alternative markets update - mid july 2022

Macroeconomic factors continue to dominate financial markets. Inflation in the US keeps rising, despite attempts of the Fed to slow it down. In June, inflation rose to 9.1%, higher than the anticipated 8.8%. Figure 1 summarizes the development of inflation over the past year in the US. The major drivers remain food and energy, but these are not the only issues. As the prior two are global issues, it is unlikely that those factors will slow down quickly. The Russia-Ukraine war has a substantial impact on those factors. Russia, a key supplier of energy, has led to the possibility of Europe not being able to use as much energy for heating in the winter as usual. Ukraine, which is a key supplier of food, e.g., wheat, puts further pressure on food prices. That Russia started burning down acres does not help the matter either. Although this has no direct impact on the US, the impact on the price of those goods is a significant contributor to the increased prices of those goods. This development has caused markets to anticipate an even larger hike in the upcoming July meeting. Markets analysts now see a hike of an entire percentage point as possible. This further emphasizes how dire the situation looks, as a few months ago, the discussions were between no hikes, a 25 bp, or at worst a 50bp hike. The US federal fund rate is now at 1.75% and likely to rise substantially. Despite these increases, inflation hit a record high (within the past four decades) in June 2022. With this in mind, voices of a looming recession are increasing. The fact that the yield curve inversion between 2y and 10y-Treasuries is at its highest since 2000, does not help mitigate this threat. Figure 2 shows the recent inversion of the two Treasury yields. This recession indicator should not be considered too much, as depending on which maturities are compared, the implications look very different. In Europe, the situation is even more serious. Not only is the continent directly affected by the war and its possibly horrendous outcomes, but it is also susceptible to possible bottlenecks for both energy (in particular gas) and food. Additionally, EU inflation hit a new record of 8.6% in June 2022 without any central bank interventions yet. The development of inflation in the EU is shown in Figure 3. ​

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RESEARCH PERSPECTIVE VOL. 183 July 2022 Alternative Markets Update July 2022 Macroeconomic factors continue to dominate financial markets. Inflation in the US keeps rising, despite attempts of the Fed to slow it down. In June, inflation rose to 9.1%, higher than the anticipated 8.8%. Figure 1 summarizes the development of inflation over the past year in the US. The major drivers remain food and energy, but these are not the only issues. As the prior two are global issues, it is unlikely that those factors will slow down quickly. The Russia-Ukraine war has a substantial impact on those factors. Russia, a key supplier of energy, has led to the possibility of Europe not being able to use as much energy for heating in the winter as usual. Ukraine, which is a key supplier of food, e.g., wheat, puts further pressure on food prices. That Russia started burning down acres does not help the matter either. Although this has no direct impact on the US, the impact on the price of those goods is a significant contributor to the increased prices of those goods. This development has caused markets to anticipate an even larger hike in the upcoming July meeting. Markets analysts now see a hike of an entire percentage point as possible. This further emphasizes how dire the situation looks, as a few months ago, the discussions were between no hikes, a 25 bp, or at worst a 50bp hike. The US federal fund rate is now at 1.75% and likely to rise substantially. Despite these increases, inflation hit a record high (within the past four decades) in June 2022. With this in mind, voices of a looming recession are increasing. The fact that the yield curve inversion between 2y and 10y-Treasuries is at its highest since 2000, does not help mitigate this threat. Figure 2 shows the recent inversion of the two Treasury yields. This recession indicator should not be considered too much, as depending on which maturities are compared, the implications look very different. In Europe, the situation is even more serious. Not only is the continent directly affected by the war and its possibly horrendous outcomes, but it is also susceptible to possible bottlenecks for both energy (in particular gas) and food. Additionally, EU inflation hit a new record of 8.6% in June 2022 without any central bank interventions yet. The development of inflation in the EU is shown in Figure 3. ECB interest rate hikes are more and more expected going forward, but it remains questionable how fast these hikes are able to slow down inflation. With the US as an example, it does not seem to work with great effect, at least not yet. In terms of potential recessions, the EU is likely to be hit harder than the US, with further treats depending on the outcome of the war. Additionally, the exchange rate between the Euro and the US-Dollar has reached parity for the first time in 20 years. Figure 4 shows the decline of the EUR respective to the USD over 2022 so far. These developments make a recession in the European Union even more likely. Oil prices continue to hold their relatively high level of around $100 per barrel (WTI Crude) since the start of the war. Oil supply is still tight and becomes more relevant in the light of potential bottlenecks in the coming winter, especially for Europe. Depending on the reaction from Russia, oil prices could soar to enormous heights. Earlier in the year, some funds and banks mentioned $200 per barrel as a worst case. A newer review from JPMorgan analysts implies that oil could reach prices of $380 per barrel if Russia should decide to cut supply, which may be a way for Russia to hurt Europe further. Yet, it is much more likely that natural gas will be targeted as Europe is very reliant on it. At least, there is some good news in the financial markets. Equity markets have slightly rebounded after their horrific H1 2022. Cryptocurrencies, which have recently been in the spotlight due to huge collapses of companies and huge losses in general, started to rebound. Most notably, Ethereum is close to recovering to the $1.5k mark, which is already a 50% increase from the $1k level it has been at the past month. Bitcoin also recovered but just surpassed the $22k mark, after trading around the $20k mark for the past months. In terms of alternative assets, for the most part, they did a good job in mitigating the severe drawdowns of public markets. Hedge funds managed to limit drawdowns to 10% according to our Cross-Asset indices. Especially global macro strategies managed to perform very well during H1 2022. Private equity, and in particular venture capital, managed to withstand the global drawdown in public equities. Although their performances could not hold their growth levels of 2021, the industry still achieved good results in H1 2022.   Figure 1: US Inflation Over the Past Year, Source: TradingEconomics & US Bureau of Labor Statistics, July 2022 Figure 2: Spread of 10-Year Treasury Notes and 2-Year Treasury Note, Source: Federal Reserve Bank of St. Louis, July 2022 Figure 3: EU Inflation Over the Past Year, Source: TradingEconomics & Eurostat, July 2022 Figure 4: EUR-USD Exchange Rate in 2022, Source: The Wall Street Journal, July 2022 STONE MOUNTAIN CAPITAL Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London with offices Pfaeffikon in Switzerland, Dubai and Umm Al Quwain in United Arab Emirates. We are advising 30+ best in class single hedge fund and multi-strategy managers across equity, credit, and tactical trading (global macro, CTAs and volatility). 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