Alternative Markets Update October 2020 - Macro and Political Outlook November 2020 by Macro Eagle

Alternative Markets Update October 2020
With the whole economic environment and the high volatility in the public market, alternatives seem like a good alternative. However, Covid-19 shocked the industry, forcing a quick adaptation. The alternative industry had a great decade so far with an annualized CAGR (continuously compounded annual growth) in AuM of 10.2%, as shown in Figure 7. It is expected that 2020 will be the first year, the AuM declined on a YoY-basis. However, the alternative industry is notoriously famous for exploiting crises, in particular private equity, which will lead to substantial growth in AuM going forward. Nevertheless, the future growth will probably not exceed the last ten years the industry has experienced. It is expected that the AuM of alternatives will reach $17.2tn in 2025, with currently being at $10.7tn. Figure 8 shows which sectors of the industry will most likely be the beneficiaries. It shows that there is a huge LP interest in private equity with 25% saying that they will substantially increase their allocation towards private equity and 56% says they will increase their allocation and only 4% are saying that they will decrease their allocation. Other sectors of high interest are private debt and infrastructure, which will experience growth in AuM by more allocations from around 67%. The remaining sectors are likely to increase slightly, whereas only hedge fund will see only 40% of people tending to increase allocation.

Figure 7: Alternative Assets AuM and Forecast from 2010 to 2025, Source: Preqin

Cryptocurrencies / Blockchain

Figure 13: Total Value Locked (USD) in DeFi in the last Year, Source: DeFi Pulse, November 2020

Figure 14: Current DeFi Ecosystem, Source: Pantera Capital, October 2020

​DeFi is probably the topic in the crypto space in 2020 and its steep rise during the summer. DeFi started with a total value locked in the area of millions in the year and is (as of November) at around $12.5bn. This development is also not expected to fade away towards the end of 2020, although it seems possible that there will be a decrease in growth compared to the summer. Figure 14 shows the DeFi ecosystem separated in sub-categories.

Macro and Political Outlook November 2020 by Macro Eagle
Should we get a Blue Wave, then the “consensus trades” are rotation from Growth into Value (on stimulus), overweight infrastructure/green-energy, short Treasuries (rising yields), short US Dollar and long selected Emerging Markets (like Mexico). The biggest risk in the short-term would be a sell-off due to fear of change in tax policy (wealthy Americans locking in “Stepped-Up Basis”, capital gains rate and/or Tax Loss Harvesting). The medium-term risk are higher US yields/curve steepening on the back of stimulus.  For a quick overview of the other scenarios (already amply covered elsewhere) see short summary below. Also important to keep the portfolio on the right side of what won’t change, whatever the outcome: (1) More stimulus and hence higher yields; (2) China bashing; (3) Big Tech under political pressure and (4) the green-energy transition. The latter obviously turbo-charged if Biden comes in.

Figure 19: An Overview of Upcoming Events in November 2020, Source: Macro Eagle, November 2020

Figure 24: Market Position with Regards to US-Election, Source: MacroEagle, November 2020

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RESEARCH PERSPECTIVE VOL. 143 November 2020 Alternative Markets Update October 2020 Last week all eyes were on the US and who wins the election. The counting of the ballots took several days and increased the tension. However, the likelihood of who wins the presidency shifted fast to Joe Biden. Alongside, a mostly Republican senate, equity market posted huge gains towards the end of the week in anticipation of four years with relatively few regulatory changes, due to the split in the house and the senate. Looking towards the end of 2020, it remains to be seen if Trump accepts his defeat or if he will try to prevent with this with several lawsuits, which are likely to not change the fact that he lost. Since the president elect has been confirmed and the markets have opened again on Monday, equities have risen sharply. The DJIA has even reached the 30k during the day but fell again afterwards. Figure 1 shows the price development of the DJIA during the last year. It is shown that the DJIA has almost reached its high again from spring 2020. Figure 1: Dow Jones Industrial Average Index from November 2019 to November 2020, Source: The Wall Street Journal, November 2020 For the remaining 2020, it is also of importance if there is another stimulus package from the government with regards to the Covid-19 crisis. Covid-19 has reached new record numbers during the electoral week and in many countries in Europe as well. Several countries are currently in lockdown, with the UK among them since Thursday last week. At least there are some good news on this front, as Pfizer and Biontech have revealed on Monday (9th November) that their phase 3 trial found that their vaccine prevented 90% of infections. Pfizer was also the major reason for the DJIA reaching the 30k mark. Stimulus packages with regards to Covid-19 and its implications on the economy have led to a record high in global debt with $258tn as of Q1 2020, as shown in Figure 2. However, as the economy was not only supported by fiscal stimulus, but as well by monetary policy with interest rate decreases to almost zero and in some cases below zero. It seems likely that accumulated debt will be reduced by inflation after the Covid-19 has passed. This scenario seems possible to certain extent, as currently $16.8tn of global bonds have negative yields, as shown in Figure 3. This development is substantial, as before 2015, it has rarely been the case that there are even bonds with negative yields. Towards the end of 2020, it is highly unlikely that rates shift from negative territory into positive, as the Covid-19 situation is getting worse and worse around the globe. A possible time of relief could occur, once there are new aid packages, such as the one discussed for quite a while in the US. Interest rates however will not experience a substantial increase (even in the following years to come). Figure 2: Global Debt from 2011 to 2020, Source: Andrews Gwynne, IIF, BIS, IMF and National Sources, November 2020 Figure 3: Global Negative Yielding Debt in $tn from 2010 to 2020, Source: Andrews Gwynne, BofA Global Investment Strategy & Bloomberg, November 2020 These developments suggest that fixed income will be replaced by other more stable assets at least to some degree. Furthermore, as the devaluation of money seems unavoidable, alternative storages of values are highly in demand. Most notably is certainly gold, whose price development of the last twelve years is shown in Figure 4, and cryptocurrencies, which are seen more and more as an asset class rather than pure speculation.  Cryptocurrencies will be discussed further below. Gold has had an extraordinary year, outperforming nearly other asset classes with 22.3% YTD. The gold price this year peaked at $2067 in early August but has since fallen to $1867 due to the recent news about the Covid-19 vaccine study by Pfizer and Biontech. In the consensus scenario the FED will let inflation rise more than 2% and will remain stable until 2023. In the continued uncertainty case, gold could rise to almost $2500 in Q2 2021. In the scenario of a hawkish FED, in which an inflation of 2% is not allowed and it would imply that interest rates would rise 2% (for the 10Y Treasury), the gold price is expected to plummet to about $1500 in mid-2021. Silver has had a rather bad year, especially in comparison to gold. Silver has not moved like gold has until July 2020, during which it accelerated quickly. However, this trend was not for long, as it plummeted again in August. Since 2016, the gold-to-silver ratio was constantly above its average over the last 30 years, as shown in Figure 5. In August, it fell below this average for the first time in a few years and it remained there since. The demand for silver has increased substantially, as in early 2020, there were around $650m in silver-related ETFs, whereas this number has increased significantly throughout 2020 to $900m, with a recent decline of around $40m. Figure 6 shows the price development of silver in the last 25 years and its forecast until mid-2021. The forecast looks really promising, as it is currently at $24 and is projected to reach $33 in early 2021. Figure 4: Gold Price Forecast from 2008 to 2021, Source: WisdomTree & Bloomberg, November 2020 Figure 5: Gold-to-Silver-Ratio from 1990 to 2020, Source: WisdomTree & Bloomberg, November 2020 Figure 6: Silver Price Forecast from 1995 to 2021, Source: WisdomTree & Bloomberg, November 2020 With the whole economic environment and the high volatility in the public market, alternatives seem like a good alternative. However, Covid-19 shocked the industry, forcing a quick adaptation. The alternative industry had a great decade so far with an annualized CAGR (continuously compounded annual growth) in AuM of 10.2%, as shown in Figure 7. It is expected that 2020 will be the first year, the AuM declined on a YoY-basis. However, the alternative industry is notoriously famous for exploiting crises, in particular private equity, which will lead to substantial growth in AuM going forward. Nevertheless, the future growth will probably not exceed the last ten years the industry has experienced. It is expected that the AuM of alternatives will reach $17.2tn in 2025, with currently being at $10.7tn. Figure 8 shows which sectors of the industry will most likely be the beneficiaries. It shows that there is a huge LP interest in private equity with 25% saying that they will substantially increase their allocation towards private equity and 56% says they will increase their allocation and only 4% are saying that they will decrease their allocation. Other sectors of high interest are private debt and infrastructure, which will experience growth in AuM by more allocations from around 67%. The remaining sectors are likely to increase slightly, whereas only hedge fund will see only 40% of people tending to increase allocation. In Europe, and specifically in the UK, the tensions are increasing, as the EU and the UK have only this week left to reach agreement. Otherwise, a hard Brexit seems like the only options left, as another extension of the Brexit negotiations is highly unlikely. Depending on the results of the negotiation UK’s economy will either slowly recover or plummet further. Figure 7: Alternative Assets AuM and Forecast from 2010 to 2025, Source: Preqin Figure 8: Investor Plans for the Alternative Asset Allocation by 2025, Source: Preqin Hedge Funds Hedge funds have performed fairly well in 2020. They have mitigated the drawdown caused by the Covid-19 outbreak in March 2020. However, they have not recovered as quickly as for example equities. Hedge funds have attracted $160bn in industry AuM in Q3 2020 and are currently topping the investor sentiment in the alternative industry. Therefore, it is likely that this trend will continue in the near future. As of now, the industry AuM is at $3,580bn, as shown in Figure 9. This development is worth a lot to the industry, as it continuously faced more redemptions than inflows for the last years. Furthermore, the industry has frequently been criticized, due to the fact that they failed to protect from drawdowns and delivering lower returns than indices. The industry is expected to grow to an AuM $4,282bn in 2025, which is a CAGR of 3.6%. This is substantially lower than the average of 9.8% for alternative asset class as a whole, which seems to be in line with the worst investor sentiment regarding the long-term view alongside natural resources. Figure 10 shows the strategies that investors are considering. By far the most popular strategy is Long/Short Equity, which is not surprising, as some funds in the strategy have posted huge gains through the crisis by exploiting the high volatility in the market. Two examples of our strategies would be the Long/Short US Equity Consumer, TMT, Healthcare and the Long/Short US Equities Disruptive Technologies strategies which are both up around 50% YTD. Also of interest are macro and multi-strategy with each 14% of investors looking to commit to such strategies. The graph also shows that fund of hedge funds have completely fallen out of favour, as 0% of investors were looking to commit to fund of hedge funds. Figure 9: Global Hedge Fund AuM and Forecast from 2010 to 2025, Source: Preqin Figure 10: Core Strategies Targeted by Hedge Fund Investors over the next 12 Months, Source: Preqin Cryptocurrencies / Blockchain Cryptocurrencies have performed extraordinarily during crisis as mentioned previously alongside gold. Bitcoin (BTC) has risen from $13,000 at the writing of the last perspective and is currently trading at $15,211 (10th November 2020). The last month was exceptional for BTC, as shown in Figure 11. For the entire year, the picture looks even better, as BTC’s YTD return is 111%. Its market capitalization is now at $280bn. BTC, and with it most other cryptocurrencies, have benefited tremendously from the development that has been made in the last few years and since its last peak at the end of 2017. It is likely to continue increasing going forward for multiple reasons. Firstly, the uncertainty may prevail for quite some time with Covid-19 rampaging, Brexit, US-China trade war and potential lawsuits to fight the election results from Trump’s side. Secondly, since its last hype, BTC and cryptocurrencies in general have gained a lot more acceptance as a real asset, instead of speculation only. Thirdly, the institutional framework has gotten a lot better with fairly robust exchanges, derivatives markets, easier access to funding etc. Fourthly, it has gained momentum throughout the year with positive news, such as major investors like Paul Tudor Jones starting to invest, Paypal adding cryptocurrencies to its network and several more. Figure 11: Price Development of Bitcoin in 2020, Source: CoinMarketCap, November 2020 Ethereum (ETH), which got boosted by BTC this year as well, has posted an even better year than BTC. As of 10th November 2020, it is trading at $444 and has posted a YTD return of 240%, as visible in Figure 12. ETH’s market capitalization has risen to $50bn. Aside from all the factors that BTC is profiting, which also apply to ETH, it has several other factors that also impact ETH positively. For instance, ETH 2.0 is expected to be launched in December 2020, which most likely causes a positive price reaction. Furthermore, most applications of the blockchain technology are based on ETH’s blockchain. Figure 12: Price Development of Ethereum in 2020, Source: CoinMarketCap, November 2020 DeFi is probably the topic in the crypto space in 2020 and its steep rise during the summer. DeFi started with a total value locked in the area of millions in the year and is (as of November) at around $12.5bn. This development is also not expected to fade away towards the end of 2020, although it seems possible that there will be a decrease in growth compared to the summer. Figure 14 shows the DeFi ecosystem separated in sub-categories. Figure 13: Total Value Locked (USD) in DeFi in the last Year, Source: DeFi Pulse, November 2020 Figure 14: Current DeFi Ecosystem, Source: Pantera Capital, October 2020 Private Equity / Venture Capital Private equity seems well positioned to profit going forward. The sector was hit less severely than others and the sector is very good at profiting from the aftermath of a crisis, as the global financial crisis in 2008 has shown. Furthermore, it was the sector with most gains within alternatives and is likely to continue, as shown in Figure 15. It shows that the sector will grow by 15.6% in AuM on a CAGR basis. This would mean that in 2025, the sector’s AuM could reach $9,114bn, while it is currently at only $4,418bn. The high growth rate in AuM will make the sector the most important one in the alternative space going forward. Despite the struggles in fundraising, a huge amount of dry powder is still available, which is likely to be deployed soon. The industry may struggle with inflows in the near future but the payout down the road are promising. Figure 15: Global Private Equity AuM and Forecast from 2010 to 2025, Source: Preqin Private Debt Private debt has been hit stronger by the crisis than other alternatives. Surprisingly the sector has set a new record capital targeted along with a new record in funds raising capital. The opposite is visible on the fundraising side, which has plummeted in Q3 2020, while it rose before. The private debt market managed to do relatively well during the crisis, as there were more larger funds. Those funds could typically raise their money easily, while newer funds struggles. This has been further accelerated by investors’ demand to only invest in one fund. Despite the solid results in 2020, the AuM has slightly decreased to $848m. Figure 16 shows the estimated value of the industry up to 2025, where is says that private debt could reach an AuM of $1,456bn, a CAGR of 11.4%. Therefore, private debt is expected to do better than, at least in AuM growth, than the average alternative asset. Figure 16: Global Private Debt AuM and Forecast from 2010 to 2025, Source: Preqin Real Estate The real estate sector has been hit hard by Covid-19. The staggering numbers in daily infections in Europe certainly did not help, especially with some countries entering lockdown again. Tourism-related real estate is facing existential problems for quite a while now and it does not look better going forward, as the best hope to reset to normal is the vaccine. Even if the newly discovered vaccine from Pfizer and Biontech works, it needs to be fully approved and being created in huge numbers as well as being distributed. This takes quite some time, so there is no short-term relief to be expected. Office buildings are also suffering from this development, although those being more robust. Probably until mid-2021, it does not seem likely that there are favourable conditions for the sector. Figure 17 shows the AuM in recent years and projections until 2025. Even though the AuM rose this year to $1,046bn, the outlook (aside from the current uncertainty) does not look great either. The projected growth in AuM is among the smallest in alternatives with a CAGR of only 3.4%. This would be an AuM of $1,238bn in 2025. Figure 17: Global Private Real Estate AuM and Forecast from 2010 to 2025, Source: Preqin Macro and Political Outlook November 2020 by Macro Eagle Welcome to NOVEMBER. Apologies in advance for the sole focus on the US election, but with markets so US-centric, it is unavoidable. Spoiler alert: I thought Biden was a “done deal”, but Trump has gained momentum … and might have a chance.   1 – OCTOBER RECAP Another month for the history books. The 1st week saw Trump in hospital with Covid (Fri 2nd). The 2nd week saw him come back (Mon 5th), announce the end of stimulus negotiations (Tue 6th) and finally call for a bigger stimulus (Fri 9th). Go figure. Then, from the third week onwards, a ping-pong pattern of good/bad news emerged centred on: (1) US stimulus hopes ; (2) worsening Covid numbers; (3) Big Tech priced to perfection/no upside; and (4) a tightening US presidential race. Of notice: Wednesday 28th saw a highly unusual drop in US equities (the biggest since June), without any of the traditional offsets working (Treasuries didn’t budge, gold fell). All this despite strong data (US Q3 GDP +33.1% - the fastest quarterly growth ever recorded) and strong earnings. This in my opinion was position squaring ahead of the election. I’m out as well. Figure 18: Comparison of the S&P500 with Major Events in September 2020, Source: MacroEagle, November 2020 2 – The month AHEAD November is incredibly “front loaded”: should the US election (Nov 3rd) produce a clear winner/outcome, then we could see a relief-rally into year-end, although constrained by higher yields, year-end tax considerations and IPO supply. In fact, on Nov 5th we will see the biggest IPO ever: Ant Financial (listed in HK/Shanghai, $34bn). Should the election turn out nasty/contested, then expect the FED (Nov 5th) to step in, which should somewhat limit the downside. In the second week we will most likely get an EU-UK agreement, while most of Europe endures another round of Covid-lockdowns. The big difference to March/April is that this time around many people worry more about the economic shutdown than the virus. Hence “lockdown fatigue” will test governments everywhere. Depending on the election outcome we will then cruise (or not) into Thanksgiving at the end of the month, with the main political event of notice being the G20 in Riyadh on 21st-22nd (probably virtual). Figure 19: An Overview of Upcoming Events in November 2020, Source: Macro Eagle, November 2020 3 – The POPULAR VOTE is BIDEN’s The betting market is firmly in “Blue Triple Whammy” territory (President Biden at 66c, Democratic Senate at 63c and Democratic House at 87c). And yes, if I look at the national level, it seems like Biden has the popular vote in the bag, even though the spread in the polls has narrowed from 10% to 8% during October, thanks to Trump’s aggressive “Blitz rallies”. What has me somewhat surprised is that forecasters predict a Biden victory with a relatively high to very high certainty (The Economist is at 95%), which I find quite aggressive, given that the granular battleground picture doesn’t look certain at all … Figure 20: Prediction of US-President by Polls and Battleground States, Source: MacroEagle, November 2020 4 – The ELECTORAL VOTE could go either way Of the traditional 12 battleground states (see map above), I give four to the Democrats (NV, MN, MI, WI). That leaves me with 8. Of these, five are pretty much a “draw” in recent polls (AZ, FL, GA, IA, OH), while three are in statistical-error-territory (FL, NC, TX). The last one, Pennsylvania, still has a Biden lead, but it is fading fast, especially after Biden walked into Trump’s trap during the 3rd debate (making anti-fracking/anti-oil statements). From a big picture perspective, the odds are obviously against Trump, as he needs to win all eight (279-259), while Biden knocks him out by winning just one of them. But the picture is surprisingly close nonetheless and notice that the bellwether state of Ohio (OH), which has been on the right side of every presidential election since 1960 is currently showing a perfect draw in the polls of polls. The other side of the same coin is obviously that Biden could win all of these 8 states, in which case we would get a Blue landslide (Biden 412-126). Bottom Line:  I wouldn’t be short the “surprise” (Trump or Blue Landslide). Figure 21: Battleground States in More Detail, Source: MacroEagle & RealClearPolitics, November 2020 5 – Keep an eye on PENNSYLVANIA Much is made about Florida, as without it Trump loses for sure. But with Biden underperforming with Latinos (compared to Clinton) and with the state within the statistical error, the more interesting state to watch is actually Pennsylvania (PA). As mentioned above, momentum here has been on Trump’s side, especially since the 3rd Debate. Needless to say, Trump is working the state hard (he was there again yesterday). And it shows: both the polls and odds (see graphs below) are much tighter for Trump in PA than at national level. In case Trump takes Florida and PA becomes the decisive state, the bad news is that counting of mail-in voting only starts on election day and votes received up to 3 days after the election will still be counted. So, this could get interesting. Figure 22: Polls and Odds of Who Wins Pennsylvania, Source: MacroEagle & PredictIt, November 2020 6 – The SENATE race As for the Senate the numbers are pretty easy: 35 seats are up (2 special) of which 23 are held by the Republicans – so the odds are against them to start with. The current Senate has a 53-47 Republican majority, so the Dems need 3-4 seats (depending on the Presidency) to flip the Senate. As you can see from the map below, I do think Alabama will flip Republican and CO/AZ/NC/ME will flip Democratic. That takes me to 50-50. Then there are 4 existing Republican seats (MT/IA/GA1/GA2) which are too close to call.   Bottom Line: the Senate will most likely end up Democratic (unless Trump wins the presidency), with the potential “outlier” of a 54-53 seat Democratic majority that would certainly cause some unease in the financial markets. Figure 23: Senate Race by State, Source: MacroEagle & PredictIt, November 2020 7 - If Biden wins – THE CABINET If Trump wins, the status quo is likely to prevail. Should Biden win, the task will start to guesstimate policy (beyond the obvious), for which we will need to know who ends up with the four Great Offices of State, as Biden himself is not known for strong views (that’s why he won the primaries in the first place). As Biden’s support has come from many “wings” of the Party, they will (rightly) demand a position in his government. The question is which one. This guess-work is both path-dependent (for example the size of the Senate majority and the safety of a Senator’s seat will define their individual chances to enter the Cabinet … hint, hint Elizabeth Warren) and iterative (with a focus on female and minorities, if a white-male gets job X, then it is highly unlikely another one will get job Y). My current educated guess would be as follows: Lael Brainard (white/female) gets Treasury. Susan Rice (black/female) gets State. Doug Jones (white/male) gets Attorney General. And Defence goes to Michele Flournoy (white/female). The policy implications I will leave for the next newsletter.   8 - PORTFOLIO Going into the election I’m no-where near as convinced of a Biden victory as I used to be. Better to wait, stay light and see what happens. Essentially, Trump first followed the 1968 (Nixon “rule of law”) playbook in the summer and is now playing the 1948 (Truman) playbook in trying to outflank Biden, who, like Dewey back then, is playing it “safe”. Who is Dewey? Exactly. Should we get a Blue Wave, then the “consensus trades” are rotation from Growth into Value (on stimulus), overweight infrastructure/green-energy, short Treasuries (rising yields), short US Dollar and long selected Emerging Markets (like Mexico). The biggest risk in the short-term would be a sell-off due to fear of change in tax policy (wealthy Americans locking in “Stepped-Up Basis”, capital gains rate and/or Tax Loss Harvesting). The medium-term risk are higher US yields/curve steepening on the back of stimulus.   For a quick overview of the other scenarios (already amply covered elsewhere) see short summary below. Also important to keep the portfolio on the right side of what won’t change, whatever the outcome: (1) More stimulus and hence higher yields; (2) China bashing; (3) Big Tech under political pressure and (4) the green-energy transition. The latter obviously turbo-charged if Biden comes in. Figure 24: Market Position with Regards to US-Election, Source: MacroEagle, November 2020 Have a great NOVEMBER ... 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 : 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. Before Goldman Sachs, Bobby worked at Deutsche Bank and UniCredit/HVB. 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. For queries or for further information around our research and advisory services please contact email: research@stonemountain-capital.com under Tel.: +442037228175. 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