The Birdseye View – December 2022

All I want for X-Mas, is VOL.

Equity markets reached all time highs in October only to initiate a steady unwind from risk assets in November. Since then, markets have welcomed the Omicron Grinch and with it volatility has spiked, ranges have blown out, a huge chunk of the market has pulled back 20% or more and inflation grew deeper roots. Our political leaders have responded to rising costs in food, oil and gas with a short lived game of Bully and most recently with demand side shocks. During this time, Central Bankers around the world continue to look puzzled at the macro picture and in spite of guidance and efforts to ease markets into the next phase of the cycle, a relentless bid in rates seems to be the most contagious variant of all!

Correlations have weakened as we saw asset classes rise together into equity highs and have only recently held their levels into the market weakness and risk off sentiment. In the US, we have a Fed which is guiding for a taper on POMO within the next 3 months, and who is targeting 3 rates hikes by end of 2022. However, it is a fine line to walk on once you approach zero rate environments for this long. Backing away is proving to be like quicksand no matter what guidance comes out of Fed chair Powell. Risk sentiment and volatility aside, what we have been witnessing is an entire planet buying up the slightest positive yield from a “riskless” seller (the US government). Even with the Fed out of the bid for US paper in the next quarter we continue to see an insatiable appetite for government bonds across the curve. We know the Fed will be driving real rates back to positive territory, but we expect the curve to remain incredibly flat as term premia continues to be stripped out of this market. Add to this the risk of a global slowdown, in which case inflation will eventually self-regulate and further support our thesis of rates staying “very Low for very Longer” (hey if the Fed can totally toss “Transitory” from their vocabulary we should be able to grammatically embellish here).

The good news is this is not only supportive for cyclical and value name risk assets. As long as credit does not tighten this is supportive of real and alternative asset classes as well. Be cautious however, as accommodative an environment it may still seem, markets are self correcting and are no longer accepting excuses for reductions in revenues or earnings. From here on out, it’s a “put up the numbers” or “get hosed” environment, so pick your ponies wisely. This is extends to the digital currency markets which are being challenged under recent heightened vol, illiquidity and market duress and struggling to show the resiliency they once suggested they would have.

Lastly, global energy supply shortages and supply chain distortions remain active themes into the 2022. Although major bottlenecks have subsided, ports still continue to work through the log jams from earlier months. We expect these logistical delays to continue well into Q2’22 and in spite of the price action in the sector, we see oil shortages and pain only being in the 3rd inning of the game. We patiently await the “green” flag from the current administration to finance, subsidize or find some back of the envelope way to encourage additional exploration and drilling locally. We see this as the only alternative to re-gain energy independence in the US and properly move into more sustainability for future generations. With that, energy companies continue to mint dollars at these elevated prices. Consensus is set on an average per barrel price of $72 for 2022 valuations. We believe it only to be a matter of time before greed finds it’s way back into the hearts of traditional investors and capital gets grotesquely re-distributed into these non-ESG fitting companies. Certainly a space to watch and consider leaning into in the new year.

In short, lets avoid a global slowdown and bounce back quickly from Omicron and into Pi (likely to be the next Greek letter to haunt us). We look to add or include some regional exposures (EU, UK, China, Russia) along side our US risk asset and FX portfolio allocations. We are favoring Brazil over other LATAM economies given the current political backdrop and remain active with tactical flatteners in US rates, primarily in 2s10s, 5s10s and 5s20s. We like long metals/materials and direct oil plays (via long dated OTM calls on Crude) as we see upside vs inflationary environments ahead of the rate hiking cycle.
Happy Holidays!