Alternative Markets Update and Macro and Political Outlook July 2020

HISTORIC FIRST HALF
​Short illustration below to remind you how exceptional these last six months have been. We went from economic optimism (“Phase One” US-China trade deal) to geopolitical dynamite (Soleimani assassination) to trade wars (Saudi-Russia oil price war) to the mother-of-all curved balls: COVID. The latter killing half-a-million people (and counting), plunging the world economy into recession and triggering changes in the geopolitical and economic landscape that will last for years to come. With regards to the latter I have written about these in past editions (the rise of “localism”, the danger of the “blame-game” and “resilience over efficiency”).

Figure: Monthly Headlines During H1 2020, Source: Macro Eagle, July 2020

JULY AND SECOND HALF PREVIEW
Three things will probably dominate. First, today’s start of Germany’s EU presidency with the focus on EU budget (MFF), recovery fund, COVID preparedness, Green Deal, China and Brexit - in that order. 

Second, the US election – with Trump becoming more erratic as his chances vanish; Biden picking his running mate and China/BigTech becoming a bipartisan punchbag. Three, COVID news on the medical and economic front. Expect the US$600-unemployment-add-on (expiry: 31-July) to be extended, but at a lower rate. Looking into Year-End, my main worry is the September/October period, when (1) the US presidential race heats up and China/EU will know about it. (2) Government pandemic-support programs globally start to taper, leading to bankruptcies, downgrades and job losses. (3) The return of colder weather and a potential 2nd wave. (4) The traditional hurricane season – since Climate Change is still happening.

Figure: Overview of Event During July 2020, Source: Macro Eagle, July 2020

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RESEARCH PERSPECTIVE VOL. 135 July 2020 Alternative Markets Update July 2020 The non directional movement in the equity market continued during early July 2020, despite the return of higher numbers of the coronavirus cases in many countries. Equities have developed differently, depending on their industry. Many companies have rebounded and are where they were before Covid-19. Tech companies have benefited hugely from the crisis, as many of them have reached new highs and are now at valuation levels prior to the dot com bubble. The VIX started to rise again, as a consequence of most likely too optimistic views on future quarterly companies’s earnings and the rapid growth of coronavirus cases around the world. However, investors remain relatively bullish due to the frequent and substantial interventions of the central banks around the world. The unseen money printing has caused the gold price to surge, as inflation hedge. Figure 1 shows a comparison of the central bank's balance sheets and the gold price per ounce. The price of gold per ounce has risen to $ 1,872 as of 8th July 2020. Figure 1: Comparison of Gold Price and Total Assets of Central Banks, Source: Bloomberg & BofA Global Research, July 2020 Bitcoin (BTC) and other cryptocurrencies have not moved much in the last two months. BTC remained mainly between $9,000 and $10,000, despite the halvening that has taken place on May 12th 2020. However, as the history of BTC has shown, it typically takes quite some time to really have an effect on BTC’s price. This is caused by the investor base of BTC, as most investors who are holding BTC are not selling them but are holding them for the projected long-term value instead. This behaviour is further undermined by the fact that approximately 83% of Bitcoin holders have achieved a profit. A substantial trading volume stems from miners instead, and the impact of the reduced mined BTC takes some time to show its effect. BTC is up 30% for the year and outperformed most other cryptocurrencies, but some altcoins, such as Ethereum (ETH), performed substantially better than BTC. ETH is currently at $245 USD, a YTD 2020 of 88%, and its price movement in 2020 is shown in Figure 2. Figure 2: Price Movement of ETH in 2020, Source: Coinmarketcap, July 2020 The hedge fund industry’s AUM is back above $3 Trillion again, despite the harsh economic environment and the increased effects of issues that existed prior to the outbreak, such as redemptions. The industry faces a surge in liquidations, as even thriving hedge funds from last year face substantial problems. One major example is the recent shut down of Sloane Robinson, a hedge fund in business for more than 25 years. The most popular hedge fund strategy, long-short equity, seems to not work anymore, as oftentimes hedge funds achieve a lower performance than indexes and face a bigger loss than the index. According to Bloomberg, 70% of equity hedge funds are down as of end June 2020, which is certainly not a good sign for the strategy. Macro and Political Outlook July 2020 by Macro Eagle WELCOME TO JULY - and well done for making it through the first half of this extraordinary year. 1. JUNE REVIEW. The month kicked off with a strange (but logical) combination of “melt-up” on Wall Street (strongest 50-day S&P rally in history) and a “melt-down” on Main Street (BLM-protests) – more on that below. Strong US employment data further emboldened an already exuberant retail crowd (h/t Dave Portnoy), who were riding the “liquidity & reopening” wave, until they hit an “air pocket” on Thursday 11th (blamed on 2nd-wave worries or just “too fast too far”). But fear not … the Fed and Trump rekindled bullish sentiment with news of further corporate debt buying and hopes of a $1trn infrastructure package (money is growing on trees, after all). Towards the end of the month the market became choppy, thanks to a combination of strong US data (retail and home sales, consumer confidence) pushing prices up … while Covid, Techlash (Facebook boycott) and geo-economics (new round of EU/CN tariffs?) were providing the counteracting gravitational force. Figure 3: Macroeconomic and Political Events in June and Their Influence on the Performance of the S&P 500, Source: Macro Eagle, July 2020 2. HISTORIC FIRST HALF … Short illustration below to remind you how exceptional these last six months have been. We went from economic optimism (“Phase One” US-China trade deal) to geopolitical dynamite (Soleimani assassination) to trade wars (Saudi-Russia oil price war) to the mother-of-all curved balls: COVID. The latter killing half-a-million people (and counting), plunging the world economy into recession and triggering changes in the geopolitical and economic landscape that will last for years to come. With regards to the latter I have written about these in past editions (the rise of “localism”, the danger of the “blame-game” and “resilience over efficiency”). Figure 4: Monthly Headlines During H1 2020, Source: Macro Eagle, July 2020 3. JULY AND SECOND HALF PREVIEW. Three things will probably dominate. First, today’s start of Germany’s EU presidency with the focus on EU budget (MFF), recovery fund, COVID preparedness, Green Deal, China and Brexit - in that order. Second, the US election – with Trump becoming more erratic as his chances vanish; Biden picking his running mate and China/BigTech becoming a bipartisan punchbag. Three, COVID news on the medical and economic front. Expect the US $600-unemployment-add-on (expiry: 31-July) to be extended, but at a lower rate. Looking into Year-End, my main worry is the September/October period, when (1) the US presidential race heats up and China/EU will know about it. (2) Government pandemic-support programs globally start to taper, leading to bankruptcies, downgrades and job losses. (3) The return of colder weather and a potential 2nd wave. (4) The traditional hurricane season – since Climate Change is still happening. Figure 5: Overview of Event During July 2020, Source: Macro Eagle, July 2020 4. BLM AND SOCIAL UNREST. Thinking about the big picture, two questions come to mind. First, Timing. Why did George Floyd’s killing create such a sharp reaction, when a very similar murder of Eric Gardner 4 years earlier in NYC didn’t. Second, depth and breadth, i.e. how come so many young whites joined the protests, when they historically hadn’t? My view is that this isn’t something “new” or “different”, but just another symptom of the much broader societal “Crisis of Trust” (in the System and its Elites), which has been going on since the Great Financial Crisis and is now being amplified by Covid (“lockdown stress”). What the young protesters in Hong Kong (unaffordable housing, not just democracy), Latin America (corruption), Brexit (industrial north), US/Trump (rustbelt) have in common with the BLM protests is: lack of economic opportunity. Which is why this Crisis won’t go away with (yet another) corporate diversity review. The problem is deeper and structural. First, most assets are owned by the Boomers, with little upside for Millenials (see chart). Second, 85% of US equity markets is owned by 10% of the people, with the bottom 75% owning nothing (source: Fed). If you have no stake in capitalism … guess what … you like Socialism (see YouGov poll below). What worries me most is that what looks short-term attractive (higher Equity markets) is a medium-term social time-bomb. Wall Street “melt-up” now means Main Street “melt-down” later. And Central Bank policy is directly contributing to that. The good news is that Capitalism will adapt (Marx forgot about that). The bad news is that (paraphrasing Tocqueville): “The most dangerous moment for a bad government is when it starts to reform”. As a good friend of mine just told me: “We are all in the same storm, but not in the same boat” (h/t James M). Fasten seat-belts. Figure 6: Distribution of Wealth by Generation, Source: Macro Eagle & YouGov, October 2019 5. US ELECTION. I have been saying for a while that Trump would lose, mainly because it is unlikely for him to lose the popular vote twice, plus Democrats this time feel like the underdogs and Pelosi is a tactical genius (I have long underestimated here). Now that the bookies agree with me on the presidency (see graph), the next key questions are: who becomes VP and who wins the Senate? On the former, the VP matters for two reasons. First, “succession”. At 78, Biden might not finish his 1st term and is unlikely to run for a second. Second, “influence”. Biden is a nice guy, but has no big views. The bookies are behind Kamala Harris (CAL). Tactically (and Pelosi excels at this game), I would go for somebody from a key swing state (like Florida/Demings). The biggest risk for Democrats is to become complacent. In any case, markets are not yet worried (they think “I have seen this movie before”). They forget that Trump is now the incumbent. But once the melt-down in the polls continues, if the Senate looks vulnerable and once Warren is rumoured as Treasury Secretary – then it will. My guess is September/October.  Fireworks ahead. Figure 7: Projection of Result of Presidential Election and Vice President Nominees, Source: Macro Eagle and PredictIT, July 2020 6. EUROPE. In a remarkable coincidence Germany is assuming EU leadership both de facto (mutualized debt) and de jure (EU council presidency). For starters, that’s great news. But … as mentioned in previous letters, I think “mutualized debt” is only a partial game changer. Germany has made a big concession, because the EU’s survival is in its unequivocal national interest (history). But that is not necessarily true for every Debtor. The next step is to clarify how to repay that joint debt in the future. This means clarifying future income streams for the Commission, which in turn means taxation, which in turn means intrusion into what many Debtors consider sovereign matters. The Dutch (leaders of the Frugal Four) will play hard as they have elections next year and their conservative-stance is highly popular at home. Poland (leaders of the V4) will tactically join the Frugals to avoid too many funds being diverted South. The Italians (backed by France) will claim national emergency (Lega is still leading in the polls and FDI are becoming stronger). And Germany (Paymaster General) will have to find consensus. Luckily, Mutti is in her last term and will knock some heads together … but I will only get EU-bullish when I see a sustainable framework and not just a short-term fix. Figure 8: Polls of Election in Netherlands, Germany and Italy, Source: Macro Eagle, July 2020 7. The DOLLAR. It seems to be a consensus view out there that the Dollar is about to collapse (Stephen Roach is forecasting -35% over the next 2-3 years). My problem with these “dollar bearish” views is that when Economists try to establish the dollar’s long-term “fair value” they consider Terms of Trade (ToT), Interest Rate Differentials (IRD) and Purchasing Power Parity (PPP), but forget the key IR concept of “Power” (difficult to measure). Hence that “Fair Value” is under-estimated (in dollar terms). Also, it is not the US Dollar's fault that the two challengers are not “fit for purpose”: the Euro would like to be bigger but can’t (until they have a fiscal union) and the Yuan could become bigger but doesn’t want to (as Beijing would lose control). If USD weakness is your worry, portfolio insurance is better than portfolio re-allocation, as FX vol is cheap. Figure 9: Comparison of Broad USD Index and the Implied Volatility of the 1Y Exchange Rate EUR-USD, Source: Macro Eagle, July 2020 8. BREXIT. As expected, Britain didn’t ask for an extension on June 30th. What worries me is that both sides call their respective approach “pragmatic” and accuse the other side of “ideological inflexibility”. Funny that. The problem is obviously a different interpretation of “pragmatism”: Britain sees it as falling back on international precedent (for example Canada deal or excluding fishery from any FTA), while the EU focuses on “level playing field” – which has more to do with self-interest. Boris is clearly keen to get things wrapped up fast and to make the point, his Chief Negotiator, David Frost, starts a new job as National Security Advisor on Oct 1st. I’m not so sure the EU will comply. But, as mentioned in previous emails, a No-Deal (worst case forecast: -8% GDP over 10 years) is a rounding error amidst the Covid devastation, so Britain is if anything more resolute to move on. Personally, I remain GBP long (strategic) with tactical short-term downside hedges as I do expect some nasty rhetoric ahead. Figure 10: Comparison of the GBP-USD Spot Exchange Rate and Its 6 Months Implied Volatility, Source: Macro Eagle, July 2020 9. MARKETS AND PORTFOLIO ALLOCATION. As I wrote last month, in the short-term the positives prevail (liquidity, stimulus, re-opening optimism, medical break-throughs), while the negatives are medium-term (bankruptcies, unemployment, debt servicing, 2nd Covid wave, possible inflation, geopolitical brinkmanship). My base case is for bullish momentum to continue in July and for things to turn for the worse in Sept/Oct. My portfolio allocation stays consistent with previous newsletters: in Equities long infra, green and small-digital … in Credit buying with the Central Banks … in FX long GBP, long USD vol, long selective EM carry and small punt on HKD de-peg … in Commodities long Gold, small long Copper … in Rates long inflation, steepeners (I know, crowded) and receiving AUD … in Alternatives small long BTC. Two data points I’m watching like a hawk: rebound of Consumer Confidence, especially of Higher Earners (graph, LHS). And inflation expectations spiking higher (graph, RHS). Regarding the latter, I know that according to MMT-nistas this won’t happen, but hey … I’m Old School. Figure 11: Comparison of US Consumer Sentiment and the 10Y US Breakeven Inflation, Source: Macro Eagle, July 2020 Have a great JULY, don't forget to laugh … and MAY THE MARKET BE WITH YOU. Bobby 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. Bobby Vedral MacroEagle E : i[email protected] M : +447899996595 Bobby is a macro-political analyst who runs his own fund MacroEagle. He is also the UK representative of the German Economic Council (Wirtschaftsrat Deutschland) focused on the German-British relationship post-Brexit. 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