After several months of serenity, global markets are now facing threats from multiple fronts. Economic and capital market regimes do not shift on one variable alone. Yet, if you read any financial news headline in May, the global weakness in equity markets that eventually permeated across all risk assets was solely driven by a few tweets. The S&P 500 declined 6.58%, while the Euro STOXX 50 declined 7.12%, and the Hang Seng declined 9.37%. The S&P 500 experienced the second lowest volatility for a greater than 5% decline in 13 years with realized volatility of only 14.5% during the month. The escalation of trade tensions caused the US 1-year swap rate to decline by nearly 30 bps in May and has now declined 70 bps from the high in November. The front-end of the US rates curve is now pricing in 2.5 cuts in 2019 with a 100% probability of a cut in July. The move has caused 3-month rates volatility to spike to a 10 year high.
Cross Asset Volatility
We are strong believers that the current fragile market is highly susceptible to sharp shifts in sentiment because it has been held together by extremely dovish monetary and fiscal policy. The combination of fundamental factors that plagued global equity markets in 2018 have become a growing concern. The factors are widespread including weakening global growth, concerns about US corporate credit, high US equity valuations, and heightened geopolitical risks driven by the ascent of populist leaders. It has now been 10 years since the end of the Great Recession. The Golden Era of Central Banks has created sustained growth in US and a handful of emerging economies and tepid growth in several developed countries including the Eurozone, Japan, the UK, and Canada.
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 OutlookWe 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 Bullish (Declining Volatility)
We expect a short-term window of reprieve prior to the G-20 meeting at the end of June. The short gamma profile of short-term SPX call options create a potential opportunity for a squeeze higher if there is short covering following the decline in May.
Directional Ideas to express this view: Call options on SPX and SX5E Volatility
Ideas to express this view: Short SPX Volatility.
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, CAD, and CNH Volatility
Ideas to express this view : Long Front End US Rates Volatility.
Long-term (6 months+): Moderately Bearish (Rising Volatility)
We expect 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 CNH
Ideas to express this view : Long Cross-Asset Correlation, Long Russell 2000 Forward Variance.
The current environment has forced our idea generation to be focused on short-term trade ideas that are monetized quickly. We expect lingering uncertainty will cause significant dislocations in the coming months as investors grapple with a growing fear of the unknown. As a result, we are positioned to benefit from a short-term period of positive market sentiment followed by a prolonged period of uncertainty. We are excited about the prospect for the second half of 2019 to be very well suited for our investment approach. After reaching nearly zero in November 2018, our global macro strategy risk allocation has increased to 15- 20% over the last two months. The combination of low FX volatility and significant macroeconomic dislocations, allow us to express catalyst driven macro views while deploying limited premium. We remain well positioned for potential tail events given the level of economic and geopolitical uncertainty.
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.
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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.
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