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Macro Digest: Strategy Change - Neutral Risk to Negative Risk - The real "virus" is insolvency and unemployment

Macro

Steen Jakobsen

Chief Investment Officer

Summary:  In this Macro Digest we look to change the strategy as we have a look at going long volatility and reducing overall risk allocation with that trade and with an increase of the cash allocation.


Here is our list of strategy changes after our review of current market:

New longs: DAX put options, STOXX50 put options, QQQ puts, USD calls (vs. ZAR, EUR, GBP and/or CAD) – Buy July/August GOLD CALLS

Why: Solvency/bankruptcies and unemployment are going to be the next major macro theme as the “time dimension” runs down the positive impact from the recent massive liquidity injections. After all, zombie companies remain zombies with or without liquidity “relief”, and final demand has collapsed and will continue to be suppressed relative to “normal levels” based on higher unemployment.

Technical caveat: We don’t have much technical support yet on fresh momentum in favour of our new strategies, but the “turn around off the highs” creates compelling risk-reward to being long downside in equities in particular, but also long US Dollars (vs. NZD, CAD, AUD, GBP, ZAR, MXN, CNH)

Targets:  Equity 20% correction, FX: USD to parity vs. EUR, GBPUSD to 1.1000, Gold to 1800, US HY spread widens 400-500 bps…

Monetary/Central Bank framework:  Fed can talk all day and all night about not wanting to go to negative rates, but… the Fed is always behind the curve in the medium to long run, even if its impressive short term liquidity injections can stop an outright panic. And long-term the modern Fed’s policy measures are nearly always inflicting long term damage on economic potential.

Yesterday, Fed Chair Powell was very dismissive of the idea that the Fed will cut rates to negative, but since when can the Fed had any predictive power whatsoever – even on its own policies? In short, the market will force the Fed to go negative, but of course first we need to go through an exercise in YCC - Yield Curve Control - as US 10-30-year yields will collapse over the next 12 months despite record issuance. A zero percent 10-year yield is around the corner and the central bank and government will continue to create fiscal and monetary spending that crowds out savings and investment and reduces the velocity of money.

They are really hurting the long term potential of the economy with their actions even as we recognize the social costs of not doing anything. As Fed Chair Powell pointed out yesterday: “… A Fed survey being released tomorrow reflects findings similar to many others: Among people who were working in February, almost 40 percent of those in households making less than $40,000 a year had lost a job in March... This reversal of economic fortune has caused a level of pain that is hard to capture in words, as lives are upended amid great uncertainty about the future.”

Headlines stories:

The Fed is now fully operational in buying corporate bond ETFs as of earlier this week. From the price action in these ETFs (JNK, the junk bond ETF, LQD – the investment grade ETF) it suggests the market has priced fully the expansion of these actions before hand as they sold off badly after gapping higher on the first day of purchases Tuesday.

  • We see significant risk of credit spreads widening under my macro theme: “Liquid Insolvent” - also read this derivative insiders assessment of CLO as risk (Mind you quality managers of CLO will make money even with these new condition, but there is so much “bad quality and bad managers” around)
  • Chairman Powell finally got to the real message in yesterdays speech: …but the recovery may take some time to gather momentum and the passage of time can turn liquidity problems into solvency problems”... Speech link
  • The “ECB isn’t the Master of Universe” - The Germany vs. EU/ECB is getting worse – market is ignoring this but is there real risk of Germany leaving…  German Constitutional Court makes it opinion heard: Link
  • We feel Europe is in its worst constitutional crisis ever: Italy, COVID19 bonds, Hungary/Poland, EU/ECB vs. Germany, Europe should have used this moment to rise to the occasion. Instead everything it does is piecemeal, slow and without credibility. Strange they don’t see it themselves. Link
  • Stephanie Pompoy calls out Chairman Powell on his “… Ah but we will stop doing “border line violations of Fed act when things normalize”… Link
  • Bubble basket: Peter Garnry has produced a basket of stocks which has gone “out of control”…
  • Stanley Druckenmiller (#1 in my book): “..stock market risk reward is the worst he’s ever seen”…  Link
  • David Tepper (also in top 10 all-timers)…. Stock is “second-most overvalued” he’s ever seen… Link

Of course, there is “massive amount” of confirmation bias in the above, but I was super positive on the low in March, as I thought that the response from governments and central banks would be enormous, and it was. But then the Fed and others decided to follow the wrong recipe of: “if a little of something is good, then a lot of it must be super positive”… of course it’s not! The world, life, nature is improving, working through marginal changes, mainly by trial and error. To think that it would work to provide a theoretically infinite safety net to take out the left-tail of risk is to ignore the laws of economic gravity.

Don’t forget that the definition of credit is: consumption moved from the future to now, or in financial terms:  Credit is generally defined as a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at a later date -generally with interest. The “repay later” component is the one where this 2020 experiment will fail. Credit can be issued but money will not be repaid as the increase in debt levels itself crowds out productivity, the velocity of money and the return of money. That brings us to the “passage of time” portion of our argument as the realization dawns that only liquidity was provided and now macro traders and actors in the economy have to consider the lack of solvency and unemployment.

Stay safe,
Steen

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