Global equity markets recouped the losses from May and finished the quarter with tremendously positive sentiment. Concerns over a trade war dissipated nearly as soon as they appeared. In the US, the SPX gained 6.9% during the month and the dollar declined against both developed and emerging market currencies. In Europe, the SX5E Index gained 5.9% and the UKX Index gained 3.7% while EURUSD gained 1.8% and GBPUSD gained 0.5%. The overhang from Brexit remains and we expect this to be a short reprieve for the broader trend of weakness in GBP. In Asia, the NKY Index gained 3.3%, the HSI Index gained 5.6% and the Kospi2 Index gained 5.2%. The JPY gained 0.4% against USD, CNH gained 1.0%, and KRW gained 3.0%. The gains in global currencies against the dollar occurred following the FED meeting where indications of future interest rate cuts were confirmed with an extended path of policy easing. US front end rates continued to trend lower as expectations of Fed rate cuts now leave 1y rates at 2% after flirting with 3% in November 2018.
Macro concerns have been thwarted with minimal impact, and most news creates a positive subjective narrative. These periods have historically sowed the seeds for the next flare up in risk as volatility compresses and an insatiable appetite for risk in all forms creates dislocations in cross asset relationships. We are starting to witness these contrasts, as the statements being made about the future by US equities, rates, and developed market currencies appear to be at odds. Temporary solutions are not permanent, yet the current market environment is creating an enormous gamma trap. Investors are being pushed to chase yields and sell volatility because they are forced to keep pace with the market environment. This pushes investors into similar risk exposures as ambiguity aversion remains at an all time high. As a result, defensive sector valuations are at post crisis highs, while credit spreads on BBB- securities are at post crisis lows. These dichotomies abound across asset classes with indiscriminate buying creating cross asset dislocations that fully depart from both macro and micro fundamentals.
Cross Asset Volatility
The low level of implied volatility across asset classes offers a unique opportunity to position for large moves with limited losses. The global macro environment has rarely been this uncertain over the last 5 years, yet implied volatility across equities and currencies is near the lows of the last 10 years.
This offers two opportunities for our portfolio. First, we can take directional macro views with a limited portfolio loss and significant convexity. We have been adding these positions to the portfolio since April. Second, when vol becomes extremely depressed, it creates opportunities to buy tails in fundamentally weak assets and sell tails in fundamentally strong assets. These opportunities were a strong driver of portfolio performance in 2018, and we think the current environment is setting the stage for similar opportunities.
The current juncture for the global economy is critical. The marginal benefit of global monetary policy has been diminishing and there is mounting concern that most countries will be ill equipped to handle the next recession. China has been the engine for global growth over the last 15 years, and is beginning to show signs of weakness. The weakness in global data has become more widespread as indicated by the Citigroup Global Economic Surprises Index, which is close to the lowest level since 2011.
Market OutlookTiming has been at the forefront of our portfolio management expertise and remains where we focus today. As such, we express varying views depending on the time horizon and our expectations for the transmission mechanism of macro catalysts. We analyze macroeconomic, volatility, risk, fundamental equity and liquidity factors to identify short-term (0-1 month), medium term (1-6 months), and long-term (6 months+) regimes that are most probable going forward. We typically view the world across these time horizons and update our views on a daily basis.
Short-term (0-1 month): Moderately Bearish (Rising Volatility)
We expect there to be a short-term period of risk aversion following the FOMC meeting at the end of July. Expectations have made it very difficult for the Fed to keep pace, and global concerns are mounting over weakening economic data and the increasing probability of a hard Brexit. Additionally, SPX dealer gamma gets increasingly short below 2980.
Directional Ideas to express this view: Put spreads on SPX
Volatility Ideas to express this view: Long NKY Vol, calendar call spread on VIX
Medium-term (1-6 months): Neutral (Oscillating Volatility)
We expect the market environment during the second half of 2019 to be choppy. Global markets will experience strong positive sentiment followed by shallow bouts of risk aversion that will cause markets to oscillate. The laundry list of potential macro catalysts leave ample opportunity for shifting expectations, but, ultimately, we do not think the short-term trends will be lasting.
Directional Ideas to express this view : Long AUD, KRW, and NOK vs. short USD, CHF, and CNH
Volatility Ideas to express this view : Long NKY vs. SPX Volatility
Long-term (6 months+): Moderately Bearish (Rising Volatility)
The path forward for central banks will be extremely challenging. The mounting risks of growth, trade, corporate credit, contractionary fiscal policy and geopolitical risk will be too much to overcome. We expect a policy error will cause a shift in macroeconomic sentiment and will cause lasting damage to the current market regime.
Directional Ideas to express this view : Short EUR, Short CNH and long protection on CDX IG
Volatility Ideas to express this view : Long Cross-Asset Correlation, Long Russell 2000 Forward Variance
The volatility in May and June offered the opportunity for us to add exposure to our vega neutral portfolio. The combination of low FX volatility and significant macroeconomic dislocations, also allowed us to express catalyst driven FX volatility views while deploying limited premium. These adjustments to the portfolio caused our margin to equity to increase in June. We remain well positioned for potential tail events given the level of economic and geopolitical uncertainty. We expect lingering uncertainty will cause significant dislocations in the coming months as investors grapple with a growing fear of the unknown. We are excited about the prospect for the second half of 2019 to be very well suited for our investment approach.
Historical Scenario Analysis
This confidential risk information (this “Report”) provides information regarding a potential investment in a vehicle (the “Fund”) or separately managed account (the “Account”) managed (or to be managed) by Infinity Q Capital Management, LLC. The information in this Report is believed accurate and is given only as of the date set forth on the cover and Infinity Q undertakes no obligation to update such information. This Report is provided for discussion purposes only, is only a summary of certain information, is not complete, does not contain certain material information about the Fund, including important conflicts disclosures and risk factors, and is subject to change without notice.
The information contained on this page is provided to simulate the effect of specific historical stress events and individual risk factor shocks on the current portfolio. These shocks occur instantaneously and do not account for the benefit of active portfolio management.
This Report does not constitute an offer to sell or a solicitation of an offer to purchase shares of the Fund. Any such offer or solicitation shall only be made pursuant to — subject to the terms and conditions contained in—the Fund’s disclosure documents —which qualifies in its entirety the information set forth herein. The Fund’s disclosure documents should be read carefully prior to making an investment, as they contain additional information about the investment objectives, terms and conditions, tax information and risk disclosures pertaining to the Fund.
Important Disclosures and Definitions:
The viewpoints expressed in this commentary are solely those of Infinity Q Capital Management, LLC and can change without notice.
This Monthly Commentary (“Commentary”) provides certain information regarding a potential investment in a vehicle (the “Fund”) or separately managed account (the “Account”) managed (or to be managed) by Infinity Q. The information presented herein is believed accurate and is given only as of the date set forth herein and Infinity Q undertakes no obligation to update such information. This Commentary is provided for discussion purposes only, is only a summary of certain information, is not complete, does not contain certain material information about the Fund or Account, including important conflicts disclosures and risk factors, and is subject to change without notice.
This Commentary does not constitute an offer to sell or a solicitation of an offer to purchase shares of the Fund. Any such offer or solicitation shall only be made pursuant to—and subject to the terms and conditions contained in the Fund’s disclosure documents — which qualifies in its entirety the information set forth herein. The Fund’s disclosure documents should be read carefully prior to making an investment, as they contain additional information about the investment objectives, terms and conditions, tax information and risk disclosures pertaining to the Fund.
The Standard & Poor’s 500 Total Return Index is a total return index that reflects both changes in the prices of stocks in the S&P 500 Index as well as the reinvestment of the dividend income from its underlying stocks. The S&P 500 Index includes 500 stocks that are chosen on the basis of market size, liquidity, and industry grouping, among other factors, and is designed to act as a barometer for the overall U.S. stock market.
The Euro STOXX 50 is a weighted stock index of 50 large, blue-chip European companies operating within Eurozone nations. The Hang Seng Index is a weighted index of the largest companies that trade on the Hong Kong Exchange.
References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for information only and do not imply that the Fund or Account will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed; unlike these indices and benchmarks, a Fund or Account’s portfolio may contain options (including covered and uncovered puts and calls) and other derivative securities, futures and other commodity interests and currencies, and may include short sales of securities, margin trading, securities of smaller capitalization companies and types of securities that are different than those reflected in these indices and benchmarks, and may not be as diversified as these indices and benchmarks. While Infinity Q seeks to design a portfolio which reflects appro-priate risk and return features, portfolio characteristics may deviate from those of the benchmark. Indices are unmanaged and investors cannot invest directly in indices. The figures for the index reflect the reinvestment of dividends but do not reflect the deduction of any fees or expenses which would reduce returns.
The information contained in the lower graphs on page 5 is provided to simulate the effect of specific historical stress events on the current portfolio. These shocks occur instantaneously and do not account for the benefit of active portfolio management.
An investment in the Fund or Account is not suitable for all investors. No assurance can be given that the investment objective for the Fund or the Account will be achieved or that investors will receive a return of their capital. Investment losses may occur from time to time. Nothing herein is intended to imply that a Fund’s or Account’s investment methodology may be considered “conservative,” “safe,” “risk free” or “risk averse.” The Fund may employ leverage and other investment tech- niques that could increase the volatility of the Fund’s performance and increase the Fund’s risk of loss. Certain information contained in this Commentary may represent or be based upon forward-looking statements. Due to various risks and uncertainties, actual events or results or the actual performance of a Fund or Account may differ materially from those reflected or contemplated in such forward-looking statements. The information contained herein represents management’s current expectation of how a Fund or Account will continue to be operated in the near term; however, management’s plans and policies in this respect may change in the future. In particular, (i) policies and approaches to portfolio monitoring, risk management, and asset allocation may change in the future without notice and (ii) economic, market and other conditions could cause the Fund or Account to deviate from stated investment objectives and guidelines. This document is confidential, is intended only for the person to whom it has been provided and under no circumstance may a copy be shown, copied, transmitted, or otherwise given to any person other than the authorized recipient without the prior written consent of Infinity Q.
PAST PERFORMANCE IS NOT AN INDICATOR OR GUARANTEE OF FUTURE RESULTS. THERE IS NO GUARANTEE THAT A FUND OR ACCOUNT WILL ACHIEVE COMPARABLE RESULTS TO THOSE SET FORTH IN THIS COMMENTARY OR THAT THEY WILL ACHIEVE THEIR INVESTMENT OBJECTIVES IN THE FUTURE.