Alternative Markets Outlook H2 2019 And Macro Outlook August 2019

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RESEARCH PERSPECTIVE VOL.113 AUGUST 2019 Alternative Markets Outlook H2 2019 The asset management industry experienced significant declines in 2018. Alternative assets achieved the best performance among non traditional long asset classes. The popularity of actively managed assets is decreasing for the last 15 years, while passive solutions and alternatives are gaining more attention, which is likely to continue. It is expected that the industry will experience more volatile markets, increased competition and more economic uncertainty. Especially the uncertainties will increase, for example how the US-Chinese trade war will develop, with the background of new elections in the US in 2020. Europe's uncertainty will peak on how Brexit is executed at the end of October. Hedge Funds Hedge funds remain strong in July after a very profitable H1 2019 and reached a new record level of market capitalization of $3.273tn. In July, hedge funds yielded positive results again. The aggregated average performance of hedge in the current year is at 7.67%, which is likely to continue. Figure 1 shows the performance of several hedge fund strategies. Noteworthy is that none of them generated negative return. The interest rate cut of the FED is likely to increase the attractiveness of hedge funds further. Investors are currently moving cash from equity strategies to lower beta strategies, as equity markets have reached all-time highs. For H1 2019, targeted strategies were mostly credit multi-strategy and relative value arbitrage strategies. However, this shifted to macro, CTA, currency and commodity funds in July 2019 and is likely to continue during H2 2019. Despite the trade war between the US and China, the allocated capital from hedge funds in China increased further. This conflict is likely to shape the general performance of financial markets, especially in the hedge fund industry. Due to current and expected interest rate decisions from most central banks as well as the volatility of currencies, hedge funds are looking for safe havens. Gold is experiencing an increased demand, causing the price per ounce to rise to the highest level since 2016 and $1600 or even $2000 is forecasted from major US investment banks.   Figure 1: Performance of Different Hedge Fund Strategies from June 2018 to June 2019: August 2019, Source: FundMap Cryptocurrencies It is estimated that crypto hedge funds collectively manage just $1bn in AuM split over 150 active crypto hedge funds. More than 60% manage less than $10m, while fewer than 10% manage more than $50m. Fundraising climate seems to improve, as the median AuM at fund launch rose from $1.2m in January 2018 to $4.3m in Q1 2019, despite the harsh market conditions and crypto winter in 2018 and Q1 2019. Note, that these numbers do not contain shut down hedge funds, crypto index funds and crypto venture capital funds. Figure 2: Distribution of Crypto Hedge Funds AuM: August 2019, Source: PWC-Elwood-Report Cryptocurrencies experienced massive price increases during 2019 so far. For example, Bitcoin rose from 3'829$ at the end of 2018 to 11'849$ as of 8th August 2019 with a short breakdown at the beginning of July. This development is likely to continue, but there is always the possible of a major breakdown as in 2017 again, as cryptocurrencies are highly volatile. However, the current price development is substantially different from the huge rise in 2017. It seems that this development is more stable, as the attention of the public is not as high as it was in 2017, which is also visible in Figure 3. It shows that the volatility of Bitcoin reached almost an all-time low. Furthermore, the industry gained more legitimacy, which led to more wholesale and institutional money attention. Along with this development, the trust in cryptocurrencies is higher than it was in 2017.   Figure 3: Volatility of Bitcoin from 2011 to 2019 YTD: July 2019, Source: Bitinfocharts & Kaiko Private Equity Aside from reaching a record market capitalization in H1 2019, the outlook for H2 darkened slightly. The PE industry is experiencing currently some rough weeks, especially in the US. Examples are the protests on Bernie Sanders' planned PE backed hospitals for low-income residents or a newly issued report which revealed that PE and hedge fund-owned retailers caused more than 1.3 million job losses in the last decade. This report is devastating, as the PE industry advertises creating new jobs. These events do not seem to improve the current development of the PE industry, which faces a decline in buyouts and fundraising. In Q2 2019, fundraising resulted in the lowest number of closings since 2014. The position of PE is not improved by the breakdown in the equity market at the end of July. However, promising is that the volatility is reduced in most countries, which might also have a positive effect on the PE industry in H2 2019.   Figure 4: Global Volatility Hotspots in Equity: August 2019, Source: Axioma The potential negative outlook might be offset by the highest amount of dry powder available in 2018, as shown in Figure 5. Furthermore, there is additional amount of $1.2tn of uncalled commitments. As this capital still needs to be invested, it might be enough to continue the growth of this industry.   Figure 5: Dry Powder in Private Equity from 2006 to 2018: April 2018, Source: Preqin Private Debt Despite the uncertainties caused by Brexit, the private debt market in the UK developed well. Even though the industry dropped substantially compared to the record-breaking 2017, Q1 2019 performed slightly worse than Q1 2018. However, in Europe as a whole direct lending achieved €2.5bn in Q1 2019 compared to €701m in Q1 2019. Fundraising in Europe increased to €10bn in Q1 2019, which is extraordinarily high for the current situation, when comparing it to the €32bn raised in the whole year 2017. Figure 6: European Direct Lending Fundraising from 2013 to Q1 2019: August 2019, Source: Acuris Real Estate After achieving a record of aggregated capital in 2018, H1 2019 resulted in even higher capital numbers. This trend is likely to continue, as the yields achieved from real estate are substantially higher than on corporate bonds, and this trend is increased by the recent decision for the US, with the FED lowering interest rates and further decreases are expected from the market in 2019. Furthermore, the valuation seems reasonable in the current low-yield environment. The economic activity in Europe is expected to remain relatively stable. Typically, economic activity and real estate tend to correlate. However, this correlation dimishes in low-yield environment, which investors face currently. The situation for the US looks promising as well. 91% of houses in metro areas in the US increased their prices in Q2 2019, reaching an annual increase of 3.4% by June 2019. Moreover, the commercial lending activity increased further in Q2 2019, which should drive the real estate market during H2 2019. This situation further benefits from investor outlook of where they want to invest in over the next 12 months. Figure 7 shows these investment intents. There is a shift from European investments towards American real estate.   Figure 7: Geographical Targets in Which Investors Plan to Invest in the Next 12 Months: July 2019, Source: Preqin Macro Outlook August 2019 by Aquila Markets RBNZ cut 50 bps from 1.5 to 1.0 % with a dovish bias – two main takeaways for me – this suggest recession risk is real in the eyes of the RBNZ coupled with lower staff projections. Secondly – a reason cited that the market didn’t factor in a 50bps rate cut and analysts were therefore “surprised” was it would cause “panic”. The RBNZ doesn’t care about panic – it cares about getting its currency down faster than everyone else and loosening domestic financial conditions. This does speak to a set of analysts who think that breaking out of the way in which things have been done over the past 10 years simply will not be done. I have news for them – they are wrong, and the lid is off the jar in terms of how nations will approach global situations – they will do what is right for their own citizens and will take the harder path (read the stance of the UK now over no deal Brexit whilst “impartial” journalists continue to talk about the UK “crashing out” of the EU). The media and commentators in general need to wake up – all potential outcomes under the normal distribution are possible, not the ones that policy makers have tried to enforce in the centre of the normal distribution while removing “tail risk”. This remains my core view – that more potential outcomes means more realised variance, and so a higher vol base generally across financial markets.This does speak to a set of analysts who think that breaking out of the way in which things have been done over the past 10 years simply will not be done. I have news for them – they are wrong, and the lid is off the jar in terms of how nations will approach global situations – they will do what is right for their own   Turkey cracking down on dissent – banning websites / social media accounts. (joining raft of other nations as I discussed Monday).   India cut 35bps.   I woke up this morning thinking of Draghi saying “Worse and worse….”. I think the risk is higher than the market expects that ECB are going to act in September – significantly. This will put more pressure on the Fed – which is just what they need.   USDCNY fix was at 6.9996, just ahead of 7.0000. Deliberate ? Of course. They have learned from the devaluation mess of 2015, and will make sure that USDCNY will gradually step higher but I am convinced it will gradually move up. The US commentators think China is under such huge pressure that they will have to come to the table to do a trade deal (or it might start a panic ?!?!?). China will not back down here, will act to resolve HK to its own advantage, and will accept short term pain, for long term gain. It is inconceivable that a nation with such a long view, is being outwitted by a nation run by a President who reacts to the events in front of him at that moment. USDCNH will continue to move higher – but in a more gradual way. The effect on markets will not change – the frog still boils eventually when the water is gradually heated up.   Bullard pushed back at suggestions that Fed will cut rates in response to the market turmoil “US monetary policy cannot reasonably react to day to day give and take of trade negotiations”. Firstly – the market doesn’t believe him given the way in which cuts are being priced in. Secondly, one bank has brought up the subject of intermeeting cuts, which stand at 10% according to their analysis. The refer to an similar situation in January 2018, when equities fell hard immediately after a FOMC meeting and Fed cut 25bps – in that case they sold off 10.3% from the end of the FOMC day until the cut day. As per my comments of above – the initial reaction to talking of intermeeting cuts is “they won’t do that – it might start a panic”. The Fed has cut 7 times intermeeting in the last 22 years……..   Finally – as another symptom of a market past – the speed with which vol picked up after the USDCNH move, and then the speed with which it sold off, is noticeable. Where does the selling come from? It feels very much like there is a total lack of desire by market makers to hold inventory, whilst the algo/black boxes – who cause NZDUSD to sell off 2% in illiquid times – come in and sell vol. This is analogous to the theme above – that once an event has passed – traders perceive we return to a world where the potential for realised vols is lower as policy makers remove tail risks. These overdone selloffs are going to present opportunities to pick up some gamma on the cheap – especially when realised vols are picking up. See below screen shot of realised vols in currency pairs – note how the variance has picked up over the last 2weeks and especially the last week. Yet the market perceives that this is all past, that it is all going to be fine. It isn’t, and a new mindset will be needed. Secondly, and more thematically for vol traders – convexity has real value. I shall be returning to this theme.   Plays of the day – patience. I was hoping that I could look to resell NZD and AUD vs JPY and CHF – but the moves overnight seen to have taken the steam out of that. Short term correlations between USDCNH, Spoos and the EURUSD seem to be playing out – 2900/2930 are 50-61.8% retracements of the move from 3026 down to 2777 spike Monday; plus the 9 D emp ma comes in at 2922. I am looking for 2900/2920 as a resell zone here. In USDJPY terms – this 9D EMA comes in at 107.00, which I am looking for it to hold. I am planning to pick up some gamma in USDJPY and EURJPY too, hopefully off a higher spot base. Figure 8: Realized Volatilities for At-the-Money Options, Source: Aquila Markets Figure 9: Price Development of S&P 500 Futures, Source: Aquila Markets The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, Stone Mountain Capital LTD. Readers should refer to the Disclaimer. Chris Eagle Aquila Markets E : chris.eagle@aquilamarkets.com M : +447712885718   Chris is an experienced executive who runs his own consultancy service which focuses on business development, market structure, financial market analysis and training. He worked on the sell-side for twenty years. He left Jefferies in 2015, where he worked in the Global Foreign Exchange and was Head of FX product distribution. This perspective is neither an offer to sell nor a solicitation of an offer to buy an interest in any investment or advisory service by Stone Mountain Capital LTD. 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