Macro and Flows Update: December 2023 - e24

Summary

The video script discusses the recent market trends and expectations for the future, highlighting the 15% S&P 500 rally since October 31st and the role of structural flows and Fed's policy pivot. It emphasizes the market dynamics such as options expirations, reinvestment of collateral, and short squeezes. The speaker also delves into macroeconomic factors, including inflation, employment, and geopolitical tensions, and suggests that these elements could drive market behavior in the upcoming year. The importance of staying nimble and adapting to market changes is stressed, along with a caution that the content does not constitute investment advice.

Takeaways

• 📈 The market experienced a 15% rally in the S&P 500 since October 31st, which was faster than expected and has significantly squeezed short positions.
• 📊 Anticipated market dynamics, such as structural flows and a marginal pivot from the Fed and Treasury, played out as expected, contributing to the market's movement.
• 🔄 December quarterly and January options expirations are significant events driving market behavior, with a large amount of decay expected to impact the market.
• 💹 The reinvestment of collateral and momentum factors are expected to continue to drive the market, especially at the beginning and end of each month, quarter, and year.
• 🚀 The potential for the market to reach new highs is strong, with all-time highs within reach, but a pullback may occur due to short-term supply and demand dynamics.
• 🌐 Geopolitical tensions and narratives influence market sentiment, with events such as the situation in Ukraine and the Middle East potentially impacting investor behavior.
• 💪 Strong wage growth and tight labor markets are indicative of ongoing inflationary pressures, which may not be as transitory as some believe.
• 🏛️ Fiscal policy, particularly ahead of an election year, is expected to play a significant role in driving economic trends, with measures aimed at supporting younger generations and addressing inequality.
• 🌍 Rising populism and protectionism are likely to continue influencing economic policy, with both left and right-wing populism driving similar fiscal measures.
• 🛡️ Investments in sectors related to government spending, such as healthcare and defense, are expected to perform well due to anticipated increases in fiscal spending.
• 📉 The script advises viewers to stay nimble and prepared for potential market volatility, without making specific investment recommendations.

Q & A

What was the initial market behavior discussed in the script?

The initial market behavior discussed was a decline into the end of October, followed by a reversal on November 1st, which was driven by structural flows and a marginal pivot from the Fed and Treasury.

What was the unexpected development in the market after the initial rally?

The unexpected development was that the market rally was even quicker than anticipated, with the S&P 500 experiencing a 15% rally since October 31st.

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

In the context of the script, 'blowoff top' refers to a situation where the market experiences a rapid and sharp increase in prices, often indicating a peak before a potential decline.

How does the script describe the role of options expirations in market dynamics?

The script describes options expirations as having a significant impact on market dynamics, with short puts held by dealers in short stock consistently having to be bought back as time passes, leading to an increase in market prices.

What is the significance of the time-weighted and volume-weighted time during the holiday season mentioned in the script?

The time-weighted and volume-weighted time during the holiday season is significant because it is considerably shorter than other times of the year, leading to an acceleration in market movements and a potential front running of certain trends.

What is the 'reinvestment collateral' mentioned in the script, and how does it affect the market?

The 'reinvestment collateral' refers to the new money that portfolio managers put to work, often at the beginning and end of each month, quarter, and year. This reinvestment can lead to a significant increase in market liquidity and can drive market valuations higher.

What does the script suggest about the role of narrative in market behavior?

The script suggests that narrative follows price, with positive news often accompanying market ups and increased bullish sentiment. This can eventually lead to a trap door for a market move lower.

What are the potential geopolitical implications discussed in the script?

The script discusses potential geopolitical implications such as increased tensions involving China, Russia, and Iran, and the possibility of a broader global conflict. It also mentions the importance of monitoring labor rights and protectionism as they relate to economic policies.

How does the script view the recent pivot by the Fed, and what are the potential consequences?

The script views the recent pivot by the Fed as premature and potentially a mistake, suggesting that history may not judge the Fed's actions kindly. The consequences could include a reacceleration of inflation and a continuation of protectionist policies that drive inflation.

What investment strategies are suggested for the coming year in the script?

The script suggests investing in areas that focus on fiscal spending, such as healthcare, defense, and infrastructure. It also recommends looking at gold as a hedge against volatility and potential risks of American policy dominance, while advising to be short on oil puts due to the expected continued support from OPEC and others in terms of supply.

What is the overall outlook for the market and economy as discussed in the script?

The overall outlook is for a continuation of the current market trends, with potential for further increases and a strong January effect due to reinvestment flows. However, the script also warns of potential risks and shifts, including geopolitical tensions, policy changes, and market corrections.

Outlines

00:00

📈 Market Analysis and Expectations

This paragraph discusses the recent market trends, highlighting the 15% rally in the S&P 500 since October 31st and the expectation that the market could reach all-time highs. It mentions the initial decline in the market at the end of October, followed by a reversal in early November due to structural flows and a marginal pivot from the Fed and Treasury. The paragraph emphasizes the quick market movement and the squeeze on short positions, as well as the potential for further market increases based on new information from the Fed. It also outlines the role of options expirations and the reinvestment of collateral in driving market dynamics.

05:02

💰 Collateral Reinvestment and Market Dynamics

The focus of this paragraph is on the impact of collateral reinvestment and options expirations on the market. It explains how the reinvestment of a significant amount of collateral following market rallies can lead to substantial market movements, especially in a liquid market environment. The paragraph also discusses the effects of short put options held by dealers, which need to be covered as time passes, contributing to market upward pressure. Additionally, it touches on the narrative that follows market prices, suggesting that positive news can drive the market higher, setting the stage for a potential reversal.

10:07

🌐 Geopolitical Tensions and Fiscal Policies

This paragraph delves into the geopolitical tensions and their impact on the market, emphasizing the ongoing conflicts and the potential for a broader global conflict. It discusses the role of populism in driving fiscal policies, particularly in an election year, and how these policies could contribute to inflation. The paragraph also highlights the importance of protectionism and deglobalization in shaping labor rights and wage growth. Furthermore, it touches on the energy policy of OPEC and its potential to influence oil prices.

15:08

📊 Investment Strategies and Risk Management

The final paragraph provides insights into investment strategies and risk management in the context of the discussed market conditions. It suggests that precious metals, particularly gold, could be a beneficial investment due to their volatility and the potential for significant price increases. The paragraph also advises being cautious of oil puts due to the high volatility and supportive OPEC policies. Additionally, it recommends focusing on government spending in areas such as healthcare, defense, and infrastructure, expecting these sectors to perform well. The paragraph concludes with a reminder to stay nimble and a note that the content does not constitute investment advice.

Keywords

💡Macroeconomics

Macroeconomics is the study of the behavior of the economy as a whole, including aggregate measures such as gross domestic product (GDP), inflation, unemployment, and fiscal and monetary policy. In the video, the speaker discusses macroeconomic factors like market trends, the Federal Reserve's actions, and geopolitical tensions, which all fall under the umbrella of macroeconomic analysis.

💡Options Expiration

Options expiration refers to the date on which an options contract becomes void and can no longer be exercised. In the context of the video, the speaker talks about the impact of December and January options expirations on market dynamics, particularly how the decay of short puts held by dealers leads to buying pressure and potential market rallies.

💡Market Rally

A market rally is a period of sustained increase in the prices of securities in a particular market, often driven by positive investor sentiment and favorable economic conditions. In the video, the speaker describes a 15% rally in the S&P 500 since October 31st and attributes it to various structural and market flows.

💡Collateral Reinvestment

Collateral reinvestment refers to the process of using cash or securities that have been posted as collateral for one investment and reallocating it to other investments to generate additional returns. In the video, the speaker discusses how the reinvestment of collateral following a market rally can lead to significant new investment inflows, influencing market movements.

💡Short Squeeze

A short squeeze occurs when a stock or other security jumps sharply higher, forcing traders who had bet that its price would fall (short sellers) to buy it in order to prevent further loss. Their scramble to buy only adds to the upward pressure on the stock's price. In the video, the speaker talks about the short squeeze that has already occurred and how it is a significant dynamic in the current market environment.

💡Narrative

In the context of financial markets, 'narrative' refers to the overarching story or explanation that investors use to rationalize market movements and economic conditions. It often shapes investor sentiment and behavior. In the video, the speaker suggests that as the market goes up, the narrative becomes more positive, which can lead to increased risk-taking and eventually a potential market reversal.

💡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, the speaker expresses skepticism about the Federal Reserve's view that current inflation is transitory and suggests it may be more persistent.

💡Populism

Populism is a political approach that strives to appeal to ordinary people who feel that their concerns are disregarded by established elite groups. It often involves a general mistrust of the establishment and can manifest in various forms across the political spectrum. In the video, the speaker connects populism to upcoming elections and fiscal policy, suggesting that it will drive economic trends.

💡Geopolitical Tensions

Geopolitical tensions refer to the strained relationships and conflicts between different countries or regions, often driven by economic, political, or military factors. In the video, the speaker discusses ongoing tensions, such as those involving Russia, China, and the Middle East, and suggests that these tensions are part of a broader global conflict.

💡Energy Policy

Energy policy refers to the set of decisions, regulations, and strategies implemented by a government or international organization to address issues related to energy production, distribution, and consumption. In the video, the speaker predicts that OPEC's restrictive energy policy will continue to constrain supply, leading to higher oil prices in the future.

💡Investment Strategy

An investment strategy is a plan or approach that an investor uses to achieve specific financial goals. It typically involves selecting specific types of investments based on the investor's risk tolerance, time horizon, and return objectives. In the video, the speaker provides insights into various investment strategies, such as investing in fiscal spending-related sectors and precious metals.

Highlights

The market's initial decline and subsequent reversal in November was anticipated based on structural flows and a marginal pivot from the Fed and Treasury.

A rapid 15% rally in the S&P 500 since October 31st has occurred, which was faster than expected and has significantly squeezed short positions.

The market dynamics and the potential for a blowoff top have been highlighted as something to be very aware of.

The December quarterly and January options expirations are significant drivers of market movement due to the decay to the skew.

The reinvestment of collateral and the momentum factor at the beginning and end of each month, quarter, and year contribute to market movement.

A 25 trillion dollar reinvestment is expected due to the market's performance, which can significantly impact the market's liquidity and movement.

The potential for a strong January effect and Santa Claus rally is tied to the reinvestment of collateral.

The short interest and the squeezing of shorts are significant market dynamics that are currently occurring.

Narrative follows price, and as the market goes up, positive news and bullish sentiment can lead to increased risk-taking and potential market reversals.

Jerome Powell's declaration of 'Mission Accomplished' is seen as a potential mistake, with a comparison to George Bush's statement.

The belief that inflation is transitory, despite previous instances, is contrasted with the potential for sticky inflation due to various economic factors.

The impact of populism and elections on fiscal policy is expected to drive inflation and protectionism.

Geopolitical tensions are expected to continue, with a focus on the alliance between China, Russia, and Iran, and their efforts to destabilize regions.

The potential for increased military spending and support for fiscal policies that focus on health care, defense, and infrastructure is expected in the coming year.

Investment in gold and precious metals is recommended due to expected volatility and geopolitical tensions.

The video concludes with a reminder that the content does not constitute investment advice and that viewers are responsible for their own investment decisions.

Transcripts

hello and welcome back to another macro

and flows update this time for the

December

expiration here we are going into the

holidays and everything we've talked

about for the last three four months has

played out exactly as we would have

expected the market got its initial

decline into the end of October and then

November 1st October 31st November 1st

we got the reversal again that was on

the basis of so many structural flows

coming as well as a marginal pivot from

the fed and treasury but the reality is

those pivots were quite small and were

really just the Catalyst to what was

fairly in our view inevitable that these

flows would then take hold we did expect

a fast move and something that began to

look like a blowoff top which is exactly

what we've seen

15% rally in S&P 500 since October 31st

um pretty incredible um if you think

about it but I'll be honest that the

move was even quicker than we've

expected it's been a bit front run uh I

mean here we are December

14th um and we we still have another

month till January 17th so a lot of time

to get that final move and all-time

highs sit only about 120 points away in

the market in the S&P um to put it in

perspective we rallied

15% another

uh 20 points from here would be two and

a

half% um so really not much at all um

and the reality is that those all-time

highs maybe a bit above is about the max

of what we thought would happened by it

now it may go further given the speed uh

given the new news that we got on a

pivot from J Powell which we'll address

a little bit

later but it is important to note that

this has been very quick and definitely

has squeezed a lot of shorts already um

where we've already began to see the

Dynamics of Market ofup which we really

highlighted for everybody as something

that people need to be very aware

of um uh and if this continues this

rally were to continue we would expect

that to continue as well um but really

an incredible move when you start

thinking about it

um what does that mean going forward

well the flows are still there those are

immutable what are these flows let's

review uh one the December December

quarterly and January options

expirations as we go into expiration

tomorrow for December which was the

biggest have an incredible amount of

Decay to the skube um so basically all

the short puts that dealers hold in

short stock are consistently having to

be bought back as time passes and as

well compress es that is a major driver

um we've known that that skew was really

big that the open interest was really

big that V was very compressed and was

going to likely limit those puts from

being in the money and once you begin to

realize that the tail is off the table

that those flows ultimately will come in

and drive things

higher um on top of that we've had the

time weighted um W volume weighted time

being considerably shorter so 30% lower

than any other time of the year from

Thanksgiving all the way to MLK day and

that really has done um you know an

incredible thing of accelerating time

and there's again a front running of

that happening but maybe the biggest and

it's even bigger than we were last

talking about it now that the market is

up almost

25% is the reinvestment a collateral

this momentum factor that happens not

throughout the year but really at a

specific moment beginning and end of

each month uh beginning and end of each

quarter beginning of of of the year and

obviously the beginning of the year is

the biggest and with the move being as

big as it's been and waiting to the end

we know that the overwheling majority of

these flows are coming here at the end

25

trillion dollar because 25% return on a

hundred trillion Market is about $25

trillion that's how much collateral new

collateral there is and if you're

rebalancing to constant risk what we

which is what most portfolio managers

are

doing you're consistently um putting

that new money to work so how much of

that is going to work uh January 1 if

it's 20% that's 5 trillion do right 20%

of a 25% rally is A5 trillion doll

investment coming in in the context of a

market that is incredibly liquid and

that moves based on approximately 50

billion a day is it any surprise that

the that Santa the Santa Claus rally of

the January effect are as strong and

consistent as they are in up years when

you have that collateral reinvestment

absolutely not so that tied with all the

options that b flows we talked about are

is a

tsunami now the overwhelming majority of

that comes off the table by the first

couple of days in

January but we still have have after

that a January expiration which is very

big in single stock

limb and anywhere where there is short

puts by dealers in single stock land I

would be expect those to begin to

outperform in that window and that's the

charm V window that we normally see

before the months I expect that to be

strong if we continue to get this

momentum heavy rally and the market up

volup that we're seeing by January 17th

the Wednesday of X in January we would

expect those flows to aate and that the

volum pinning that comes with that not

to mention just the simple potential

energy of lifting this Market to higher

valuation significantly higher off the

ground if you will um creates massive

potential energy all of the shorts that

are being squeezed that we're seeing the

significant moves that we're seeing in

short interest will also remove uh

demand from the market as the market

heads lower if and when that happens

happens these are all very important

Dynamics last but not least is narrative

narrative follows price the more the

market goes up the more we get news that

seems positive and everybody then begins

to get very bullish and becomes risk on

taking more risk and eventually opening

the trap door for a move lower so not

there yet a lot of flows that are

immutable they've been front run so that

can dampen the ball a bit but the

squeeze squeeze is happening those flows

are still coming and it the market can

always go further than people expect a

perfect setup would be to hit the

all-time highs and get a double top or

better yet get a blowoff kind of quick

uh minor new high get people talking

about 5,000 5100 other numbers that seem

crazy not too long ago and then at that

point you could begin to see a

reversal so

um that is what we're still looking for

again this has been spoton um we still

have a month to go this should be a wild

interesting month here at the end I will

say all of that said given the moves

we've had in the short term meaning the

next couple of days and the next week

into Christmas there should be a

consistent amount of B Supply here

because of the decay of the de um

expiration tomorrow morning on the 15th

leading to everybody being long behind

it what was cheaper and became into long

V so that should dampen V create a

little bit of digestion here much like

we've seen a couple times already in the

last month and a half um but I would not

expect much of a pullback even if we do

get a pullback and even that should be

bought based on these flows coming uh

with by by January 17th by the by the

new year and January 17th um that's the

important flows to be aware of at this

juncture now from a macro perspective

what what's going on J Powell has come

in and all of a sudden declared Victory

Mission Accomplished right similar to

George Bush's mission accomplished

statement we believe that this is going

to be a major mistake and history will

not judge J Powell kindly um there was a

lot of talk about Arthur Burns and

vulker and which one was J Powell um and

it's really interesting to see how

quickly he's now pivoting in the face of

3 7% unemployment not even close to what

Arthur Burns was facing when he pivoted

not even a

recession Burns was aiding year and a

half deep recession at the time of his

pivot so very interesting they clearly

believe um at the FED that this

inflation is transitory that's something

we've heard for a couple years now uh

we've had transitory 2.0 at this point

this will again prove to be transitory

3.0 We Believe

does that mean inflation might might not

stay uh at 3% or 3 and a half% for the

next year no that does not mean that

that can't happen but it will be sticky

and the more they pivot the more they

they begin to stimulate um I would

expect a reacceleration of inflation we

see in the services uh without real

estate inflation

significant um uh stickiness to that

number uh

6.1% believe it or not on the services

side um uh the employment continues to

be very tight uh labor rights be

continue to be very tight very strong

wage growth continues to be sticky and

that is a function of protectionism

deglobalization creating onshoring at

home it is protecting labor rights

popularism is Alive and Well labor

Supply is we me and that is an important

Dynamic to keep an eye on we've been

highlighting this for several years by

the way before it got started on top of

that we're going into an inflation a u

election year and what comes with

elections populism and elections go hand

inand so you better believe fiscal

policy is on the way it will take on

lots of marketing uh colors uh think of

uh the inflation protection act

but it will be fiscal spending not all

the same in particular expect measures

as we've already begun to see notes of

this to help Millennials and that voting

block on down get support that is the

entity that feels most hurt by this

inequality they are behind significantly

from their uh baby boomer peers at this

point in the the generation uh only 40%

of the wealth creation household

formation of that generation and they

are unhappy they want change and every

four years they have a significantly

greater voting block as baby boers

continue to decline and pass away so

better believe believe populism on the

left and right will be alive and well

it'll take on different personalities

left and right but economically will be

the same policy whether it's Trump or

Biden hard to imagine I know everybody

gets caught in the tribalism but they

the same and rhetoric they are both

talking about rusted out cities in

Middle America and also pounding the

table on fiscal

spending that populism will continue to

drive inflation that deglobalization and

the protectionism will be heard from

both sides you better believe the

anti-china rhetoric uh will be very

strong I would also expect the coming

year to have significant continued

geopolitical tensions when Russia

invaded ukra Ukraine everybody was

shocked but that's because partially the

market was down and reacted in ways

where that narrative became front and

center now with a Hamas inv you know uh

uh terrorist activity in in in Gaza and

the Israeli response you don't really

hear that much about that anymore The

Narrative with markets up has been very

complacent our view is that that is

actually a second front on the global

war

Iran is part of that backing of Hamas

they're the biggest backer of Hamas and

they are working actively with their

allies in Russia and China to

destabilize that area how do we know

that that effort by Hamas was done

immediately days before Saudi and Israel

were going to sign a peace

pact that is one of the most dangerous

things for the East and not surprisingly

by making this a issue in Palestine we

had they had managed to peel away Saudi

Arabia and importantly the eastern most

member of of NATO turkey away from the

west Western Alliance that is a very

successful policy um unfortunately so we

believe that along with thinning out the

military needs um uh of the West um by

creating a second front in

is part of a policy from the alliance of

China Russia um and Iran to begin to

operate um a broader global conflict so

we believe World War I is actually in

place already and the spending that will

be needed to support it will not only

continue but increase so that is also an

important um uh piece of the puzzle here

much like it was in the 70s when the

Vietnam War was a significant uh and the

spending tied to it were a significant

ific accelerate of inflation as well as

fiscal policy lastly we continue to

believe despite this pullback in oil

that energy policy from OPEC will

continue to be restrictive and Supply

will continue to be restrained and as

demand picks back up we will see a

significant move in oil higher next year

this is another buying opportunity there

precious metals in particular will also

do quite well as we've called for for on

uh in the coming year as we see more

geopolitical tensions and more narrative

shifts one way and the other

surrounding uh uh effects and interest

rates um and uh the potential risks of

American policy

dominance as we said before gold calls

is the way you want to play this the

volatility of the gold uh trade will be

significant so you'll see ups and downs

but the shut will be significantly

higher over the long run meanwhile it is

oil puts that you want to be short um

that volatility we believe is quite High

given what's happening it it really is

the the uh the support that we're seeing

from OPEC and others in terms of Supply

that will continue to underpin price

there continue to invest in things that

that focus on fiscal spending government

the government budget if you go through

a one by one whether it's healthc care

or defense spending um all of the items

that you would would expect to see an

infrastructure all of those uh will see

significant increase spending in the

next year and should do quite well in

the context of the next move duration

which has done quite well is already

beginning to reverse a bit here we

believe that will that Trend will

continue next year and we will be see

continuation of the Year prior 2022 is

um

outperformance um of of those

entities have a Happy New Year to you

all and don't forget to stay Nimble be

water look forward to another profitable

successful year of health for

everybody this does not constitute an

offer to sell a solicitation of an offer

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