Global equity markets extended 2019 gains during Q3 despite the choppy trading environment. The quarter began with positive sentiment as expectations for a dovish Fed fueled an extended move higher, but sentiment shifted quickly as the Fed was more hawkish than anticipated and the US announced additional Tariffs the day after the Fed meeting. This led the PBOC to allow USDCNH to gap 3% higher to 7.10 from August 1st to August 5th.. The unexpected spike higher caused USDCNH volatility to reach the highest level since January 2016 causing a short-term period of heightened volatility across global equities. The concerns over an escalation in the trade war dissipated nearly as soon as they appeared, and order was restored by the end of August. In the US, the SPX gained 1.2% during the quarter and the dollar rallied against both developed and emerging market currencies. In Europe, the SX5E Index gained 2.8% and the UKX Index declined 0.2% while EURUSD declined 4.1% and GBPUSD declined 3.2%. The overhang from Brexit remains and the risk has become two sided for GBP going forward. In Asia, the NKY Index gained 2.3%, the HSI Index declined 8.6% and the Kospi2 Index declined 1.4%. The JPY gained 0.3% against USD, CNH declined 4.0%, and KRW declined 3.6%.
The future direction of the global economy continues to be a major concern for investors. The third quarter highlighted large disparities across countries. The US continues to plod along with slightly below trend growth at 1.5-2.0%, but production, employment, government/external, and inflation data have softened. Euro Area GDP is expected to slow to 0.5-1% in 2020 with a higher risk of recession if there is a further escalation in the ongoing trade wars. In Asia, China GDP is expected to decline further during the first half of 2020 with South Korea, Singapore, Taiwan, and Thailand expected to follow a similar path. The level of macro economic fragility is heightened at a time when global central banks may only have a modest ability to stem the next sharp economic downturn.
Cross Asset Volatility
There is a large divergence between equity and FX volatility levels. Equity volatility is hovering around the 10 year average across regions, while FX volatility is almost uniformly at 10 year lows excluding idiosyncratic situations (UK, China, South Africa, and Turkey). We think this divergence is unlikely to persist and are looking for opportunities to buy FX volatility where macroeconomic and fundamental catalysts can cause a regime shift. Equity volatility has interesting disparities as well where equity volatility levels can deviate from fundamental data. For example, HSCEI Index trades at a P/E 1σ below the 10 year mean, yet HSCEI 1-year variance is trading slightly above its 10-year mean. In comparison to Kospi2 Index, where 1-year variance is trading 3.4 vol points below its 10 year mean, and the P/E is 0.2 σ above. We continue to see discrepancies like these across asset classes creating opportunities for our volatility portfolio.
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 October. Expectations have made it very difficult for the Fed to keep pace, and global concerns are mounting over weakening economic data with limited monetary policy tools to stem potential weakness.
Directional Ideas to express this view: Put spreads on SPX, short EURUSD, short USDJPY
Volatility Ideas to express this view: Calendar call spread on VIX
Medium-term (1-6 months): Moderately Bullish (Declining Volatility)
We expect the short-term weakness will be followed by a period of strength. There is a pocket of opportunity for EM equities and EM FX to perform well in the absence of any global shocks. The combination of depressed equity valuations and event catalysts being pushed into 2020 could create a window of opportunity for risk assets.
Directional Ideas to express this view : Long FXI and EEM Calls, Long Basket of EM FX vs. short USD, EUR, and CNH
Volatility Ideas to express this view : Short HSCEI Index vs. Long Kospi2 Index 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 August offered the opportunity for us to monetize our CNH positions. We also utilized the move higher in volatility to add exposure to some of the most interesting relative value trades in our vega neutral portfolio. We were also able to monetize some of our catalyst driven FX volatility views. As a result, our margin/equity slightly decreased during the quarter. We added country selection and sector selection strategies in our equity L/S portfolio expressed through options. We expect these strategies will provide better asymmetry during tail events. Our average daily gamma exposure increased in July and then was reduced in August and has now creeped back near the YTD highs. Due to our long gamma positioning, we are well positioned for potential tail events and expect to dynamically trade around our core positions in Q4 given how quickly regimes have been oscillating.
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 Nikkei 225 index is a price-weighted stock market index for the Tokyo Stock Exchange. The Nikkei measures the performance of 225 large, publicly owned companies in Japan from a wide array of industry Sectors.
The Hang Seng Index is a weighted index of the largest companies that trade on the Hong Kong Exchange.
The FTSE 100 Index is a share index of the 100 companies listed on the London Stock Exchange with the highest market capitalization. The KOSPI 200 Index is a market-cap weighted Index consisting of 200 big companies on the Korea Stock Exchange.
Sigma (referred to on page 1 by it’s Greek letter, “σ”) is defined as the standard deviation of a given dataset, calculated as the square root of variance. Within the context of the reference on page 1, the term is referring to the amount of variability in the given dataset.
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 appropriate 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 3 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 techniques 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.