💡Globalization

Globalization is the process by which businesses, markets, and economies become increasingly interconnected and interdependent on a global scale. In the video, the speaker mentions globalization as a backdrop against which conflicts and competition are more likely to occur, affecting the global landscape and financial markets. The interconnected nature of globalization means that economic and political events in one region can have repercussions in others, leading to complex market dynamics.

💡Liquidity

Liquidity in financial terms refers to the ease with which assets can be bought or sold without affecting the asset's price. In the video, the concept of liquidity is central to the discussion of market dynamics, particularly in relation to government spending and the issuance of bonds. The speaker talks about how increased government spending and bond issuance can pull liquidity out of the system, affecting stock markets and risk assets.

💡Structured Products

Structured products are financial instruments that are created by combining various assets, such as stocks, bonds, and derivatives, to form new investment products with specific risk-return profiles. In the video, structured products are discussed as a significant factor that has helped stabilize the market despite liquidity concerns. They have allowed banks and market makers to maintain long positions and hedge effectively, thus supporting market stability.

💡Gamma

Gamma, in finance, refers to the rate of change of an option's delta with respect to the change in the price of the underlying asset. It is a measure of the curvature of the value of an option in relation to the underlying asset's price. In the video, gamma is used to discuss how changes in the market can affect the value of options and, by extension, the overall market dynamics. The speaker suggests that gamma, along with vega, can influence the market's movement, particularly in the context of expected rallies and declines.

💡Vega

Vega is a term used in finance to describe the volatility of an option's price in relation to the overall volatility of the underlying asset. It measures the sensitivity of the option's price to changes in the implied volatility of the asset. In the video, vega is discussed as a key factor that can influence market movements, especially in the context of large expiration events. The speaker suggests that vega and gamma can provide support or pressure on the market, depending on the circumstances.

💡Rally

A rally in financial terms refers to a recovery or an upward movement in the price of assets, such as stocks or commodities, after a period of decline. In the video, the speaker predicts a market rally following the October 6th expiration, based on the structural support and positive liquidity effects expected at the end of the year. The rally is seen as a temporary reversal of the previous downtrend, driven by various macroeconomic factors and market dynamics.

💡Volatility

Volatility in finance is a measure of the variation in price of a trading instrument over time, primarily used as an indicator of the risk associated with the price movement of an asset. In the video, volatility is discussed as a key characteristic of the market, particularly in the context of the expected rally and the subsequent decline. The speaker suggests that volatility will increase as the market moves into November and December, leading to more dispersion and rotation in the market.

💡Tech

In the context of the video, 'Tech' refers to the technology sector of the stock market, which includes companies that specialize in the development and sale of electronic and high-tech products and services. The speaker predicts that the technology sector will perform better than it has in recent weeks and regain some momentum. However, it is also suggested that this sector will experience a second leg down after the expected rally, indicating a shift from growth to value stocks.

Highlights

The ongoing war in Gaza with Hamas attacking Israel is seen as another front in the larger geopolitical conflicts involving the West, China, and Russia.

The global landscape is becoming more competitive, leading to an increase in conflicts and activities worldwide.

The speaker expects more conflict and competition, which is well telegraphed and understood by countries like Russia and China.

Conflicts and competition influence the oil and other resource markets, as well as safe havens like gold and the dollar.

The current global situation is compared to the 1970s, with an OPEC crisis, the Vietnam War, and the Cold War, along with significant fiscal spending.

There is an increased need for bond issuance to meet spending, both internationally and domestically, leading to a pull on liquidity.

The speaker predicts a positive Q4 due to two major liquidity effects at the end of the year, with significant reinvestment of capital.

The expected Santa Claus rally and January effect could lead to a large positive reinvestment of new capital on January 1st.

The market is expected to be tough to be short in Q4, especially with the ongoing war and geopolitical tensions.

The FED meeting on November 1st is highlighted as a potentially important date that could influence the market's direction.

Structured products have played a significant role in pinning the market despite liquidity concerns.

Banks and market makers are well hedged due to structured product issuance, preventing the market from getting out of hand.

The market is expected to rally back towards recent highs by mid-January, setting up a potential blowoff top situation.

Volatility is expected to increase as the market heads into November and December, leading to a potential market uptick.

Gamma and vega may not be the worst thing to play this route, with long-dated calls being a good way to play the rally.

Tech is expected to perform better than it has in recent weeks, but a rotation back to value from growth is anticipated post-rally.

The speaker advises watching the market closely in the coming days, as it could indicate the market's direction in the short term.

The end of October and the beginning of November are expected to be positive for the market, with the FED meeting potentially leading to a bullish market run.

Transcripts

hello and welcome back to another macro

and flows update for here at October

expiration um let's start with macro

this time around there's been a lot of

that going on um for one we have a war

in Gaza Hamas attacking um

Israel uh we've talked about macro quite

a bit this year particularly in terms of

the coming conflicts that are likely to

happen during a time of

globalization um unlike many we actually

see this as just another front on an

ongoing war that already exists the West

versus China and

Russia add to it Iran and entities like

Hamas uh this despite being an old

conflict is invigorated there is a new

war U because countries see an opening

right and what is now a much more

competitive world

we've talked about this for several

years now we expect there to be more and

more activity globally like this more

conflict things like this put a put

underneath the oil market and under

other resource markets globally puts a

put under Ed things like gold and safe

havens like the

dollar um this is something that you can

continue to expect these things are not

a straight line but the probabilities of

them um continue to be quite high so

this is not a

surprise um and I would argue actually

it's something that's well

telegraphed um and something that Russia

in particular Iran as a vassel of that

um and China by extension um are very

very aware

of

um add to that conflict and that growing

drum beat of war and competition that

we're seeing um the continued need for

more issuance uh to meet spending

spending that's happening uh in Ukraine

uh by the US government uh spending

that's happening uh at home to meet

individuals and growing uh distrust in

government um spending that's happening

uh across the board to support the

economy this is very similar to the

1970s we have we had an OPEC crisis then

we had a Vietnam War we had an active

cold war and we had a great society

program the last big fiscal spending

program since what we have now um these

are all threads that I would continue to

expect to be pulled on as we move

forward in the years to

come this issuance to meet that spending

is pulling liquidity out of the system

at the end of the day somebody has to

buy these bonds uh somebody has to fund

this spending and there is less and less

Supply um of of money to come meet that

that money as interest rates go higher

pulls liquidity out of the stock market

ultimately and other risk assets which

can now go to the alternative there was

no alternative there was a Tina effect

for all these years now there is a

reverse Tina that is slowly sucking

money out of risk assets as

well we're seeing that in particular

since the TGA was drain after the debt

ceiling we talked about this for several

months um it doesn't happen right away

there's a lag as we've discussed but

here is that lag but again that issuance

despite being negative is met by other

structural flows and that those

structural flows are very very strong

during certain windows as we've talked

about if we go back to last month in

September uh a big quarterly expiration

as we mentioned we we mentioned there be

there should be significant support into

the window of strength um which we saw a

massive dampening of all support against

an otherwise weak uh liquidity picture

led to a market going essentially

sideways after that initial decline in

early September that we called for um we

mentioned that if that decline was well

uh well uh supported in that window as

we expected and that Vault continued to

be compressed that come October 6 we

give a very specific date we would

expect the market to Rally back and

begin the process of healing that those

September declines eventually because

November December have structural

support we'll get to that structural

support in a second but October 6 indeed

was the bottom that we expected and we

have since seen a significant rally in

the S&P of 170 to 180 points uh that's

about

4% um not bad four four and a half

percent

um we expect this now to continue from

here despite some some maybe uh declines

briefly in this window of weakness here

after October expiration but except for

that we would expect this rally to kind

of continue um and we expect a very

positive

Q4 um why do we expect a positive Q4

we've talked about this before but let's

review two major major liquidity effects

at the end of the year uh on January 1st

uh there's about 10 to 20% of the total

collateral that's been gained this year

there's A1 trillion Equity Market let's

say the Market's up about 20% that's $2

trillion if about 15% of that goes back

into reinvestment at the beginning of

the year if you have that

recal and increase of of investment that

comes in first of the year is about $3

trillion in the context of a market that

has incremental flows of about 50

billion very small amount to move the

market on a day-to-day basis um 3

trillion is a massive massive amount um

that is months of volume and incremental

flow so that will get front run as it

always does in positive years with not

always but in most situations for that

Santa Claus rally that January effect

afterwards so that month but importantly

because of the holidays during that

period both Thanksgiving and Christmas

uh New Year's President's Day um you

know we're likely to get some uh some

significant V and charm buyback into a d

toally expiration that has a ton of open

interest and a ton of skew as it's been

out there for many years and one is one

of the biggest expirations out there so

expect a lot of supportive Decay uh to

to to the market in terms of v and charm

expect a big positive reinvestment of

new capital on January 1st and that

really means all of November and all of

December into mid January is a very very

tough time to be short particularly in

new wall of worry with the war that

we've been talking about um and whatnot

yes that issuance U is still a problem

but that should uh slow a little bit

into the end of the year and we think

that November 1st in particular is a

very important date that fed meeting is

given the war given the the creep up uh

and yields and concern by by fed

presidents like Lori um Lori Logan of

the Dallas fed who's a significant Hawk

um you know will likely cause the FED to

not only pause but take an extended

pause here into the end of the year um

and it will also lead the treasury We

Believe to shorten duration on its

issuance and slow uh some of the

issuance as well that combination of

slowing some of the liquidity drain

despite it still coming out paired with

um uh a a increased uh Von and charm

flow structurally into to the end of the

year could likely uh squeeze the shorts

We Believe into what could be a very

very interesting rally back towards the

recent highs and we believe all-time

highs uh by mid January that would be

the perfect setup for January 17th

Circle that date on your calendar the

Wednesday of January expiration the vi

expiration in January to Mark a

beginning turning point for then a

coming larger decline we do believe that

this

uh could very well move uh quite

convexly given um you know of almost 10%

given the amount of uh flows that we

will likely see into the end of the year

that would be the perfect blowoff top

situation we'll see if we get it or not

um I want to review Structured Products

the amount dramatic amount of issuance

that we've seen there has uh has played

a significant role in helping to pin

what has otherwise been significant

amount of drawn liquidity GL Global

risks in the market um and that

structured product issuance uh has left

Banks and market makers significantly

long ball and well hedged um allowing

the market to not get out of hand

despite all these risks and despite the

seasonally weak period with period with

all of the issuance the fact that it was

able to pin the market and hold it at

Bay despite the 5 to 7% decline we saw

is a significant win for the Bulls in

that week period and is very telling we

believe that there will be a significant

um you know amount of support likely um

in this coming

window

um there's usually a cash Crunch at the

end of the year as Banks need to have

more capital on their books um we also

believe that the fed and Treasury and

with the understanding that that is

likely coming more so than most years

given the IL liquidity will be very very

cautious and potentially as a result

quite supportive for liquidity into the

end of the year as

well so this is the macro picture um

we've you know that having been said we

are are having this conversation on uh

on on Monday of expiration a little bit

earlier than we usually do very strong

Monday as they tend to be of expiration

um with all the Vana and support going

into expiration week um the next several

days are very

important why because this is a very

supportive period uh tomorrow Tuesday

and Wednesday of expiration morning U

have structurally positive flows if this

Market despite the strength on Monday

cannot continue to build on the strength

for the next two days that would be a

sign that in the very short term meaning

for the next two weeks that we could see

a little bit more Digest question so

watch the next two days very carefully

um there is a chance that if that is not

building the momentum that we need we

believe it will but if it does not and

we see some continued weakness um uh you

know into what is otherwise a strong

period that would be a clue that after

expiration we could see some some again

some weights of that issuance and

liquidity pull continuing to to make the

the market digest a bit longer that said

We Believe by October 31st end of the

month beginning the month flow should be

quite positive this month because it is

an up month if it continues to be um we

also believe then with the FED meeting

on November 1st itself that uh given

what we think is a positive macro um

outcome for the FED there we could

really begin to see into November 3rd

and Von a charm week of November really

the markets start to to to run

so um a bullish message here after uh

the the pullback that we expected in

September and that October 6th turn that

we've we've called for um again this

does not mean don't take profits along

the way we we do expect this will be um

a a volatile um uh market and

increasingly so as the market um heads

into November and December we also

believe that that volatility will

actually lead ironically into market up

vol up as we get into um late December

early January um and V gets to a nater

so we do believe that V will eventually

bottom here and that actually gamma and

v may not be the worst thing um to way

to play this route a long dat call

position we believe set out in uh

February or March um Opex for next year

could be a very interesting way to play

this rally with a bit of protection um a

nice amount of convexity for what could

be a decently large rally and a ball

that will likely have to uh bottom at

what is a a realized ball that will

slide too low so calendar call spreads

in particular um long-dated calls um are

probably the best way to play this rally

we believe in the months to

come um ultimately a blowoff top we'll

see market up B up potentially for weeks

um before some type of Decline and we do

believe that will come in late January

and February if we do get this rally

that we um likely see in terms of areas

to focus on We Believe Tech um will will

actually do a little bit better than it

has been um in in the last several weeks

and regain a bit of end ofe push uh as

we get a trash Dash um uh you know some

of the Russell might actually do okay as

well uh we believe it'll be a lowquality

rally um uh in particular but we also

believe that those items those those

those entities that rally during this

period are also the ones that are most

likely to kind of lose um in the coming

decline we do believe Tech in particular

will begin its second leg down after

this uh this rally comes and it will be

a dramatic rotation back to Value from

growth into this coming decline um

ironically it'll happen as as we believe

yields will actually come down during

that period for um for some initial

period uh and and again counterintuitive

much like the tech rally this year has

come in the context of rising yields

which again has been a very count

counterintuitive duration move expect

more dispersion to continue index ball

should be more pinned dispers that

should lead to more more risk and more

rotation as we've seen all year that

should continue to be a great trade as

we have had in our VA neutral as

well it will be an interesting Market

continue to be water thanks again for

joining me um until next time this is

jeem Caron with your macro and flows

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