Macro Dragon Special S1E3 - Current Outlook & Macro Views...

2020-Jan-28

Macro Dragon Special S1E3 - Outlook & Key Macro Views

Current 2020 Macro Ideas, The Craft, T-Views, Contingency Plans, Risks… 

This is the first of a series of Macro Dragon Specials that will come through over the year – in this first series we’ll attempt to capture KVP’s current thoughts on global macro & cross-assets over 2020, current outlook & assumptions, current strategic (long-term) positioning views, risks, hedges & contingency plans… as well as what seems to be consensus vs what the market does not seem to be focusing on (yet). Note these are very different from the daily macro dragon cross-asset views

This is MDS S1E3, as always all thoughts / comments / constructive feedback appreciated

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Outlook & Key Macro Views – Assumptions & thoughts

(mixed certainty & probability)

• The Meta multi-year trend in global macro is still one of lower yields & rates.
• Even if we go sideways to up on yields this year, say USTs go from current 1.80 lvls to test 2.00 & even 2.10/2.25 (bunds from -20bp back to neutral, JGBs from neutral to +10bp). There is just too much debt in the system for yields to significantly move up & stay up, when the vast majority of that debt is sitting on the central bank BS.
• It is not the Fed that was ahead of the curve when they were hiking in 2018, it was the BoJ who’s BS sits at +100% of Japan’s $4trn GDP. We could barely unwind half a trillion (from 4.5 trn) on the Fed BS before the market freaked out (4Q18) – there is no escape from the vortex of debt, need for liquidity & lower yields – its akin to the dope addict who needs a constant stream of ever higher dosages.
• It likely does not get into the end game until we see UST well south of 1.00%, 0.50%, etc… which is a far cry from the current 1.75-1.95% YTD range. KVP personally feels the front end of the US curve will eventually be negative… but thats big picture… the bottom line here is… do not lose sight of the meta trend. And note, we’ve not even highlighted the technological & demographic (US boomers retiring) deflationary structural forces globally. Nor the fact that next decade will likely be seeing more debt from the government fiscal side, as opposed to monetary which will likely stay loose.
• Don’t forget the meta trend. It implies that for any long horizon portfolio there is a default core position on duration (bonds), precious metals & assets that will benefit from a thirst of yield that we have still not seen. Obviously one should also have a trading clip that they trade around to monetize volatility & take advantage of short-term overshoots & undershoots. That hard decision this year could be holding on to your core bond exposure if we have a dramatic move higher in yields (pressured to liquidate) or dramatic move in yields lower (pressured to take profits)

• Obvious key risk to this meta trend is some kind of scenario that results in a massive growth spike, sustained inflationary pressures that somehow force central banks to hike despite the level of debt in the system.

  • Probability? Far from high… sub 5% feels right. Paradox in all this is that real inflation: education, healthcare, housing, etc is very real & creating a lot of social unrest globally – do pay attention to food prices & subsidies

• Default view on equities at the start of every year is to be long. As an asset class historically they tend to rise the majority of the time (positive convexity). Also generally in a year such as 2019 where the S&P was up c. +30%, the following year tend to be up +10% - there is decent chance QE has a multiple factor on that historical +10% (i.e. 1.5x to 2.5.x). Its worth noting the blow-out top of the dot.com saw the Nasdaq 100 doing +100% in 1999.

• So it’s a question of how long to be & where to allocate to equity longs. And where to have some potential hedges and short exposure. Say what you want about the buy the dip gang (post GFC market participants), since 2009, we have only had c. two drawdowns of -20% in the S&P equity index (3Q 2011 EZ crisis & 4Q18 Fed QE/liquidity finishing) – with the vast majority of major pullbacks falling in the c. -5% camp.
• Apart from the UK (& sterling assets), KVP has no current strong views on country specific equity allocations. He is skeptical of those advocating US equity shorts vs. say longs in the EZ or EM – there is a reason the US has consistently outperformed those other markets over time. And it boils down to it being a relative world – its about the least dirty shirt, where there is one fiscal & monetary policy system.
• Still we will touch on a few equity names that are part of meta themes in their own right. 

• Commodities – we’ve already touched on the structural longs in precious metals if you have the same long-term meta trend. Of course if you view is that yields & rates are heading higher, inflation is coming back, etc… then you are likely going to be want to be short the precious metals complex. KVP also likes energy as a space equity wise & think oil finishes higher for the year – yes we were way overdone in the US/Iran tiff at the start of the year.
• Currencies – perhaps even stronger than at the start of 2019, it feels like rightly or wrongly everyone is advocating US Dollar shorts. From a combination of lower interest differentials given the Feds 3 cuts last year, the fact that EM, CMDs & RoW tends to net benefit from a weaker dollar (funding pressures lower, profit margins & liquidity goes up) & we also have a president who has been adamant on wanting a weaker USD.
• KVP is really not to sure on this & like most people got the overall direction of the USD wrong last year (yet got the outperformance of the likes of MXN & RUB right). At the end of the day its a relative world & the question is, if not the USD what other major currency benefits?
  • Now GBP certainly & KVP is massive structural bull on sterling & sterling assets – seeing this as a multi-generation opportunity to go long UK assets. Yet a much stronger EUR & JPY are harder to envision. Also if ‘everyone’ is saying we should be going into a period of stronger growth outside the US & more importantly bigger earnings growth, then why are we not seeing a weaker USD? He would prefer to play USD shorts through select crosses, that will be covered in a later Macro Dragon Special on current 2020 positioning views
• In regards to volatility it is hard to see a structural rise higher with yields & rates in a structural move lower. That’s not to say that we will not see spikes & potential VIX explosions past 20 & 30… its just they are likely not to last long.

• The long vol bugs are going to have to wait for that big recession bear-market crash to get that VIX +50-100 lvls, which may still be a few years away.
• However if you are playing long vol for 2020 – and bear in mind we are in many cases seeing all-time volatility in things like currency options – you perfect storm is a Sanders/Warren coming in & out of contention, before one of them finally winning the primary & then one of them looking to win vs. Trump, then losing in the last few hours of the election. That, plus the Fed hiking out of nowhere would give you that perfect vol storm for 2020. And of course the usual black swan systematic shocks – the unknown unknowns.
• The positive thing about the low vol environment is that protection or/and getting exposure with finite level of risk has never been cheaper historically.

• On monetary policy things are likely to be a lot more accommodative, most importantly with the Fed which is likely to have at least one cut before E-1H20: 2020 is Half-life for the Fed... Likely 1 cut by 1H20 (Special Sun Edition) Cuts from the likes of The United Kingdom, Australia, Canada & New Zealand can be expected. As well as in general across the EM realm (Mexico, Brazil, India & China come to mind). What is going to stand out are those that are either sitting on the sidelines or could potentially hike – as we saw with Norway’s Norges bank in 2019.
• On the fiscal policy side – this is likely going to be structurally thematic for the next 3-5-10yrs & well into the next global recession – we could see some big surprises out of Australia, given Scott Morrison & his incumbent governments dismal response to the godlike wildfire devastation across Australia (damages likely to be +$100bn. At some point Germany will likely pivot to the FP side as well, yet things in Europe may need to reverse lower & to the worse before that happens (maybe 2021). Yet FP is really something to be moving up the list of important things to monitor.
• Lastly the push towards addressing the climate / sustainability crisis is a behemoth of a theme that will be symmetrical in scope & transcend the private, corporate & government sectors. If you think this is a kumbaya, we are the world, fluffy fad that is only limited to millennials. you better crawl out of your ignorance cave & recheck not just the facts but change in perception – its not just the Norwegian SWF at it again, but the likes of +$5trn dollars that Blackrock is sitting on that is shifting towards addressing the need for sustainable growth. (that’s actually bigger than the BoJ’s $4trn BS)  
• Check out our brilliant colleagues in Saxo’s 1Q20 The Great Climate Shift