ALTERNATIVE MARKETS UPDATE - MACRO AND POLITICAL OUTLOOK OCTOBER 2020

Alternative Markets Update October 2020
The Covid-19 crisis does not seem to stop, as many countries are facing a severe increase in cases, as the northern flu season is about to start. In Europe, where the spreading of Covid-19 has decreased during summer, has seen a huge resurgence of cases among most countries, some of them even topping the spreading back in March (such as Austria). In the US, where the situation with Covid-19 did not really improve during summer, the President was infected and hospitalized for two days, is now back in the office. The tension is increasing, as the election is less than a month away and due to the chaotic presidential debate. Figure 1 shows the US unemployment rate over a seventy-year period. Due to Covid, it spiked to an all-time high (not considering WWI and WWII). Nevertheless, the unemployment rate already halved again as of the last report in early October and is now 7.9%. In times of crises, real assets such as gold tend to do very well. Through this crisis we have seen the first time how cryptocurrencies do during such times, and they delivered what was expected. 

Bitcoin (BTC) and Ethereum (ETH) are up 46% and 159% for the year. This boost in the main cryptocurrencies also affected the value of DeFi (decentralized finance). Figure 2 shows the value locked in DeFi, which has surpassed the $11bn mark compared to around $1bn at the beginning of 2020. Our crypto strategies have worked well in 2020 with YTDs between 62% up to 323% (see table above). ​​

U.S. Employment Rate in Percentages, Source: Charlie Bilello & Compound, October 2020

Value Locked in Decentralized Finance, Source: Pantera Capital, October 2020

Macro and Political Outlook October 2020 by Macro Eagle
October PREVIEW
Packed calendar ahead. This week we get employment in the US, while China goes on holiday for week (mid-autumn festival). Next week we have the only VP debate, plus we will find out if Congress manages to pass another relief-package before the recess starts on Columbus Day (Oct 12th). Then, the Third Week promises fireworks with the EU Council meeting battling over the recovery fund, the EU budget and Brexit. We also get the 2nd Presidential debate, the start of Q3 Earnings and tons of economic data. After that, the Fourth Week brings us the 3rd Debate. Interestingly, on the same day, the FDA will hold a “vaccine update committee”, which makes me think that this could provide a platform for Trump to announce a tactical “huuuuge breakthrough – biggest ever”. Finally, the Fifth Week will feature the ECB (strategy review, PEPP, maybe AIT) while everybody else is counting the days to Election Day the week after. With the al-fresco days of summer now officially over, the start of the “normal” Northern flu season is upon us, so before we talk about the US election, let us quickly turn to Covid.

An Overview of Upcoming Events in October 2020, Source: Macro Eagle, 2020

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RESEARCH PERSPECTIVE VOL. 141 October 2020 Alternative Markets Update October 2020 The Covid-19 crisis does not seem to stop, as many countries are facing a severe increase in cases, as the northern flu season is about to start. In Europe, where the spreading of Covid-19 has decreased during summer, has seen a huge resurgence of cases among most countries, some of them even topping the spreading back in March (such as Austria). In the US, where the situation with Covid-19 did not really improve during summer, the President was infected and hospitalized for two days, is now back in the office. The tension is increasing, as the election is less than a month away and due to the chaotic presidential debate. Figure 1 shows the US unemployment rate over a seventy-year period. Due to Covid, it spiked to an all-time high (not considering WWI and WWII). Nevertheless, the unemployment rate already halved again as of the last report in early October and is now 7.9%. In times of crises, real assets such as gold tend to do very well. Through this crisis we have seen the first time how cryptocurrencies do during such times, and they delivered what was expected. Bitcoin (BTC) and Ethereum (ETH) are up 46% and 159% for the year. This boost in the main cryptocurrencies also affected the value of DeFi (decentralized finance). Figure 2 shows the value locked in DeFi, which has surpassed the $11bn mark compared to around $1bn at the beginning of 2020. Our crypto strategies have worked well in 2020 with YTDs between 62% up to 323% (see table above). Equities have suffered by the turmoil during the last few weeks, especially big tech companies, which were the winners in crisis, started to see severe drops since September. Our SMC Equity Strategy Index is up 12% as of August 2020 and remains to be seen, how the recent drop has affected these strategies (some of which are up more than 40%). The bond market suffered more when the crisis hit, but has started to recover slowly, but relatively stable. Our fixed income strategies have largely moved in the positive area for 2020. The private debt market was hit severely as well. Major strategies such as direct lending have suffered, but there are many opportunities in the distressed area and that investors may consider switching from public debt to private debt. Figure 3 shows the fundraising in the private debt market. Despite the surprisingly good numbers in Q2, the impact of the crisis is visible in Q3. The good numbers in Q2 could stem from the opportunities that arose with the crisis, but also partly backed by the fast recovery of the equity market and the bullish market sentiment coming with it. Private equity and venture capital (VC) have done fairly well in 2020. Figure 4 shows a bullish indication for the venture capital market going forward. The value gained from VC-backed exits has steadily decreased over the last four years. In the first two quarters, those numbers stayed steady, despite the fact that in such a crisis, exits are difficult to arrange. The exit value in those two quarters was around $40bn each. In Q3, this number skyrocketed to $120bn, by far the highest number reached in the last five years. This is remarkable, especially considering the economic environment we are facing currently. Figure 1: U.S. Employment Rate in Percentages, Source: Charlie Bilello & Compound, October 2020 Figure 2: Value Locked in Decentralized Finance, Source: Pantera Capital, October 2020 Figure 3: Global Private Debt Fundraising, Source: Preqin & Bloomberg, October 2020 Figure 4: Quarterly Venture Capital-Backed Exits by Type, Q1 2015 – Q3 2020, Source: Preqin, October 2020 Macro and Political Outlook October 2020 by Macro Eagle Welcome to OCTOBER.   1 - September REVIEW Last month (Sep 2nd) I wrote how despite “the best August in 34 years” there was a “whiff of irrational exuberance” in the air, ending my note on a recommendation to turn “tactically defensive”. The next day we saw the fastest 10% drop in the Nasdaq ever (over 3 trading days). Lucky! Three ongoing themes dominated September apart from “headline risk” (see chart): (1) the US fiscal stimulus ping-pong, (2) the Second Covid “autumn” wave and (3) the underperformance of some BigTech, despite WFH, as they start to suffer from their size and level of expectations. Take Tesla: the Sep 3rd market sell-off took place the day after a big Asset Manager disclosed a (forced) reduction in Tesla holdings due to size limits (too big!). Then, Tesla had its biggest ever 1-day drop (Sep 8th) after it failed to be included in the S&P500 (expectations!). The week after, a rampant IPO market forced allocators to make space for newbies, cutting the biggies. Finally, on Sep 23rd, the shares dropped after a much hyped but ultimately disappointing “Battery Day” (expectations, again). Bottom line: long Tech, cautious Big Tech. Especially since the latter is a bipartisan punchbag. Figure 5: Comparison of the S&P 500 with Major Events in September 2020, Source: Macro Eagle, October 2020 2 - October PREVIEW Packed calendar ahead. This week we get employment in the US, while China goes on holiday for week (mid-autumn festival). Next week we have the only VP debate, plus we will find out if Congress manages to pass another relief-package before the recess starts on Columbus Day (Oct 12th). Then, the Third Week promises fireworks with the EU Council meeting battling over the recovery fund, the EU budget and Brexit. We also get the 2nd Presidential debate, the start of Q3 Earnings and tons of economic data. After that, the Fourth Week brings us the 3rd Debate. Interestingly, on the same day, the FDA will hold a “vaccine update committee”, which makes me think that this could provide a platform for Trump to announce a tactical “huuuuge breakthrough – biggest ever”. Finally, the Fifth Week will feature the ECB (strategy review, PEPP, maybe AIT) while everybody else is counting the days to Election Day the week after. With the al-fresco days of summer now officially over, the start of the “normal” Northern flu season is upon us, so before we talk about the US election, let us quickly turn to Covid … Figure 6: An Overview of Upcoming Events in October 2020, Source: Macro Eagle, 2020 3 - COVID Based on ever better testing, it looks as if this Second Wave is one of “cases”, but not of “deaths”. What will be very interesting to see is if the national approach adopted during the First Wave makes any difference for the Second (remember that Sweden for example never locked down). For governments, this Autumn Wave will be much tougher, as unlike the First Wave, they will not be able to shower voters with goodies. In fact, they will most likely have to start taking many of the increasingly unaffordable measures away. Winter of discontent? Also, should a vaccine be announced in October, I’m not so sure the market will be that happy: no more stimulus, higher yields and (as the unemployed don’t fear mass gatherings anymore) more social unrest. In addition, the countries which suspended bankruptcy procedures (Australia, Germany) will find out how many Zombies they actually have. According to the CEO of Deutsche Bank every sixth company in Germany risks becoming one. Ouch. Figure 7: Number of Daily Cases of Covid-19 in the USA, UK and Sweden, Source: Macro Eagle, October 2020 4 - US ELECTION In September Trump’s summer momentum in the polls broke down (see chart). My model, which gives Trump the benefit of the statistical error, is currently predicting a Rust-Belt (WI, MI, PA) flip and hence a Biden victory (279-259). Without that bias it actually gives me a “Blue Wave”. The Senate race on the other hand rests on a knife-edge. I currently see a draw (50-50) with the Democrats losing 1 (AL) and gaining 4 (AZ, CO, ME, NC). If not, it is likely that we will have to wait until Georgia’s special election (Jan 5th) to find out if we get a “Blue Sweep”. So, while the market is worried about a protracted and contested election result (VIX Futures term structure pricing in the biggest “event risk” in its history), I wonder how the market will react to a Democratic Sweep? It feels to me as if the narrative will become that the benefits of more stimulus and less trade wars will offset the downside of tax hikes. That could work as long as yields don’t rise. As for SCOTUS the narrative is that Trump seeks to install ACB before the election to bias the Court in his favour should the outcome be contested. I think the opposite is true: if installed before the election, the Evangelicals have less reason to vote for Trump, as the Court will now have a conservative bias for a generation. But then … a lot can happen in the next 33 days. Figure 8: US Election: Polls, Odds and Predictions, Source: Macro Eagle, October 2020 5 - BREXIT September brought two bombshells: (1) Boris’ October 15th EU Council deadline and (2) the infamous “Internal Market Bill” (IMB). The question is why did No10 decide to do that, when they could have addressed their concern through the Joint Committee (paragraph 16 of the NI Protocol specifically allows either party to take unilateral “safeguards” in the face of “serious economic, social or environmental difficulties”)? They must have foreseen the uproar their action would cause. So, again, why do it? The root cause was clearly the EU’s “maximalist” negotiation tactic, which probably went too far. Take fish. First, it is a blocking topic for everything else set by Brussels (France), although in GDP terms fishery is as irrelevant for them as for Britain (put politically critical for Macron’s re-election bid in 2022). Second, the EU requires Britain to be worse-of outside the EU than inside (understandable), but at the same time demands that its own EU (especially French) fishing quotas remain unchanged. Isn’t that “cherry picking”?  Third, if the international practise is to negotiate quotas on an annual basis (as the EU itself does with Norway), then why deny this right to Britain? Anyways, I understand why Britain grew frustrated with this attitude, but their messaging was absolutely shambolic. My base case now is that the UK will offer some sort of transition period on fish (that helps Macron) plus some fudges on State Aid and then we get a basic FTA by Year-End. Then Britain will focus its energies towards the CPTPP internationally and on “levelling up” policies domestically. Both the G7 leadership and the COP26 Summit next year will provide it with a useful international platform. I continue to believe that UK assets are a “strategic long”, mainly because so much bad news is in the price already and for being the “consensus underweight”. See poor relative FTSE and Pound performance below. Only Gilts have done well (rate-cut expectations). Bottom Line: Long-term bullish UK, short-term cautious. Figure 9: Comparison of UK’s Stock Market, Currency and Bonds to Other Countries, Source: Macro Eagle, October 2020 6 – EUROPE As mentioned over the last two months, after the July Recovery Fund (RF) agreement, the market has gone Europe-bullish. In August we saw record speculative EUR-long positions, which duly corrected. Now we are seeing Italian 30y debt yield hitting all-time lows at 1.72%. Not just because of the RF, but also because of the positive local election outcome and lower Covid infection rates. But the upcoming EU Council on October 15th will likely show that the EU is still a long way from being functional, as Member States argue over the exact details of the July agreement. The Nordics are still worried that the flexible PEPP rules will be expanded to other programs and don’t like the RF grants anyways. The Easterners (Poland/Hungary) are threatening to not ratify the RF as long as there is no clarity on the parallel EU budget and the “rule of law” conditions. And the Southerners are happy to take the money, but it is still far from clear if they will be as happy with structural reforms. All this while the EU’s embarrassing inability to sanction Belarus continues (the vote requires unanimity and Cyprus is blocking). Meanwhile, the UK has gone ahead and imposed sanctions weeks ago. Bottom line: those Italy 30y yields look tight. Figure 10: Italy’s 30Y Yields and the Exchange Rate EUR-USD, Source: Macro Eagle, October 2020 7 – TAX WARS After the Trade Wars, came the Tech Wars, next come Tax Wars. Frequent readers know my long-term view that thanks to decades of globalisation and technological change, the next decade will be characterised by “politics moving right (nationalism) and economics moving left (redistribution)”. Covid’s long-term fiscal challenges have, if anything, accelerated this trend. Tax increases, re-shoring, financial repression and redistributive policies (such as Minimum Wages or Universal Basic Income) are among the likely economic policies required to balance economic with societal necessities. Quick reminder that after previous periods of economic devastation and high debt, like WW2, the US top marginal tax rate reached 94%. In the US we are already seeing Tech-Tycoons and Business-Barons flee from States announcing higher taxes for the wealthy (New Jersey, California, New York, Connecticut, Illinois) towards low-tax states such as Florida and Texas. The same will increasingly happen at the national level. The most recent example is Uruguay announcing a 5 years tax holiday for new residents buying a house ($380,000+) or investing in a business ($1.7m+). The declared aim is to attract 100,000 wealthy Argentinians. Needless to say, Buenos Aires is not amused. Welcome to Tax Wars. This could get nasty.   8 – PORTFOLIO My portfolio is unchanged from last month in that I only have my strategic positions on, having reduced everything tactical. My core views remain the same: long real assets (equities, real estate, land, commodities). Tactically I do like rates payers (yields up), especially if Biden wins or we get a vaccine. I’m not as bearish as Druckenmiller (he sees sees inflation reaching 5-10% I the next 4-5 years) but with rates volatility so low (see chart) in absolute and relative terms, those hedges look good to me. Favourite “event risk” hedge? Turkey was my short over the summer. Now I think a speculative short is the Taiwan Dollar (via puts). The currency’s economic fundamentals are strong and it is hence trading at a 11 year high. But it is THE geopolitical hotspot, with China (yet again) sending military aircraft across the mid-point of the Taiwan Strait in September, probably as a retaliation for the announcement of new US arms sales to Taiwan. With China a bipartisan punchbag, there might be more to come. Figure 11: Overview of Volatility in Different Asset Classes, Source: Macro Eagle, October 2020 Have a great OCTOBER ... stay safe … 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. Bobby left Goldman Sachs in March 2018, where he was a Partner and Global Head of Market Strats. His previous responsibilities included Systematic Trading Strategies, eProduct and FX/EM Structuring. In his external functions he was Member of the ECB's FX Consulting Group. Before Goldman Sachs, Bobby worked at Deutsche Bank and UniCredit/HVB. 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