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Editor's Note: Hamish Risk | November 3, 2020
We figured that your inbox is probably choke-full of US election guides and the like today, so today’s Macro Briefing will spare you that and instead highlight some other interesting research that may distract you ahead of the incoming election results. Firstly we highlight the importance of the V in the MV=PQ equation as Ollari Consulting explains why it is so crucial to the Federal Reserve fulfilling its inflationary mandate, and for policymakers looking to avoid the mistakes following the GFC. Meanwhile DataTrek outlines why the scene is set for a strong performance for equities in 2021 based on an equity volatility and political/fiscal stimulus set up very similar to that of 2009 and the Capital Markets Outlook Group explore alternatives to Treasuries as effective equity hedges. Further afield, Deep Macro explains how big data is confirming the above trend growth reported by the Chinese authorities, that confirms China’s economy is the stand out recovery star, while 3Fourteen Research takes a nuanced look at the oil market, warning investors against jumping on a simple bull or bear story.
Inflation velocity of circulation Ollari Consulting
1. Yes, V mattersChristophe Ollari at Ollari Consulting says there could be signs – albeit fragile at the moment – the deflationary boat is turning. He points to the fact that the latest release of V – the velocity of M2 – is displaying signs of bottoming out. A crucial factor in turning the massive amounts of money injected into the financial system into actual increases in GDP – as opposed just fuelling asset price inflation – Ollari says the next election will be all about the V, and the ability of the next administration to avoid the balance sheet recession that characterised the post GFC financial landscape and further increased the inequalities within society as a whole. That he says is why V is so crucial for the US economy to avoid a deflationary spiral. After all, as Ollari points out, the only times in recent years V has bounced convincingly was in 2002/3, 2009 and 2016, and these were also the only times when the Federal Reserve, at least briefly, ended up fulfilling its inflation mandate.
equity vol US equities DataTrek
2. What 2020’s equity volatility says about 2021Nick Colas at DataTrek says the S&P 500 has risen or fallen by 1% on nearly 100 (99 to be exact) trading days so far in 2020, a level only reached in 6 other years in the past 6 decades. In the year after those occurrences, he says the S&P has typically rallied strongly (+37.0% in 1975 and +25.9% in 2009). That said, Colas concedes the early 2000s saw a difficult three year stretch with +100 one percent days and disappointing returns (-9.0% to -22.0%). Even so, he thinks this year’s recession best resembles the scenario in 2008/2009 given that markets are mostly dealing with an economic shock and face a similar election setup. Investors want more fiscal stimulus as soon as possible, says Colas, but a Democratic sweep of the White House and Congress this week could delay a new deal until after Inauguration Day 2021. US equities should rally thereafter, he says, as long as investors think the policy response is adequate, but volatility will remain elevated and US equities will likely suffer until that happens.
Asset allocation equity hedges equity rotation Capital Markets Outlook Group
3. Equity hedges and the 60/40 portfolioMuch has been made of the demise of the 60/40 equity/bond portfolio, and the ineffectiveness of bonds as a hedge for equity, with last week’s equity sell off being a case in point. Thus the search for alternative hedges is becoming a more crucial focus for investors. Connie Everson of Capital Markets Outlook Group says that while it’s possible that the treasury market is being held back by a post-election scenario that entails substantial fiscal stimulus, there remains a much broader issue that treasuries can no longer be relied upon to offset declines in the stock market. Typical ‘bond proxies’ in the equity market don’t have much protection either, says Everson, because they too have been dragged higher in the speculative equity wave this year, and so are consequently vulnerable to the downside too in a major market correction. So what are the alternatives? Everson’s analysis favours those assets that provide an asymmetric risk profile. In other words, assets that provide limited opportunity to rally in rebounds, but likely provide large participation in market declines. While they produce income, there is a cost to holding them as short positions, but the key is not the fundamentals of each asset, but rather, what will happen to them in an extreme event, compared to likely upside in favourable times. Everson identifies international high yield as an example of an asset that is not expected to outperform in an equity rebound. Investors have also been wondering whether a rotation to cyclical shares might be happening. Everson noted that cyclical shares have had the lead on several occasions since May, however lasting changes in leadership normally happen in conjunction with sharp equity corrections because leaders that had been attracting speculative capital do not just stay in place if they lose momentum. Through October, there were still signs of breakdown among a number of sectors, but her firm is watching carefully.
China economy China equities DeepMacro
4. China is first to enter the “expansion” stateMuch ink has been spilt over China’s recent GDP print and whether it had been manipulated, says Jeffrey Young at Deep Macro, but measurement issues should not distract investors from the big picture: the Chinese business cycle is on the mend. He says Deep Macro’s big data series, which the Chinese government doesn’t touch, are showing a firm upturn. According to Young, nitrogen oxide pollution levels over China suggest that October industrial production will outstrip the 6.9% year on year pace seen in September, while job offer data suggest growth in the services sector has been even stronger. He says China’s economic growth state has nearly entered the “expansion” state, where growth is above trend and rising. China would be the first major economy to achieve this, Young adds, and he doubts it is only because it got a two or three month head start on the rest of the world.
oil markets 3Fourteen Research
5. Oil – what story do you tell yourself?In the oil market, says Warren Pies at 3Fourteen Research, two divergent narratives are currently gaining traction. In one corner, he says, the bulls are convinced that they are the out of consensus contrarians who think years of low prices have killed upstream investment, which will lead to an inevitable supply collapse and then a price spike. On the other hand, Pies says bears point to physical market weakness, a slow recovery from the coronavirus lockdowns, and the existential threat of peak oil demand pulled forward by EV adoption and government policy. He says the real story is much more nuanced than either the bulls or bears believe, however. According to Pies, the “bull story” is more like a list of stretched relationships and oversold conditions. At some point, he says, these could form the foundation of a solid rally, but without a catalyst, stretched relationships can keep going. As a risk manager, Pies says he has no interest in trying to time this without an identifiable catalyst or the seeds of a reversal. As for the “bear story”, he says he has a really hard time being constructive on energy when OPEC+ holds so much spare capacity. Still, Pies says oil demand is not dead it’s only in hibernation, and oil will remain a crucial input for the global economy, but the journey back to normalized demand will not happen overnight. Pies reckons that to get excited on the long side, the market would probably need to see a quick plunge that takes Brent down to the mid-$30s around support, which would likely push Managed Money shorts back to a new buy signal. Pies recently launched 3Fourteen last month after a 10-year stint as Ned Davis Research’s energy strategist. As well as continuing to focus on energy markets, Pies and his team will also provide analysis on broad secular themes, real asset allocation and innovative modelling techniques utilising AI. Click below to join the 3Fourteen distribution list and also access to this note.