Global Macro Outlook - May 2021

My personal investing outlook taking into account global macro factors and drivers.

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Overview

  • Global central bank liquidity provision + accommodative fiscal policy looks likely to continue albeit with the rate of increase slowing.

  • Drawdown on US TGA most likely leads the Fed to ‘twist’ - suppression of long term bond yields in order to finance fiscal spending. US 10yr has stabilised recently at the 1.7% level.

  • World still continuing monetisation of deficits through central bank action – MMT taking precedence = historically explains majority of performance of risk assets.

  • Is this already consensus? Depends on the sector - tech equities, after a period of underperformance relative to the market, are looking reasonable from a valuation perspective again. FCF of financials, energy, will be supported but valuations not as attractive as they were.

Source: FRED (Federal Reserve St Louis), Yardeni Research. 13th May 2021.

  • Long term inflation expectations (US 5y5y) have increased dramatically; difficult to tell if this is transitory or permanent.

  • Rally in industrials has led to valuations pricing in a significant earnings recovery, whereas growth (that also benefits from a recovery) has seen valuation compress - see CAT vs. FB NTM EV/EBITDA below. Unless inflation resets at a meaningfully higher base level, hard to justify decade high valuation multiples for industrials.

Source: Federal Reserve Bank of St Louis, Koyfin as of 14.05.2021

Tradeable Fixed Income (Rates, Credit)

  • Are investors being compensated appropritely? Potential for yield curve twist favours long end US Sov vs. short end. For corporate, probably not on average: e.g. given where US HY OAS spreads are trading, especially relative to the overall US corp universe. Spreads are pricing in a favourable credit risk environment already.

  • For IG, need to apply some leverage to get a decent ROE.

  • Need to analyse, in detail, fixed income instruments on a case by case basis; I would personally focus on EM or DM corporates with strong normalised FCFF and current liquidity ratios, limited currency mismatch on their BS, with business models that can’t be disrupted easily BUT where there is a solvable problem in a relatively short amount of time (e.g. management or cost structure) and therefore YTM are attractive.

  • With rates still pinned low, can take a decent amount of duration risk BUT need to be wary of non-consensus move in rates.

  • However, given this environment, why not just focus more on equities to generate capital gains performance (long duration), especially if stable, low realised vol yields are already being achieved through private assets in a private portfolio (e.g. real estate, private equity / credit, ownership of operating businesses)

Source: Federal Reserve Bank of St Louis, Gavekal, market data

Tradeable Equities

  • After the sell off in “growth”, tech valuations are looking attractive again relative to cyclicals. Need to remain tactical, flexible given how quickly markets are moving.

  • Need to be discerning, especially around valuations and positioning for single stocks. Within tech, preference for platforms leveraged to re-opening and horizontal software infrastructure providers leveraged to an increase in technology capex budgets. I use my personal experience in this sector as an operator to understand complexity to beat consensus.

  • Stock performance dispersion looks set to continue; prefer looking at specific situations where I can get really comfortable with the actual business model, product strategy, organisation structure and management and financials (e.g. margin structure, balance sheet structure, cashflow generation, future financing requirements and use of cash) to get to a view where my expectations of growth are beyond consensus.

  • Strong preference to actively trade around core positions as volatility remains high. Can look to opportunistically short weak companies or objectively overvalued companies, ideally in the same sector to play dispersion and being capital efficiency (being careful with position sizing).

Source: Koyfin as of 14.05.2021

Tradeable Equities - Specific Long Ideas

  • All are relatively liquid $2m a day. All are net cash on the BS and have limited ESG risk.

  • Overall perspective, however, is to remain flexible and not too enamoured with specific companies given pace of change and overall macro uncertainty

  • Prefer to hedge portfolio net risk if markets are overextended or if credit is giving ‘sell’ signals through shorting liquid index futures, or simply move to cash to manage downside volatility.

Equity Derivatives

  • Implied volatility is not generally trading at either extreme (30day implied vol on both SPY and QQQ around 50th 1yr percentile). If it keeps dropping, good environment to substitute futures for options for tactical portfolio protection purposes. Trading behaviour appears to be balanced.

  • Interestingly, IV for deep OTM QQQ call options is lower relative to 52 weeks average indicating less bullish views being expressed through options for capital efficiency. Flatter and lower skew is typically a more bullish signal (better positioning).

  • 25 delta 1yr skew (put-call) for FB vs. GS shows tactical differences in outlook for global tech vs. financials (increased hedging activity for FB on a relative basis). Positive from a positioning perspective for tech.

  • I generally like to use options strategies such as call spreads or put spreads when indicators are extreme to express tactical directional views or for hedging

    Source Market Chameleon. Data as of 14.05.2021.

    Other Asset Classes

    Commodities

    • Both private assets and traditional commodities should have value if we are in a mid cycle recovery if signs of inflation prove non-transient.

    • Although there are supporting tailwinds for industrial metals, positioning seems toppy now (see Copper spec positioning below).

    • Continue to look at the crypto universe given significant institutional traction in a liquidity rich environment (<5% of portfolio value)

    Source: investing.com as of 14.05.2021

    Currencies

    • I personally don’t like having investing positions in currencies as valuing it is difficult. For me, currency holdings are a means to an end to execute on other asset class investment views. If anything, expecting some further USD weakness.

    Private Equity

    • Most portfolios should have more exposure to PE than they do. Differentiated source of investment opportunities, especially in technology through VCs (or direct investments) although increasingly, entry valuations that can lead to good IRRs are becoming harder to find. Even accounting for illiquidity premium, there is IRR uplift that should come from operational improvements that managers can do and have been building up capabilities for the past 5+ years.

    Private Credit

    • As with PE, should be potential to get access to differentiated investment opportunities. Dislocation in private credit can be interesting, especially with loan exposure included. However, not as valuable as private equity since in this cycle, given relatively robust bank balance sheets and central bank / fiscal action, there will be less distressed credit.

    Real Estate / Real Assets

    • Proven ability to provide inflation protection over history. With mortgage rates low and credit still available to quality borrowers, good time to generate ROE through this asset class.

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