Macro Hive Intelligence Report: Black Swans Fly In Formation

(Bilal Hafeez, [email protected])

Last week was incredible and our Hive of experts have been busy debating, analysing and positioning the market moves. I had over 100 pages of transcripts of our discussions to sift through, and I’ve cut it down to the juiciest 15. As usual, the opinions are not the official views of Macro Hive. We cover various markets (credit, equities, rates), we discuss oil, dollar shortages, recession and inflation risks. We also highlight some useful info on COVID-19, go deep on complex systems and end with some advice from Benoit Mandelbrot and some humour.

For the full Hive Intelligence Report and for weekly access to our internal independent thoughts, please contact me directly on LinkedIn or email me.

Crisis Roadmap

• Big moves won’t be the trigger. Disorderly is the trigger.
• Margin and collateral issues will be their rationale, but in the understanding that that cut would be their last...
• Option shorts and correlation longs are deeply embedded across factors, sector, products... across everything.
• QE has led to the misallocation of risk capital on an egregious scale.   
• But momentum has papered up the cracks.                     
• Black swans fly in formations, hovering over.             
• If you want a single name for a systemic disaster: JPM CDS.         
• I guess the ‘Deployment Option Value of Cash’ is something everybody is learning about today.     
• ALL EXCESS RISK IS BAD – even winning trades. 
• Counterparty risk is today’s lesson.
• Liquidity auctions are the name of the game; as various markets shut or cease trading, you need to stay abreast of where liquidity is available.          
• But this is the global short liquidity position.
• Minsky Moment. Risk of Ruin > Risk of Recovery.
• Banks saying recent market moves have been a bloodbath… tips guys got crushed… relative value crushed... there’s also talk of someone big in trouble with the breakdown in correlations.

Credit

• The majority of issuance in last 12-18 months has been BB. That’s where the bodies are buried.
• Benchmarking means that just the capitalisation weights force investors to hold more BB too.
• Reality check: the vast majority of BBB downgrades will be to BB, not CCC. It will take another year or so of bad times for most downgraded BBB companies to get to CCC. And most of them will stay in the BB or B range.  
• Disagree: we are discussing solvency – it’s not a gradual decline of the business cycle after destocking it’s cash flow?           
• The CCC sector is populated with a fair number of small energy producers. Given the news about a Saudi price war, they will fall soon unless the government somehow steps in for national security purposes.
• But BBB companies are BBB companies in large part because they have business models that generate decent cash flow under most scenarios. It would take a plunge into depression and economic standstill to kill them in one blow.         
• True, but there is also a point of fees and putting the money you have in your funds to work.
• Yes... but it’s their supply chain that goes insolvent. That’s the great compounding risk of leverage. That’s the economic standstill depression scenario.     
• There is a big risk that a bunch of BBBs go to BB based on what is developing, but only a small risk of going straight to CCC – that is, unless you get the economic standstill scenario.   

Equities

• My recommendation: keep the shorts on.           

•   That looks a lot like 35-40% just right there. Time for gravity to reassert itself.

BUT

• S&P profits and economy-wide profits are apples to oranges.
• S&P is the largest corporations. In Monopolistic US, they make the bulk of the profits.
• 500 firms in SPX are only a small part of total firms in the US. Then there is a difference in the way earnings and national accounts profits are estimated.
• If you use a broader index than the SPX, the difference with national accounts profits is not that big.   
• Sectoral weights of SPX are far from representative of GDP weights for the respective sectors.

Monetary policy             

Fed bazooka

• ‘Specifically, the Desk plans to distribute reserve management purchases across eleven sectors, including nominal coupons, bills, Treasury Inflation-Protected Securities, and Floating Rate Notes.’
• Buying now across the curve. And 500 billion slugs of repo.
• The system has tried to deleverage many times now. And the Fed always says 'no'. This carries a price, however. Risk has consequences... eventually.
• And at PEAK NAV!
• Why the Fed’s large balance sheet poses a problem as zero lower bound nears.

TLTRO and TFS

• The BOE TFS shows that CBs have a very powerful new tool; no need ‘to buy everything’ as CBs worry about financial stability.            
• ECB was the trailblazer here with the TLTROs program. I think it is the most innovative CB; the Fed is still stuck firmly in the past.    
• Dual rates are the way forward.
• MM rate targeting; UST yield pegging is suboptimal.       
• The downside of the new programs is that CB still relies on the banking system for monetary/credit transmission, which means really twisting the banks’ hands to lend. Banks are dying a slow death, with their margins on a structural decline. At some point the CB will have to go into direct lending.   

BUT

• The major problem for CBs is exogenous. This is a situation whereby the use of schemes like LTRO are always accessed via collateral and relevant haircuts.                
• The assumption is 100% clear: that the collateral remains ‘money good’ and there is NO DEFAULT.         
• Unfortunately, that is perhaps not a good assumption. They have to make it ‘money good’ and Ponzi it up.
• No haircuts and zero rates and fingers crossed.       

For the full report further covering COVID-19, bank risk, oil price cuts, recession risk, the pension crunch, private equity and more, please directly contact me here on LinkedIn or email me.

Thanks,

Bilal

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)