ALTERNATIVE MARKETS UPDATE - MID JANUARY 2023 & MACRO AND POLITICAL OUTLOOK 2023 BY MACRO EAGLE

​With the currently pessimistic view of 2023, markets are under substantial pressure. Most market participants are expecting a recession in 2023/2024. High inflation, steep interest rate hikes, and historical yield curve inversions are just a few indicators that suggest tough times ahead. However, there are some indicators that provide hope that a larger crisis can be avoided. While inflation is high, it has been steadily decreasing, at least in the US. Rate hikes are also expected to increase only slightly in 2023. Nonetheless, this provides little help in avoiding a recession, as it is still unclear how fast inflation will drop down to the acceptable 2% and below range. Furthermore, interest rates will remain high for 2023 with a low to moderate probability of rate cuts in 2023. These still pressure businesses that are expected to earn less in 2023, as consumers have exhausted most of their resources in dealing with the impact of inflation. The biggest saving grace currently is the labor market, which functions very well. In Western countries, the unemployment rates are close to record lows of the past few decades. In the US and the UK, the unemployment rate is 3.7%. In the EU, the unemployment rate is 6%, while Switzerland sees an unemployment rate of 2.2%. Figure 1 shows the jobless claims in the US in 2022. While there has been some variation during 2022, these were small and at very low levels historically. It is even more promising when addressing the private sector. Since early 2021, the private sector in the US is adding jobs at a constant pace. Figure 2 shows this development. 

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RESEARCH PERSPECTIVE VOL. 195 January 2023 Alternative Markets Update January 2023 With the currently pessimistic view of 2023, markets are under substantial pressure. Most market participants are expecting a recession in 2023/2024. High inflation, steep interest rate hikes, and historical yield curve inversions are just a few indicators that suggest tough times ahead. However, there are some indicators that provide hope that a larger crisis can be avoided. While inflation is high, it has been steadily decreasing, at least in the US. Rate hikes are also expected to increase only slightly in 2023. Nonetheless, this provides little help in avoiding a recession, as it is still unclear how fast inflation will drop down to the acceptable 2% and below range. Furthermore, interest rates will remain high for 2023 with a low to moderate probability of rate cuts in 2023. These still pressure businesses that are expected to earn less in 2023, as consumers have exhausted most of their resources in dealing with the impact of inflation. The biggest saving grace currently is the labor market, which functions very well. In Western countries, the unemployment rates are close to record lows of the past few decades. In the US and the UK, the unemployment rate is 3.7%. In the EU, the unemployment rate is 6%, while Switzerland sees an unemployment rate of 2.2%. Figure 1 shows the jobless claims in the US in 2022. While there has been some variation during 2022, these were small and at very low levels historically. It is even more promising when addressing the private sector. Since early 2021, the private sector in the US is adding jobs at a constant pace. Figure 2 shows this development. Figure 1: US Initial Jobless Claims Reach their Lowest Point in Three Months, Source: Bloomberg, January 2023 Figure 2: The Private Sector Is Still Hiring – Measured by a Survey of ADP, Source: Bloomberg & ADP, January 2023 The development of the US-Dollar also poses further risks. Especially in 2022, the US-Dollar strengthened substantially compared to a basket of other currencies. The strengthening can be largely explained by its safe haven properties, and the higher interest rates compared to other major economies, such as the Euro area, the UK, and Japan. Large contributors here are the Euro and the British Pound, as the exchange rates have hit historical lows over the past decades. However, towards the end of 2022, the US-Dollar lost a substantial amount of value in a brief period of time, as it lost almost half its gains in 2022 so far within a quarter of a year. Figure 3 shows the development of the DXY Dollar Index from 2019 to the end of 2022. The sharp turn in the bull run of the US-Dollar can be attributed to a more promising view of market participants. This stems from the steadily declining inflation over the past months. This led market participants to believe in less steep hikes in 2023 and possibly rate cuts already in 2023. Other reasons include the higher relative growth expectation, especially in China and Europe. In China, these growth changes are based on the reopening and a shift from their no-Covid policy. Europe’s growth was adjusted following the (so far) warm winter and little causes for concerns about their gas supplies. Figure 3: The US-Dollar Downward Trend Measured by the DXY Dollar Index and Its 40-Week Moving Average, Source: Bloomberg, January 2023 Hedge funds had an eventful year in 2022. Most funds certainly did not appreciate the market development in 2022, but many also managed to deliver excellent returns, especially compared to the market. The hedge fund industry achieved a slight loss of 0.7% in 2022. While not great, it is remarkable, as the core asset classes of equities and fixed income both lost value in 2022. However, the difficult year of 2022 also presented many opportunities, especially in the commodity, FX, and fixed income markets. Global macro hedge funds stand out in 2022, as many of them were able to generate record gains. Aggregated, macro funds achieved more than 12% in 2022 and outperform any other hedge fund strategy substantially. Most other strategies yielded returns close to 0%. The industry was negatively affected by equity hedge funds, which represent the largest share of hedge funds. Equity hedge funds lost on average 13.4% in 2022. Figure 4 shows a summary of hedge fund strategy returns in 2022. Our hedge funds mostly followed this general trend, albeit with higher magnitudes. Global macro strategies yielded more than 80% as of November 2022. Contrarily, equity hedge funds suffered slightly larger losses on average with 17%. With a similarly difficult year ahead in 2023, the prospect remains comparable to the developments in 2022. Markets in general will be rough, but many opportunities will arise. In this ecosystem, it does not surprise that experienced and large managers were able to manage the crises better than small and inexperienced funds. It is also unattractive to launch new funds in such an ecosystem. New fund launches in 2022 were close to their historical lows. Figure 4: Comparison of 2022 Returns of the Hedge Fund Industry and Its Sub-Strategies, Source: Bloomberg & PivotalPath, January 2023 Macro and Political Outlook January 2023 and 2023 by Macro Eagle I. What I LEARNED in 2022 (a year few will miss) First, despite the doom & gloom, geopolitically it was a good year for the Liberal West: Ukraine/NATO weren’t as weak & incompetent as the Kremlin had expected. And looking at China’s self-inflicted Covid-chaos, the West’s performance suddenly looks relatively good. Second, despite the above, don’t get complacent: the invasion has started a new era of great-power politics, which will make the 2020s very different to the previous decades of ‘one-world-kumbaya-investing’, as corporates move from “Just-in-Time” to “Just-in-Case” economics, supply chain “friend-shoring”, “cybersecurity” and more. Big opportunities by the way, but also big risks.  Third, inflation changes everything: rarely have so many asset classes been down at the same time and rarely have so many ‘hedges’ (Treasuries/Gold/Yen/even options) not worked. And while we might have seen ‘peak’ inflation, it is the ‘stickiness’ (around 3-4%) that will become the problem. Fourth, in the future, avoid any strategy called ‘Zero something’ … as the U-turn will be brutal: “Zero Interest Rates” has led to asset bubbles, inequality, debt and laid the seeds for inflation. In Europe, “Zero Emissions” has led to an Energy Crisis. In China, “Zero Covid” is ending in tears. Bottom line: more “balance”, less maximalism.  Five, economic nationalism is back: as the idea of limited government is taking a beating, industrial policies are making a comeback and investors should take increasing notice. The ‘Fed Put’ is dead, long live the ‘Fiscal Put”. Figure 5: S&P 500 in 2022 and Major Events in 2022, Source: Macro Eagle, January 2023 II. Year Ahead #1: SENTIMENT … … is low, which normally is a good counter-indicator (and should be a bullish sign). US CEOs are negative (left chart), US consumer sentiment seems to have hit bottom (middle graph) and investors are as bearish as it gets (right graph). Add to that most economists/strategists are equally bearish (including the IMF, which sees a third of the world in recession this year) and it really shouldn’t get worse.  But it will. For me the above doesn’t mean the “bear market” is over (more below). It just means that there are painful “short squeezes” ahead (followed by While-E-Coyote moments, see last monthly). Figure 6: Sentiment of the US Economy of CEOs (left), Consumers (middle), and Investors (right), Source: Macro Eagle, January 2023 III. Year Ahead #2: HISTORY … … tells us that two consecutive down years in the S&P500 are very rare. In fact, I only found 4 cases over the last 100 years (see left graph).  But … as frequent readers of my monthly know, my playbook for this healthy and orderly “asset deflation” bear-market is the period 2000-2002 (see right graph). Not that I think it will be identical, but “it will rhyme”. The way I see it is that we are unwinding the “zero interest rate” bubble of the 2010s in three punches (boxing): (1) first a jab to take out the outright ridiculous, like Meme-Stocks, SPACs and various Crypto-visionaries. DONE. (2) Then a cross to take out “long duration”, from Bonds to Tech. That also delivers a blow to “passive investing” given Tech’s concentration in the indices. WORK IN PROGRESS. (3) Finally, a hook to mark down private and illiquid assets. JUST STARTED (see property, with VC/PE next), as they always hope for a short bear-market like 2008/09 to avoid the mark-downs. Not so lucky this time. Figure 7: Rarity of Consecutive Down Years of the S&P 500 (Left) and a Comparison of the S&P 500 Now and During the Dotcom Bubble (right), Source: Macro Eagle, January 2023 IV. Year Ahead #3: MARKETS  Despite the negative sentiment noted above, markets seem quite complacent: Looking at the EPS estimates, equities are still pricing in record profits for next year (left graph). In the bond markets (middle graph) the inverted curve predicts recession, but given where yields are trading in absolute terms, that recession looks likely to be mild. The credit markets (left graph) don’t look too worried judging by the HY-IG spread. Inflation swaps are predicting 2%+ inflation by the end of the year (what?!?) and thanks to a warm European autumn/winter, NatGas prices are at pre-War levels.  The consensus view, in summary, is something like this: “yes, markets might be choppy for a while, but China is re-opening, the US is still flush in stimulus and Russia is losing the war. Hakuna matata.”  To which I suggest reviewing how last year’s consensus ended. Exactly. Figure 8: Optimistic US Equity Earnings Estimates (left), Yield Curve Inversion (2Y-10Y) (middle), US Credit Spread (Corporate Bonds Rated BBB and Treasuries) (right), Source: Macro Eagle, January 2023 V. Year Ahead #4: EVENTS When asked what the most troubling aspects of his premiership were, British PM Harold McMillan (1957-63) answered: “Events, my dear boy, events”.  On that note, the overall focus will obviously be on: (1) inflation and unemployment data, (2) central bank comments, (3) liquidity conditions under QT, (4) China re-opening, (5) national fiscal policy, (6) the War in Ukraine, the weather and European energy supply for next Winter, (7) US-China relations and (8) the various angry nuclear wanna-be out there, from Rocket-Man in North Korea to the mullahs in Iran.  But when it comes to the “known events” with an actual date, I would say: in January, focus on corporate earnings (downgrades!). In February it’s all about the Fed and Cricket. In March it’s China: Covid Wave and economic projections at the National People Congress.  In April BOJ’s Kuroda steps down (more surprises?). In May its about the G7 (tax?), again in Japan.In June keep an eye on the Turkish election. Geopolitically increasingly important, President Erdogan is in a tight spot in the polls, which might lead to some extra-territorial meddling to shore up domestic support.  In July the US debt-ceiling debate might come to a head. Having witnessed last weeks ‘House Speaker election’ chaos (biggest drama since 1855), this divided Congress promises high entertainment value. In August, like last year, it’s all about holidays and Jackson Hole. September brings the Rugby World Cup and the G20 in India (which, by the way, in 2022 overtook Britain to become the 5th largest economy and in 2023 will overtake China in terms of population). In October (tbc) the centre-right should win the Spanish election. In November, again, focus on Beijing’s 3rd Plenum and any updates on economic targets. In December, I will probably read the above and laugh out loud about how wrong I was. But then, as Eisenhower said: “Plans are nothing. Planning is everything”. Figure 9: Schedule of Major Events in 2023, Source: Macro Eagle, January 2023 VI. PORTFOLIO As mentioned previously, I do think there are various interesting opportunities/investment themes out there, especially in the areas of resource security (energy, food, minerals), defence, climate, health/aging and obviously digitalisation. So, even though I still think we are in a bear market, it doesn’t mean one shouldn’t be investing. In fact, world beaters are born in tough times and there is nothing more fun than finding them.  I just think you want to make sure that (1) your assets are as liquid as possible, (2) fix your own debt and avoid leverage/margin, (3) own strategic tail hedges to avoid forced selling of the former. Or as an old trading floor boss of mine used to say: “Hope is not a strategy” (risk management is).  Figure 10: CNN Fear & Greed Index (left) and Emphasis on Risk Management (right), Source: Macro Eagle, January 2023 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 : info@macroeagle.com 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. 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