(These are solely the views & opinions of KVP, & do not constitute any trade or investment recommendations. By the time you synthesize this, things may have changed.)
2020-Mar-24
Macro Dragon: Potential Positive & Negative High Probability Pathways...
Folks as a pin going forward during this turbulent times, let us please remember:
The Covid-19 crisis with all its challenges, stress, chaos & opportunities will also eventually pass. What defines humanity & ourselves as individuals is how we both individually & collectively act under adversity. Think of how you want to look back over this period, doing your part to keep your family healthy, society healthy & functioning. Keeping a cool head, when others are losing theirs, maintaining an objective list of positive aspects & negative aspects of the policy responses & economic shock the world is/could go through. And lastly gratitude, sympathy & empathy for one another. Asia got/is getting through this & RoW.
The one big positive from all this, is it reminds us we are all One & we are not at the top of the food chain. Covid-19 does not care if you are rich, poor, what your ethnicity & skin color are, what passport/s you hold, nor what you age or profession is. Our greatest achievements are almost always those that we collectively do with others & sometimes as in this case, as a species. Lastly keep your mind open to growth & opportunities.
Top of Mind…
- Once again, remember the regime we are in – likely the mother of all bear markets, across assets classes & almost certainly 100% across global economies. The 2nd & 3rd order consequences are too numerous to calibrate now, yet its worth remembering, once again, that this to shall pass. No matter how bad it will get across the EU, US & RoW… look to parts of Asia (HK,SK, SG, CH, JP, AU) which are likely through the worst of the storm from a virus growth perspective. This too shall pass.
- So lets look at both potential positive & negative high probability scenarios, they may range from not 0%, to 25% to +50% to as certain as you can get to 100%. Note there is nor sequential order here, nor are any of these supposed to be sequential… obviously there are pockets of domino effects. For instance, the latest Fed moves overnight were biblical & historical from a monetary policy perspective – check out Jakobsen’s latest Macro Digest
- KVP personally thinks it would have been a -5% to -15% cash session in the US equity market – post the failing the US Fiscal package over the wkd – if the Fed had not done what it did, so keep that context in mind, we are seeing huge positives & effort from policy makers which is fantastic. We are still about price in the market, not yet about value – yet these are the milestones we have to drive past.
Potential High Probability Pathways that we can expect before we come out of the Covid-19 Global Crisis
(Bear in mind different probabilistic pathways can change dramatically given actions or lack of actions of all the cooks in the kitchen: governments responses to the Covid-19, fiscal & monetary policy measures, citizens actions around compliance self or government driven, virus mutation, vaccine, etc )
If you think that we are stopping at c. 10% of GDP from a fiscal perspective globally, think again. More is coming, this is basically as 100% probability… KVP envisions that that we are likely to at least see +2x to +2.5x from here in rgds to fiscal support coming out of the US, as well as globally. We are going to move towards the biggest deficient in the US since WWII which was c. 30%. And we will blow right past the 10% lvls that we got in the Obi era. This is all hugely positive given the one of kind scale of demand shock, supply shock & wealth destruction that we have seen & potentially will continue to see globally.
- From a monetary policy side, regardless of what you have seen – don’t think they cannot do more. Never think that. In situations like these, the rules get re-written because its not about implications of the consequences of their actions in the future of the system, its because of the potential irreversible break of the system – more importantly colossal societal wealth destruction that cannot be reversed. What’s the biggest Godzilla of it should be too big to fail? That’s right, a nation.
- What KVP has also been super pleasantly surprised & glad to see, is the Team Mnuchin & Team Powell really have Main Street in mind & rightly so. Just for context, US economy has 15m people working in the restaurant industry… the US cannot have 15m people from ONE INDUSTRY suddenly having no income (remember this is a country with +300m guns, & as a species we are just a few meals away from being civil, empathetic social citizens). So there is a lot of flashes of brilliance in the support out there (that realize social stability is a huge issue to try to solve for), expect more. Plus expect other central banks to take a page out of the Fed, RBNZ & the ECB. And yes, the balance sheet on the Fed (c. 25% of the GDP before covid 19, could easily get closer to the BoJ’s BS being +100% of GDP).
- Just one last point, the US’ Fed & deficient lvls are things that they (US vs. RoW) will be able to get away with at a much lower structural cost than say another smaller country globally – I.e. combination of still being the reserve currency of the world, as well as the depths of its economy & markets relative to the rest of the world.
- Expect global government response going from not fully understanding the gravity of the situation, to where officials are clearly panicking. For instance, the US government officials are still clearly not on board the severity & the need for unity in all this – as we said on our Clues from Asia piece, the world is going to look back at this era & applaud the initiatives taken by China, Singapore, Hong Kong, Korea, etc.
- So don’t be surprised if we have a martial law (or similar) declarations across the entire US & Europe at some point before this is over, as well as different countries in the world. The 1st order costs of a systematic & complete lock-down are always less inexpensive than the 2nd & 3rd order costs of the inverse. The investing world has its hands full with the US & EU, at some point we will turn to focusing on EM & FM, where stress in the systems continue to increase.
- If a combination of the recent Godzilla & super positive (for credit, funding, bonds mkts, main street business & main street employees) actions from the Fed & (a yet to come) US fiscal policy waves cannot overcome the inevitable (& likely) massive step up in confirmed infections in the US – then we could still see cases of sever market sell-offs, especially in the equities market. Anything where we are doing -10% to -20% in a session, or a run of -30% to -50% on the S&P (as well as major global equity indices) could lead to a coordinated multi-week shutdown of the markets. The probability here is much smaller post the most recent actions of the Fed, yet it could still come back.
- In such a situation with traditional liquid markets shutting for an extended period (forget the two days that the Philippines did), KVP would not want to be caught outright short… because the mkts would likely only open up once the virus was in check & a lot of uncertainty had abided, so you could get two back to back limit up days of +20% in the S&P… any outright net shorts portfolio positions, would experience a supernova. I.e. if KVP had short positions, they would likely be entertained as long puts… yes vol is high, but its high for a reason. Not saying there will not be opportunities to play the downside, just be nimble
- Expect limit up days & limit down days across asset classes. Still feels like a traders market, yet we are seeing more & more of the signs of measures needed to take us from price, back to thinking about value.
- Expect the precious metals, at some point to get the structural bid on debasement concerns around the level of debt in the system. OTM Call options short, medium & long dated on gold & silver resonate with KVP structurally. Yes, they had a big session yest & today, yes there are likely still pockets of liquidity… yet it will take a while before the full market can even participate on this theme. Remember its still about price, its not yet about value. This theme is going to be Thanos with the infinity glove still working.
- Speaking of which, the mother of an all legal ‘front running’ will be on show – talking here credit… Fed has basically told the market we are backstopping IG & Munis… That structurally will lead to dampened volatility across bonds as a whole. For context as of last Fri, European HY bonds were trading at 3-4% vs the US’s 10%. Why? Because the ECB has been buying European bonds for years. Again cannot emphasize how incredible this is, bear in mind the Fed has cut rates to zero… so i.e. there is credit out there yield +10% on strong companies, with cash & cashflows & maturing soon… in a world where the Fed has cut rates by 150bp. This will be ‘UGE! Expect it to be the trade that everyone in the BO will eventually be on for potentially years.
- Just as we had massive numbers & record being made in the +11-12yr bull cycle run, expect colossal record numbers to the downside…numbers we have never seen or heard of before.. numbers that you would be called loony for saying out loud… (i.e. +1m to +2m jump in jobless claims) be they GDP or unemployment or PMIs (Fed/Treasury has already through acting fast & colossally, dampened quite a lot… but its like slowing down a meteor… may not sound like much, but if you are a family of 4 in the F&B industry, then getting $3000 in this environment or job security due to your company getting a credit line for the next 2m, etc… it’s a MASSIVE deal… ). So don’t watch puck, skate to where the puck is going.
- From an economic fall-out perspective Covid-19 will be bigger than the GFC – likely the bounce post will also be faster than during the GFC, yet it may not be symmetrical globally & definitely not from a sector perspective. There will be a CV19 overhang in travel, tourism & luxury for not just months, quarters yet in some cases years. The markets will almost certainly bottom before the number of virus cases starts to turn lower in the US & EU, as well as way before the lowest GDP contraction of this global recession.
- Lastly, KVP continues to think that the blackish swan of a mass production & roll-out of a prototype vaccine will be much sooner than most people’s 1-2yr horizon. If you are part of the 20% that have to be hospitalized, half of which to a quarter of whom it could be quite severe, you will roll the dice for the trial vaccine, there will only be upside. And obviously never have so many governments globally been so focused on just one global problem, that focused intensity will likely lead to results that we could not dream of in the normal day to day. This could have massive change in the psychology around the virus.
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We could continue to be in a gang buster period of volatility both to the up & down side until at least mid-Apr to back-end of May. Some, time decay is needed in the system, both from a Covid-19 spread (past peak velocity upwards), even bigger & even better government / fiscal / monetary policy response & virus fighting measures, to overall heads of governments giving this the 2nd & 3rd order consequences thinking that it needs. This will also pass. Keep you minds & hearts open.
Good luck to everyone out there, be nimble & position accordingly.
Namaste,
KVP
