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The Search For Alpha...
Where to generate alpha? Alpha in the markets as we know it is the ability to beat the market, to gain excess return, and find that ‘edge’. Well, in today’s market it has been very difficult for investors to navigate markets with the only clear winner year-to-date being energy companies which have outperformed due to supply constraints globally. The consumer defensive sector has fared well when compared to the broader market where Tech has taken the majority of the pain due to higher borrowing costs. Looking out to public markets the ability to generate alpha in one’s portfolio has only gotten harder, but that depends solely on your time horizon. For the portfolio manager that needs to perform on an absolute return basis, he or she would really need to evaluate what their strategy would be to outperform. However, for the upcoming investor/trader, although it sounds boring, time and patience, beats the test. Currency markets Switching over to FX, the pound and euro have faced a tonne of heat as the U.S Fed has begun tightening liquidity and raising rates. This not only applies to the euro and cable but even the likes of EM currencies such as the Renminbi and Rupee. Higher interest rates in America make emerging markets less attractive for investors causing a rush to the dollar. The pound fell sharply on Monday to 1.23200 levels not seen since the July of the 2020 pandemic. With growth set to stall in the Uk and the BoE set to slow down with interest rate due to an already weakened economy the pound can only trade lower as we journey through the storm. Analysts see the euro dropping to parity against the dollar in the near term as Putin prolongs his attack on Ukraine. The Eurozone has been on the edge of banning Russian oil, however, the reliance on Russian oil in Hungary has added a sour twist if they were to proceed with the ban which would further weaken the euro. China’s PMI fears The most recent reading of Services and Manufacturing PMI data from China added deeper worries about a global slowdown. As we know China’s economy drives global synchronised growth and is a great indicator of where the U.S will follow so a contraction in Services PMI which accounts for 53.3% of GDP and manufacturing respectively 39% of GDP paints a bleak outlook for the global economy. As Rebecca Patterson of Bridgewater Associates said: 2nd order thinking. I’ve been away for a few days sorting out a few things for our newsletter but I’m back now with more in-depth insights! Thanks for reading, be sure to share and let me know your comments via my social media pages (LinkedIn, Twitter etc)
May 10, 2022 · 3 min read
Fear In Risk-Assets Push DXY Higher
Red across major U.S equities What seemed to be the cue for risk to re-enter markets proved short-lived after markets wiped out all gains made on Wednesday’s comments. The S&P faired its worst day since March ‘20 alongside the Nasdaq which closed down more than 6% for the day. Jerome Powell delivered a speech yesterday that temporarily had the bulls bursting out of the cage but that didn’t last very long; traders’ concerns resurfacing about the Fed’s ability to control inflation were not answered by Powell leading to a consensus that this was a communication mistake. The probability of the Fed Funds rate by December 2022 has shifted towards the 275-300bps range. Currencies outlook In the current macro landscape, we’re in it’s hard to find a sector to park your capital when markets are in this phase. When there seems to be no trade there’s only one other option, you guessed it right, go into the dollar. The dollar managed to close up by 1.2% after investors fled risk assets and moved into cash positions. The BoE delivered another dovish policy meeting after hiking rates to 1.00%. There is a clear division within the central bank as three members opted for an even greater rate hike to curb inflation which Andrew Bailey said is poised to reach 10% by Q4. An even dimmer outlook for Uk citizens as Bailey stressed the “pain” that would be felt by lower-income households caused by ongoing disruptions in Russia. It is clear from this chart how the BoE has consistently been behind the actual print of inflation when looking back. As rates rise and inflation continues to break records the dollar poses the only “safety” like feeling as commodities such as gold tend to perform best in periods of stagflation (low growth, high inflation) accompanied by low rates. Gold as we know it is an inflation hedge only up until central banks do exactly what they’re doing now, raise interest rates. This forces investors to realise the opportunity cost of holding onto a non-yielding asset which is what we have seen occur as the Fed has raised rates.
May 6, 2022 · 3 min read
Fed Powell Resizes Further Rate Hikes
As expected the Federal Reserve hiked rates to 1.00% after a 50bps hike not seen since the Dot-com crash of 2000. The markets quickly turned around to close in the green after the FOMC Press Conference where Fed Chair Powell ruled out the expected 75bps rate hike. Powell went on to confirm saying “additional 50 basis-point increases should be on the table for the next couple of meetings.” Prior to the announcement, markets had been pricing in a 75bps hike for the June meeting however with Powell putting all bets to bed this allowed equities to rebound as the broader equity market had already priced in such aggressive hikes. The S&P 500 closed up 3%, the Dow Jones was up 2.5% and the Nasdaq was the biggest gainer up more than 3% on the day. Fed Tightening Powell confirmed that the balance sheet runoff will kick in from June 1st at a rate of $47.5bn per month and increase to a maximum of $95bn per month after a quarter. Although there’s a certain runway to the tapering process Powell mentioned that “I would stress how uncertain it is on shrinking the balance sheet”. Going further to mention the difficulty of providing forward guidance up to 60 days due to the economic uncertainty presented right now. One thing that stood out from the press conference was Powell’s hawkish tone towards the labour market; stating that the labour market is overly tight with little availability of workers for open positions. Powell said “There is a way to decrease labour market demand without increasing unemployment” which seems increasingly challenging as killing demand isn’t something that the Fed can do without any repercussions in the labour market. The question is, is there a point where supply truly meets demand in the labour market? Money market reprices dollar strength A “knee-jerk reaction” could be the best way to describe what we saw across G-7 currencies mainly the dollar. At the time of writing the Dollar index is trading above the 102.00 handle. Cable managed to get some breathing room to the upside trading north above 1.2600 ahead of the BoE meeting today where we expect to see possible upside unless Gov Bailey delivers the message of doom regarding the wider economy which is highly likely to keep cable below 1.2600. The Euro managed to squeeze above the 1.0600 handle as a soft dollar pushed the rates higher; on a wider spectrum, the euro is expected to hold below the 1.0500 mark as the U.S initiate its quantitative tightening process.
May 5, 2022 · 3 min read
Queue The Fed Tightening...
Anticipation of aggressive Fed policy U.S10Y bonds slid to 3% escalating losses for the bond market as traders reposition in anticipation of a 50bps point hike by the Fed. U.S equities managed to close slightly higher for the day on Tuesday, however, the fears lingering around risk assets is what path the Federal Reserve will take to reduce its balance sheet, which sits at $8.9T. Leading up until now the markets have been graced with a period of massive stimulus from central banks, adding up to more than $22bn this past year. In this goldilocks environment, it really is hard to be wrong when the Fed is buying up everything including stocks, the real challenge is how to navigate markets whilst the Fed runs off its balance sheet. Markets are already seeing the ramifications of a slowing economy although major indices may not present this at the current time. In the March minutes, we heard first news of the Fed planning to tackle its balance sheet run-off by a reduction of $95 billion per month. Investors fear the unknown as the Fed shrink liquidity in asset markets, particularly the bond market which drives all things from equities to general day to day financing on mortgages and loans. Eurozone Heading over to Europe today we will hear from President Lagarde on the state of their economic health and possibly any signs for their future policy meetings. As it stands the upcoming June ECB meeting is set to be the most important meeting thus far for the ECB as the end of their asset purchase program is set to come in the third quarter according to the central bank. This could then lead to a hike plan for the Eurozone which has fallen behind the tightening cycle of the Fed & BoE. For now, sit tight and react to the Fed Press conference which is set to deliver all of the fireworks! We’ll be back again tomorrow — Make sure to subscribe for more insights!
May 4, 2022 · 2 min read
S&P's Worst April in 52 years
Red for Equities The S&P closed off April with its worst performance in 52 years; the average performance for April being 1.4% the negative 8.8% has been the worst month since the Covid-19 panic of March ‘20. All around U.S equities faced a rough month leading into May which usually presents the old "sell in May go away” saying time and time again. Dollar Surge & Corporate Earnings Over the past month, we have seen the dollar reach a two-decade high fueled by a number of geopolitical and macro factors. In times of economic and geopolitical uncertainty, there’s one safe haven that investors flock to more than anything, and it’s not gold. The dollar has seen flows as the ongoing war in Ukraine escalates with more attacks on the country, a resurface of fears as Chinese major cities such as Beijing and Shanghai enter lockdown in attempts of reducing Covid figures. Not only is a war and covid escalating the demand for the dollar but an extremely hawkish Fed monetary policy is widening the interest rate differential between the U.S and major central banks (BoE, ECB & BOJ). With back to back 50bps hikes forecasted for the Fed at 95%>, you have to think where are investors most likely to hold their deposits? That’s right, the dollar. With opportunities to generate alpha in public markets dwindling, right now investors seem to be pulling out of risk assets and moving into cash positions with research showing investors withdrew $27 billion from the largest equities-focused ETF funds in April. U.S GDP contracting by 1.4% in Q1 only provokes the concerns that the Fed are on the route to leading the economy into a recession, which only requires two consecutive negative quarters. As corporate earnings drag, we must remember that a strong dollar presents only further challenges for institutions to pull out good figures. A study case was Apple in 2015, where a strong dollar forced the company to raise prices in stores ranging in New Zealand, France, Canada, Australia, Denmark and Sweden. Bank of Japan If you haven’t seen dollar-yen rates you’re in for a shock. For years now the Bank of Japan has been implementing a policy known as yield curve control (YCC) in hopes of stimulating its low growth economy by capping Japanese 10-year bond yields at 0.25%. Unfortunately, that has had little success in the country as low growth still remains the Achilles heel of the nation. BoJ Chief Kuroda reaffirmed his stance adding clarification that they “will offer to purchase 10-year JGBs at 0.25 percent every business day through fixed-rate purchase operations”. Now you don’t need to understand the full grasp of what his comments mean but rather turn to the Yen rates to see the true reflection. The Yen weakened to multidecade lows against the dollar, the message understood by investors is simple, the BoJ believes the Japanese economy is too fragile to tighten monetary policy near to the pace of other central banks amidst the inflation crisis. The dollar-yen rate sits at 129.00 levels not seen since 2002. I hope you have enjoyed this in-depth macro breakdown! I’ll be back with more material like this! If you appreciate my efforts to deliver this material it would mean the world for you to share this piece within your network/social media!
May 2, 2022 · 3 min read