November 2020 Macro Markets Blog Post

Recap

Hi all, and thank you for tuning into the November update from MacroSquawk. First looking back to the September update, there were several positives and challenges that might serve as clues to what's coming next in - what's likely to be an incredibly challenging end of year environment. One of the more prescient points made was a reference to the slowdown in the initial labor market recovery from reopening. Another was the continuation of the short dollar trade and that inflation might be reflected in the commodities markets. A most important reference was to the possible strengthening that might be enjoyed in EM assets as a result.

The challenge, as with most things in macro, was the timing. What the last post failed to predict was the importance of the stalling out of the labor market recovery. This stalling out, in my opinion, was the primary cause of the grinding action that we had seen in risk assets in September and October (hence no blog posts). This failure in timing, however, provides clues to the fundamental logic for what's likely to come next. 

 

Macro Thesis

I think we are going to be coming into an incredibly challenging end of year environment for market participants. This is on the back of conflicting news on the possible macro outlook. On the one hand, we have rising case counts and an incoming Biden administration that seems set on lockdowns. On the other hand, we have the resilience, and even improvement, in the economic data which has largely beat expectations, along with possibly game-changing vaccine news. I think that latter will win out against the former - for the time being. 

As referenced in the recap, it seems to me that the primary cause of the grinding action we had seen in September and October was as a result of the stalling out of improvement in the labor market data. One thing that surprised throughout this whole time was the fact that retail sales remained relatively robust, along with a muted level of small business closures. This I think is indicative of the resilience of household and small business balance sheets as a result of fiscal stimulus. An important point worth noting about this period is that it also seems that we traded in a wide range on the indexes largely as a function of uncertainty around the election, which has mostly dissipated. With the October data now available, it seems that now even the labor market has continued its surprising, upward grind. This is indicated by improvements in manufacturing PMI and the unemployment data. As a result, it seems that the consolidation we've been seeing is likely over and we finish the year with a rally in risk. 

However, I am cautious about the nature of this rally in risk. I am skeptical about the long-heralded "rotation into value." It seems that market participants were overjoyed at the prospect of a vaccine being released. This is likely to have led into the biggest reversal in factor correlations on record this week. I think this optimism is misplaced, and is not a constructive factor for the outlook yet. This is because even though Pfizer is claiming a 90% effective rate, it seems that its vaccine leads to symptoms that are worse than the virus itself! This is on top of the distributional issues, which makes widespread vaccination unlikely. Another, and I think important, angle to consider is vaccine politics. This in the sense that a large portion of the population is unlikely to vaccinate, given the polarized, political discourse surrounding it. For these reasons, I think that the vaccine only becomes an important factor in the middle of next year, making the rotation into value right now unlikely.

However, there might be another way to play this rally in risk while building a portfolio hedged for several outcomes. Similar to the last several blog posts, I continue to have a short bias on USDs. This is because the Federal Reserve is starting to erode the nominal expectational anchor through its average inflation targeting system. This is coupled with the possibility for a second, albeit 'skinny', stimulus bill that injects money into the real economy rather than the reserve system as with QE. As a result, my base case for commodities continues to be bullish. However, being long commodities would benefit from the same factors that would drive the rotation into value. As a result, the commodities trade allows for the exposure to the same theme with better odds, and a higher return given that commodities tend to be more volatile than even single names. 

This leads to the question about how to hedge for the downside? Given the rising case counts, this is certainly something market participants are looking at. However I think there is a timeline to this risk being materialized. Given the fact that the mortality rate is down from the first incidence of Covid in March, it seems to me that the case counts are not the story. Instead, the story is the policy response to the virus, which is much more detrimental the real economy. Here, there is an obvious timeline. This timeline is the actual confirmation of Joe Biden by electors, which happens on December 14th. It's at this point that markets would have much more certainty in an eventual lockdown, which is where the economic damage would be felt. Therefore, for the time being I think the rally in risk is largely unimpeded. In the meantime, we might be seeing the warning signs being flashed in the bond market, as we are starting to see a bull flattening. Therefore being a long bond receiver might work as a possible hedge in the meantime. As we get closer to the end of the year, it might make sense to leg into index riskies to pre-empt any lockdown news.

Summary of Macro Thesis

• We are set to see a rally in risk coming into the end of the year
• This rally is on the back of resilience and improvement in labor market data, consumer spending, and robust performance from small business
• The "rotation into value" trade off of vaccine news is likely to be overblown - better to be long commodities rather than cyclical and value names
• While rising case counts are a risk, it's the possible policy response in a Biden administration that is likely to deal economic damage. These risks will become clearer after his official ascendancy to the office on December 14th. 
• Until then, I think being long risk is the pain trade given the possible missteps, which is why it's likely to be profitable. These risks could possibly be hedged with bonds as they're possible early movers here.

Long Tech/ Long Commodities - Long Software and Semiconductors, Long Copper and Oil

Above we see a relative performance chart of US sectors. Given a bias for tech in this environment, it might make sense to buy the consistent outperformers which are semiconductors, internet, and software names.   

Above we see the 4 hourly chart of copper. It can help provide exposure to the long commodities view given that it has broken out of an important resistance at 320, as well as an ascending triangle. A patient investor might wait for a pullback to or around 320 before initiating any new longs. This would be a function of discretion. 

 

Here we see the daily chart of WTI crude. This is an interesting setup in that it had a false break below the support. Given this false break along with the fundamental view, it might provide evidence to be long oil coming into the end of the year. There's also a nice set up in that it is also holding the round number resistance at 40 quite well. 

Short USDs - short USDMXN, USDBRL, long GBPUSD

As described above and in previous blog posts, I remain a dollar bear. This is due to the Fed moving to an average inflation targeting framework, as well as the possibility of stimulus to the real economy. Above we see the chart of BBDXY having finally broken out of its months long range. It seems that we have had a pullback to previous support now acting as resistance before making new lows. 

Here we see the chart of USDBRL. I like being long USDBRL because of the market's implication of relative strength. This is that in spite of the expectation of massive fiscal stimulus through UBI in the country, which is being priced into rates markets, it's actually the case that BRL isn't selling off. This indicates to that the incidence of UBI might actually end up being a net positive for Brazil's  real economy for the time being.  

Here we see the chart of USDMXN. The reason I like USDMXN is the fact that along with the USD weakening trade, Banxico has indicated hawkishness on monetary policy for the time being. This might last into sometime in the middle of Q12021 as they are looking for indications of disinflation and deflation before cutting further. In the meantime it provides a higher carry alternative to USDs. 

I think that GBPUSD is an unlikely winner of the short USD trade. This is because in spite of numerous instances of policy inefficacy this year, there are still some positive catalysts. These are the possibility of some kind of deal being arrived at on Brexit, which has become much clearer in the past few weeks. Along with that, GBP might be a much cleaner trade on vaccine news. This is because their economy is heavily locked down, more so than other DMs. As a result, they are more sensitive positive developments in that narrative. As a result, this pairs nicely in the here-described portfolio in that even if this portfolio misses the rotation into value via vaccine news, it catches through other methods.

Long 30 year Treasuries - Tentative 

Here, we see the chart of the US10s30s. This flattening might be indicative of some rumbling in the bond market as risks with rising case counts start to get priced in. It could very well be the case that bonds are moving ahead of the rest of the market on this risk off move, as is often the case.  

The reason for this position to labeled as 'tentative' is because the price action might not be offering the best setups with which to manage risk. This is because it seems that it continues to trade in the downtrend established in the middle of the summer. Therefore, a way to trade this might be to wait for a clear breakout from the downtrend followed by a pullback. Another possible method is to trade it now while setting tight stops and expecting to take some papercuts until it sticks. 

Thank you for reading. Any feedback and suggestions on how to improve are greatly appreciated. I am a recent at NYU Stern graduate with a major in Finance and Philosophy and interested in the Financial Services Industry. I can be contacted at snd314@stern.nyu.edu