Discretionary Trading Q4 2020 commentary

Market overview

The fourth quarter started with the continuation of correction in equities although not as sharp as in September. The quarter was punctuated by rallies in expectation of another fiscal stimulus, but downside forces prevailed till the US elections. The two main factors behind the fall were: the realization of a second wave of Covid 19 epidemic coupled with subsequent lockdowns in Europe and the expectation of a Democratic sweep and gain of all levers of executive and legislative power in the US. 

A Democratic government could lead to higher capital gains taxes in 2021 and market was expecting a sell off of profitable shares in 2020 to realize profit in lower tax regime. In reality, although Democrats eventually took control of US Senate in January, the anticipated tax minded sell off didn’t occur. Instead, we witnessed powerful rally in equities. The move was supercharged by the approval of Covid 19 vaccines that spurred rotation into cyclical, value sectors of the market. Another boost to the market was the next round of fiscal stimulus agreed in December. 

Why is the US fiscal stimulus is so important to the market? it is expected that a portion of the $900bn will, similar to what happened with the March stimulus, end up in capital markets. Thanks to fiscal stimulus, involuntary savings are rising, people are restricted to their homes because of the Covid 19 epidemic and can't spend it in the real economy. Capital markets are markets for savings, so they are temporarily inflated, leading to jarring difference of performance between financial markets and the real economy.  

This ultra-easy policy mix led to continuing slide in the USD and despite Fed support, to a mild fall in bonds in expectation of bigger fiscal deficits and rising inflation expectations. Commodities were also rising although precious metals complex was suffering, first from vaccine risk positive development and probably from increasing competition from Bitcoin that is becoming the gold of the new generation and digital era.

Strategy performance (net of all fees*)

*Performance net of all fees represents performance after all costs, including transaction costs, product costs, 0.5% annual service fee and 20% performance fee. The performance fee is only payable on profits above the previous high water mark. 
The performance fee presented here assumes the investor has been invested since inception. Therefore an individual's performance fee is likely to differ based on date of entry.

**The estimated impact of the performance fee on the strategy's returns has been deducted from December performance for illustrative purposes - meaning December's performance would be greater without this performance fee incurred. In practice, the performance fee is deducted from the account in the first few days of the new quarter.

Generally, the strategy performance during Q4 was not due to big positive and negative trades but to a steady addition of value through positive execution during market fluctuations.

In hindsight, the impact of the vaccine discovery on cyclical risk assets should have been factored in more. Although the vaccine was expected since May, it nonetheless had a big impact after it was announced. Current market behavior appears to be driven by social, cultural phenomena, whereby trends of growing social acceptance are much longer and you don't have to be that nimble and contrarian as in the past.

Best-performing positions

• Gold (+3.5%). Both long and short positions based on technical analysis and position developments. Trading was tactical and opportunistic.

• GBP/USD (+3.2%). The strategy manager followed Brexit negotiations during the quarter and for the last 2 years. The idea was to trade the changing probability of a deal through the British pound as this market had clearly distilled reactions on this development. 

• 30Y UST bonds (+2.8%). Rotation into long and short positions as the US election situation evolved. Long when the prospect of a Republican win was higher and then short as things reversed and a Democratic win was more likely. The idea is that a Democratic sweep could translate into gigantic fiscal deficits, more debt issuance and rising yields. 
  

Other notable profitable trades included: long Russell 2000 and Copper positions on a possibility of a fiscal stimulus deal. Short NAS 100 and SP 500 into elections and renewed lockdowns. 

Worst-performing positions

• Russell 2000 (-1.8%). Short position following vaccine news on the expectation of a profit taking correction after unusually big rise. This ended up not happening and contributed negatively to performance.

• EUR/PLN (-1.5%). Long position based on negotiations of a new EU Budget and Recovery Fund. Conflict around conditionality led the strategy manager to believe that Poland would be excluded from the Recovery Fund which would potentially lead to a big fall of its currency. This ended up not happening as the negotiations were resolved without a big market impact.

• USD/JPY (-1%). This was part of a group of trades that rode weakening USD trend but this pair got caught up in the vaccine announcement as it briefly reacted more to changing risk environment than weakening USD trend and had to be closed at a loss.

Outlook 

A look back of the strategy performance during the last 6 years (2014 to 2020) shows a pattern of a very good year followed by a bad year. A further look back (2011 to 2014) shows a different pattern with only steady positive performances. The strategy manager’s goal is to revert to the earlier pattern and he believes that the combination of a vast inflow of new money in the markets and huge economic uncertainty will lead to volatile periods that can be exploited by this strategy. In Q1 2021, the impact of another gigantic fiscal stimulus in USA on the markets will be closely followed, as well as the developing speculative froth in equity markets.

The general outlook is that markets will be reasonably generous in 2021.