Alternative Markets Outlook 2022
2021 was firmly in the grasp of Covid-19 through the Delta and Omicron strain. Although Covid-19 was managed solidly, the imposed restrictions and the economic interventions have severely impacted the economy and society. Not only has inflation skyrocketed but it is also likely to persist for quite some time. In January 2021, the US CPI was at 1.4% and rose to 6.8% in November 2021. In Europe, the situation looks similar, although the initial surge started earlier in the US and currently Europe’s inflation is lower with 4.9% in November 2021. In 2022, inflation will prevail with even higher levels in early 2022 with a realistic chance to subside towards the latter part of 2022. This rather grim outlook is largely in line with the observation during 2021, when inflation targets were mostly too low and the estimated time period were too short. The US will probably experience slightly higher levels, due to the larger extent of money printing to fight Covid-19 originally. Central bank intervention will be reduced to normal levels in the latter part of 2022. It has been already announced that they will scale back their asset buying programs but not entirely. Depending on how Covid-19 is evolving, it seems reasonable that towards the end of 2022, these programs will be discontinued. Aside from these monetary interventions, there were also substantial fiscal interventions, as shown in Figure 1. Figure 1 depicts the US national debt and the increase of additional trillion of debt. Since Covid-19 emerged, six additional trillions were spent to fight the immediate impact. In particular, the speed at which the money was spent is remarkable. While it took between 30 and 300 days for an additional trillion during Covid-19, it took between 170 and 320 days during the global financial crisis in 2008. The measure undertaken to fight Covid-19 are massive but they have helped the economy to bounce back. Among others, the development of the employment is largely desirable. For example, in the US, the unemployment rate was reduced to 4.2% from its peak of more than 14% in 2020. Equity markets, which have contributed in a major fashion to the overall success of 2021, will be largely impacted by Covid-19 in 2022. This was once again observable in November 2021 when Omicron emerged. Assuming a positive development, it is likely that equity markets will keep rising, although at a normal pace below unlike 2020 and 2021. Figure 2 and 3 show the S&P 500 and the Euronext 100 indices over the past two years. Since January 2020, the S&P 500 gained 47.5%, while the Euronext 100 gained 18.9%. The gains since their bottom in March 2020 are 118.4% for the S&P 500 and 86.0% for the Euronext 100. One potential reason for the strong growth in 2020 and 2021 may be due to expected inflation ahead, which is compensated by higher nominal gains. This effect is likely to fade given the enormous growth numbers in 2021 which have given rise to doubts about the sustainability of these profits alongside fears of another financial bubble. This is in particular true for industries that have benefited from Covid-19, such as technology. One example of seemingly unhealthy gain is Tesla, which is up more than 1,000% since Covid-19 emerged. The companies benefiting from Covid-19 should be viewed with caution, while companies that were negatively affected by Covid-19 certainly involve less risk. A negative development with the handling of Covid-19 could turn the situation upside down again and trigger similar effects as in March 2020. This may occur, for example, if a new strain emerges with a substantially increased fatality rate, is spread relatively easily and vaccinations are of only mediocre effectiveness against the new strain. Yet, this scenario is rather unlikely given that with each wave, the number of infections remains at a relatively similar level, while hospitalizations and fatalities decline. Furthermore, virus strains that spread more easily, such as Omicron, frequently are less deadly. These two observations favour the good scenario going forward. In an environment of high volatility and many opportunities, alternative assets are well positioned. Figure 4 highlights the volatility in the market measured by the VIX. Since the occurrence of Covid-19, the volatility in markets has never reached levels prior to Covid-19, although there has been a massive improvement. From the peak in March 2020 and a level of more than 80, markets have stabilized between 15 and 25 in quiet times with occasional spikes. With regards to alternative assets, 2020 and 2021 were highly beneficial for several reasons. Firstly, in crises, actively managed vehicles are of increased interest as they try to mitigate the negative impact of the crisis. Secondly, due to the nature of being a healthcare crisis, this brings many opportunities with it. Thirdly, the substantial uncertainty in markets also favour alternative assets, as for example, private equity funds are less sensitive to significant short-term volatility. 2021 was especially profitable for the private equity and hedge fund industry, which make up the largest part of alternative assets. In the following sections, hedge funds, private equity, private debt and crypto assets are discussed in a more detailed fashion.
After an exciting time in early November 2021, the enthusiasm in markets faded quickly. The newly found strain of Covid-19, called Omicron, caused a minor shock to markets. Apparently, it seems to be milder than for example the delta variant, but it spreads even faster. Nevertheless, any conclusions on the virus strain are too early to be reliable. Omicron further worries European countries, as their number of cases has been surging regardless of the high vaccination rates. Many countries are imposing further restrictions, after some travel bans have been initiated. Those have not proven to be effective, as Omicron has been detected in most countries already. Among the strictest countries is Austria that has announced that the vaccination is mandatory as of early next year. Despite this rather grim outlook before Christmas, equity markets only took a slight hit. Figure 1 shows the value of the S&P 500 over the past three months. Even though Covid-19 is again a major topic, the drop was only minimal. Equity markets still had a stellar year. The S&P 500, for example, is up 23.4% as of the time of writing. The SMC Equity Strategy Index is up 10.7% in 2021 and gained remarkable 4.16% in October 2021. Major contributors were the strategies Long/Short US Equity Consumer, TMT, Healthcare and Long/Short US Equities Disruptive Technologies with 9.33% and 9.50% in October 2021. The situation looks a lot worse for oil. WTI crude oil lost almost all gains from the past three months, as shown in Figure 2. Oil prices fell from almost $85 per barrel to $66 per barrel. This strong decline stems from the fear of excess supply, if Omicron should lead to more severe restrictions, such as lockdowns. Regardless, oil still has come a long way from its negative value back in March 2020 when Covid-19 became problematic. At the current price of $66 per barrel, oil is up 33.5%, which is still remarkably lower than its previous peak of 67.0%.
Hedge funds experienced a great Q3 2021 and October 2021, as the average fund gained 1.68% and the majority achieved profits. In particular discretionary macro hedge funds gained substantially and according to JPMorgan the outlook for 2022 looks exceptionally promising for macro hedge funds. The market ecosystem is favourable, as there is considerable volatility in the market. A large, and concerning, driver is inflation that keeps rising for the entire year, although it was not a widely discussed topic at the beginning of the year. In November, the US CPI reached a new 30-year high after having stabilized since summer 2021. Figure 1 shows the US CPI and US Core CPI since 1990. Both indicators are at levels last seen around 1990s, which is quite worrying, as during the dot-com bubble and the global financial crisis, the CPIs did not spiked as much as they do now. Even more worrying is the fact that inflation is only expected to drop in summer in 2022, although this threshold has continuously been postponed, as the anticipated peaks have. A large contributor to this development are the interventions of the Federal Reserve, as shown in Figure 2. Not only has the Fed printed substantial amounts of money to fight the economic damage of Covid-19, but it also used quantitative easing to a huge degree. The balance sheet of the Fed grew from $732bn in 2002 to $2.2tn in 2009 and to $8.6tn in 2021. The increase in 2020 exceeds $3.1tn, which is more than the total balance sheet was after the financial crisis in 2007/08. This further emphasizes the degree of the intervention of the Fed. In the UK, the situation does look slightly better. This can be largely attributed to the lesser intervention from the Bank of England (BoE). Although the percentage increase is similar, the assets of the BoE “only” increased by £0.5tn and are currently at £1.07tn, as shown in Figure 3. Currently, inflation in the UK is only at 2% but it is expected to rise during 2022. In August 2021, the estimated peak was at 4%, while in November 2021, this was corrected to 5%. Unfortunately, this has been a general trend in 2021. Hence, it can almost be expected that these estimations will rise going forward.
Hedge funds have experienced a great third quarter and continue to do well in October 2021. Partially due to the surge in volatility, the hedge fund industry is close to reach a milestone of $4tn in AuM. Nevertheless, the strategy of hedge funds is of utmost importance when determining how well a hedge fund is doing. This is in particular true for 2021. Crypto and equity hedge funds tend to profit the most from the current market ecosystem, as their asset class is surging at a rapid pace. Global macro and fixed income-based strategies have a more challenging ecosystem. Figures 1 to 6 show the returns as of Q3 2021 of the different SMC Strategy Indices in comparison to other relevant benchmarks for the specific strategy. Cryptocurrency strategies unsurprisingly did the best this year with the average strategy being up 177%. All strategies in that area cover the best performing strategies of the year with Token Liquid and Token being the best among them with a performance of 316% and 260%. The SMC Equity Strategy Index achieved a lower return than some of its benchmarks in 2021 with 7% as of Q3 2021. The best performing equity strategy is Equities US Activist Event Driven which is 27% up in 2021. With regards to the less beneficial ecosystems for fixed income and global macro related strategies, the SMC Strategy Indices did well. The SMC Credit Strategy Index is up 4.49% an outperforms almost all benchmarks shown in Figure 2. The situation is even better for the SMC Global Macro Strategy Index that achieved a YTD of 37.40%, thereby outperforming any benchmark by a lot as shown in Figure 4.
The most noteworthy event in September 2021 was probably the apparent collapse of Evergrande, one of the largest real estate companies in China, whose status is currently unknown. On Thursday, 16th September 2021, Evergrande issued a statement that it will not be able to repay the outstanding interest payments that day. Following this announcement, the financial market was in substantial stress. Equity markets all around the world lost a few percentage points and volatility spiked. Bond trading was under pressure as well, as Evergrande’s bonds were downgraded and frozen from trading. It sometimes was already referred to the next “Lehman Brothers” case. The volatility the stock has seen since is tremendous, as it lost nearly 80% in the first few days after the announcement. It seemed as though the situation had stabilized, but since not all due payments were paid on Friday, 24th September 2021, the status is unknown. If nothing else happens, which is highly unlikely, the company would enter a grace period following bankruptcy. There are three critical features involved in Evergrande. Firstly, China and Chinese people are heavily engaged with the company, as the company has sold many buildings already without having built them yet. A default would cause huge issues for the affected people. Secondly, many companies are frequently doing business with Evergrande, in particular construction, design and other suppliers, could also face bankruptcy alongside Evergrande. Lastly, the collapse of Evergrande would pose a substantial risk to the financial system of China. The latter one is in particular difficult, as the company has outstanding debt at more than 250 banks, which could put additional pressure on China’s ability to offer cheap debt, which is necessary to maintain growth level. Moreover, it does not make a China a more appealing place to invest for foreign investors, which were already on the decline since the recent developments
August 2021 was a very good month for many asset classes. Equities in general did very well, as the S&P 500 surpassed the 4,500 mark at the end of last week. This was largely backed by surge in technology-driven stocks that have done very well since the crisis began and do not seem to slow down. There also was a substantial rebound from the continuous selloff of Chinese stocks, in particular tech stocks, as for example Alibaba surged 9% in a single day. Similarly, hedge funds also had a strong July and saw continued inflows since May 2021 during which period the AuM increased significantly to $4.32tn. Aside from inflows, the AuM was also boosted by the good performance of hedge funds, as our SMC Single Manager Cross-Asset Index is up 5.4% in July 2021. These gains largely stem from tactical trading and cryptocurrency-based strategies, while only equity strategies were down slightly. The best strategies in July focused largely on cryptocurrencies that have recovered well from their severe drop a couple of months ago. The market cap of cryptocurrencies just surpassed the $2tn mark again, largely due to the surge of altcoins. Bitcoin (BTC) is relatively low with $48k at the time of writing. Ethereum (ETH) is a lot higher, but also quite far away from its peak with being worth $3,200 currently. Other altcoins like Cardano (ADA), the now third-largest cryptocurrency, have surpassed their previous records by almost 50% already and continue to reduce the dominance of BTC and ETH. Gold, and other precious metals, that suffered in 2021 so far, have seen an upward trend over the last weeks, but they remain at relatively low levels.