Hive Intelligence Report

At Macro Hive, we have a thriving community of experts constantly debating the big issues of the day. We don’t necessarily agree with all the views or even endorse them, but they’re fascinating, nevertheless. Here are the notes to our discussions over the past week:

China and nCoV

Political Risks

• China’s Leader Wages a War on Two Fronts—Viral and Political   V interesting because China’s response shows the strength and weaknesses of its economic models.
  • Strength: ability to mobilize quickly resources on a large scale and coordinate policies.
  • Weakness: inability to get bottom up feedback, lack of flexibility, responsiveness and initiative.  Will be interesting to see which is stronger
• I don’t want to sound overly pessimistic but if growth in China takes a real hit and popular discontent rises further, we are likely to see political instability there. The one man rule Xi has put in place is much less resilient than the collegial leadership that used to prevail
• in other word China won’t be able to implement a new strategy to deal with the epidemic and its economic consequences without getting rid of Xi and there are currently no “institutionalized mechanism to do so” because of his jailing all potential rivals

China’s Supply Chain

• The reason I am taking the virus more seriously is not the epidemic curves but the development of transmission chains out of China as well as China’s policy response that is too centralized and heavy handed.
• I think we are in for a global pandemic, both in terms of virus and panic, and that China’s policy response means unprecedented disruption of global supply chains
• The consensus of the DM markets and policy makers. — short term GDP divot a policy response or two, and then boom.  I definitively in the skeptical camp that things come back as quick as assumed and thinking about linkages akin to tariff war (18/19) and others.
• Seems to me more difficult to handle than tariff war because this time around given China’s central role in global manufacturing it will be more costly/ will take longer  to find alternative sources of supply
• also in terms of China before the tariff war China was already losing ground in global exports, trade war has added to that but nCov is likely to speed up that process further so there could be long term damage to China manufacturing capacity

Can CBs Offset Virus

• In China, if everybody is confined to barracks… how would injecting liquidity help at all. IP will collapse. Sorry, IP has collapsed
• Short term liquidity will be needed to support supply chain normalisation- so there will be a big lead time which needs funding
• It could with corporates patching up cash flows for debt payments or other liabilities.
• The point in supply chains is that this will be required to prevent contagion – the rest of the world is teetering and the supply chain effect is how it will be felt first – I wonder if coordinated central bank action would be implemented- perhaps this is the root of the recent oversubscribed repo auction
• also i dont think monetary policy will have much impact on the real economy due to fear; what would work is an old fashion round of public spending but much more difficult politically than money easing
• Surely this is finally a good reason for fiscal thrust
• Fantasy Fiscal Policy Ken Rogoff disagrees on fiscal.
• We start to see global supply chain unravel over this month. CB support is less likely to be effective. This is not going to ve about funding: it is not a liability crisis. Its an asset issue. Closed factories and closed logistical channels are unproductive assets.No demand for our goods. No supply of their goods

China’s Factories Struggle to Resume Operations After Virus Shutdown This suggests Disruption of global supply chains that has so far been mainly reported in Asia is going to reach the US.  US retail will also be impacted.

Inflation Risks

Food Inflation

• The trouble is the supply shock is most harshly felt in supply chains for deflationary items – it’s the food (core) that will be inflationary
• Another point abt food price shock – even if that is smallish portion of expenditures it is also critical – if food supply/prices become volatile there is impact on confidence, which feeds (sorry) through to econ activity
• I’m guessing food prices are one of the biggest factor behind riots
• Swine flu , Aussie bushfires , locusts and bumblebee extinction – these type of events at the very periphery of our urban existence have monumental impact at the point of our shared needs (food!) and prosperity- Disposable income drought , high debt loading , and a disinflationary corporate sector are totally unprepared for the fall out of an input shock from which they can’t reflate margins – then watch that bbb dam burst
• I couldn’t agree more, yet softs $DBA (Invesco ETF) is trading at all-time lows.
• Yes true but check out the regional perf – Chinese pork chicken , wheat and rice for example
• Wholesale prices are up 100%, 30% ,25% and 69% yoy
• So, massive disconnect. I never understood the argument of softs selling off if China does not buy from US suppliers b/c it was buying from Brazil and Argie nevertheless.
• Big big structural fall out of climate change and demographic concentration.
• Hedge fund billionaire Ken Griffin calls markets ‘utterly and completely unprepared’ for jump in inflation

Parallels With 1970s

• If this virus thing lasts for another couple of months (the overall effect of the virus, i.e. even if the spread levels off, the measures taken to contain it stay), the negative supply shock to the global economy could be huge b/c of years of globalization and interconnectedness.
• The last time we had a negative supply shock of such magnitude to the world economy was the 1970s oil embargo which lasted just 6 months.
• So, it is very conceivable that the corona virus turns out to have a stagflationary effect. The surprise here will be the ‘inflation’ component, as the consensus is deflation. if this indeed happens, the risk is that CBs panic (as the Fed did

BUT:

• Even with non core: do you really see a huge increase in energy prices? food is a small part of consumer expenditures in advanced economies
• That’s the point the disposable income is under stress – which parts of the individual wallet can be excluded – and which can’t ? Food I’d argue is fairly high on the list hence the entire cycle is far more vulnerable to shocks here. In the UK consumer patterns within grocery shopping have shifted to lower cost entrants …. the same in France and Germany too
• Food about 10% of US HH spending . plus I would agree that it can be grown without parts form China though of course global prices could push up US prices.   Possible: Am not a buyer of pork, has anyone seen an impact on US pork prices from China’s pig disease?

And There is Long-term Deflationary Trend

• Since 1970s/80s global environment has become deflationary imho because mkt power of workers  has been weakened  see that we have no wage growth even though we are at full employment so weak demand and inflation  because not enough value added goes to household  that are main source of demand for goods and services and too much goes to capitalists that are main source of demand for financial assets
• plus monopolization of economies is a global trend, which increases further the market power of capitalists relative to workers
• The one trend that is common all over the world is a decline in the income share of workers at the same time as we had a decline in inflation “the great moderation” also worldwide

Recession Risks

What to Watch For Recession

• There’s a 70% chance of recession in the next six months, new study from MIT and State Street finds
• One number I follow closely is employees income ie wages times hours worked and NFP, yoy because it is strongly correlated to consumption, currently the only growth engine. Payroll data show more stabilization of employees income than reversal of the weakening trend
• The other indicator is capital goods orders ex defense and aircraft – it is more influenced by business confidence than employment (because cost of getting rid of excess  capex much higher than those of firing excess workers).  Next release on Feb 27 will have full impact of ncov panic
• We will get first hints of how ppl are reacting to ncov with U mich on Feb 14
• Most folks dont realise how exposed they are to their rapidly declining disposable income.Its never been so cheap to be rich or so expensive to be poor

Defaults?

• Fed data shows delinquency on farm loan rising but so far no noticeable impact on food prices

Oil Update

• Some thoughts on oil: being driven by two factors at the moment – demand effects caused by the virus (bearish) and the swift returns of volumes from Libya (bearish) where 1 mbd has gone offline.
• The prompt Brent curve has moved from a steep backwardation into contango as demand from the worlds largest importer has plunged
• Refinery margins are also weak with many product curves in contango – indicative of slowing demand
• All in all crude and spreads (June dec and dec dec) are arguably oversold – but not sure if we can quite say the lows are in just yet because it’s too early to assess the scale of the demand hit on international global supply chain from The virus
• OPEC and Russia are tussling about cutting supply further – OPEC (Saudis) want to cut – russia wants to extend the existing deal…
• Long RUB short INR if u think the bottom is in
• From Bob Dudley, outgoing CeO of BP: ‘one thing I’m always struck by in terms of investing, I always go back to the fundamentals. And I would say, right now, we’re in a world where sentiment seems to be more important than the fundamentals. And I think in reality, you’ll always have to get back to the fundamentals’

ESG and Climate Change

Tech heavy

• Looking at ESG MSCI USA ETF the top holdings are MSFT, Apple, Amazon, Alphabet, FB- pretty much index
• ESG funds look a lot like tech funds in disguise. When the correction starts , it will be phenomenal.

Need ‘Dirty’ Firms to Build Green

• The leading proponents of ESG are incredibly levered to the owners of the supply chains – who ironically seem to be excluded from some ESG indices – think about how all of this green tech is built and powered ….
  • These same ‘dirty’ firms are cash rich , high FCF and typically have decent dividend cover too.
  • I can see a time that passive adoption of ESG principles will see an orphan class of companies created who are dirty by perception but ultimately own the green future via supply chains …

ESG arb

• Bring on ESG arbitrage as index providers get played by corporations adapting their ESG credentials for pennies on the dollar but yet gain huge share price benefits
  • it’s so ripe for arbitrage due to opacity of ESG ratings agencies – and the fact it’s all encompassing (it touches every single commercial aspect of the capital markets model).
  • it seems to me there is more money to be made on shorting stocks with high or higher exposure than on going long stocks of firms with strong ESG score. Possible shorts: assets heavy firms eg utilities manufacturers in states exposed to extreme weather eg flood prone, hurricane corridor, etc

Climate Change and Food Production

• Climate change brings risks to food production but how do we play it since it is a gradual process with unforeseen event shocks extreme weather manifestation.
  • In the US delinquencies on agricultural loans are going up, are there bonds that could be shorted?
  • Also how about trading the relative environmental foot print of different commodities. Does beef production requires more water and grain than pork, cocoa is more water intensive than coffee etc ? What’s mispriced?
  • Last one: the locust and other biblical type event are going to have political consequences:  are there sovereign bonds to be shorted?
  • High water wreaks havoc on Great Lakes, swamping communities Shorting munis is illegal in the US but are there local banks that are listed and have a high exposure to earl estate located in at risk areas

Good Reads

• FUSION STARTUPS STEP IN TO REALIZE DECADES-OLD CLEAN POWER DREAM
• The ETF Universe Great visuals. ESG is tiny proportion of the total ETF universe
• Doubling Down On Sustainability: BlackRock iShares Planning Major ESG ETF Expansion
• PLSA warns against ‘hasty’ reactions after report of ESG policy failings

German Politics

CDU weakness

• Outrage as German centre-right votes with AfD to oust Thuringia premier
• German Nativists Drive Wedge in Merkel’s Conservative Party
• CDU is basically getting ready for a coalition with the Greens. Looks like the Greens are getting more powerful
• After Germany’s far-right scandal, Left party surges as Merkel’s CDU sinks

After AKK Stepping Down as CDU Leader

• First we have Bavarian election and CSU Soeder might even want to be a possible future Chancellor candidate so see how he does.
• Then leadership contest for CDU which doesnt automatically mean Chancellorship.
• There is speculation that the new leader could call ‘early’ elections in 2021. Official Germany doesnt have a general election due until the autumn of 2021.
• Merz resigned from Blackrocks supervisory board Merz will try to pull the CDU back from the middle to centre-right in the hope of reducing the flight of voters to AfD. Merz is seen as ‘too’ conservative…but he dares to bring up topics like limited immigration, lower taxes etc
• AKK resigned. Many in Europe and France will be relieved, but beware, the orderly transition that Merkel attempted has failed. It will take time for German politics to sort itself. That means EU initiatives are blocked, probably until well into 2021.

Geopolitics

China-Russia

• How the geopolitical partnership between China and Russia threatens the West seeing a great-power coalition … The implications for Australia: dangers of armed conflict involving China and Russia against the West; and some conflicts might involve Australia more directly…Russia’s supply of advanced weapons to China threatens to undermine the Australian Defence
  • The author of the article belongs to a familiar school of thought: “It’s hard for us to understand the Russians, but we can’t admit it. Therefore, let’s assume the worst”.
  • The fact that the first US politician he quotes is Zbigniew Brzezinski (who was an ardent anti-Soviet ideologue) speaks volumes. The article conveniently does not mention that it is Trump, not Putin, who has recently pulled out of the strategic nuclear treaty.
  • As for the strategic alliance between Russia and China, it is indeed strengthening, however, it has its limits. Russia has a deep distrust of China and is aware of a long-term strategic threat to its rapidly depopulating territories in the Far East.

Turkey-Syria

• Seems like Turkey might go to war against Asad
• Syrian Regime forces shot 5 Turkish soldiers. As well as last week. Turkey is sending hundreds of military vehicles to Syria.
• Don’t forget Libya, and that Turkey is a NATO member, and has the largest NATO army… Isn’t it becoming a little clearer just what is going on here? Erdogan is doing NATO’s dirty work in exchange for… what exactly?
• Turkey is the ‘plausible deniability’ of NATO in the Med.
• Well turkey and Russia have a strange alliance where they support opposing powers in Libya and Syria. Turkish media believes Russia approved Syrian regimes bombardment of Turkish soldiers.
• Erdogan is playing east against west. A NATO mercenary force, for the right price. This is the role Germany played in Europe during the 18th century.
• This is an interesting take on Turkey’s role, but I view the situation a bit differently.
  • Erdogan lost his faith in the West (and in particular the US) after the recent coup, which he believes received a tacit support from the West.
  • Turkey no longer aspires to join the EU and keeps the appearances for the sake of maintaining a good business relationship.
  • Putin tries to play Erdogan whenever he can, sometimes things blow up owing to Erdogan’s impetuousness.
  • I am not saying that the relationship between Russia and Turkey is at no risk from the deteriorating situation in Idlib.
  • However, atm both countries seem to be genuinely interested in an alliance on important issues such as development of mutual economic ties, gas exports etc.
• I’m not sure how this does not show Turkey playing east against west? Where is the evidence that Turkey has taken sides? Or does the above make Turkey appear more neutral than aligned either way?
• Turkey is to the MidEast what Germany was to central Europe in the 18th century, or so I see it.
• My impression is that Turkey is definitely not on the side of the West anymore, and that its NATO membership is an anachronism. Also, I think many of Erdogan’s recent actions (such as occupying a swathe of North Syria back in October) have not won him any friends in NATO or the EU. The motivation for Turkey’s recent actions in the Middle East is clear I think, they are attempts to restore AKP’s popularity at home, however, I can’t see how it fits with the narrative that Turkey “plays” East of West.

So NATO’s largest MidEast airbase is in Turkey and NATO ships have free passage through the Dardanelles but Turkey is not a friend of the west? Agreed. Turkey is neutral. They are playing the Great Game from a v difficult position.

Peg Risk

• As an illiquid EMFX guy mostly long wrong way / peg risk, I’ve also obsessed on fragility in the past. The problem is not so much knowing what to be long /short when things blow up but controlling the negative carry while waiting for an unpredictable event. I’ve learnt to distinguish between two types of fragility: (1) isolated fragility, (2) contagious fragility.
  • Isolated fragility (small country / sector) can be surprisingly effectively hedged with diversification.
  • One has to be short something to hedge contagious fragility. I’ve looked into three areas here (i) options, (ii) basket of basis trades and (iii) systematic stress signalling. I am far from sophisticated on options but struggled to make it work as the requirement to always be near ATM pushed you…
• Treasuries and risk parity have worked very well historically, are positive yielding and quick to react. Debatable on how well they’ll do going forward or on stagflation but the bet is they probably will. Fx vol works incredibly well if you buy early or find a cheap way to hold continuously but I’ve struggled to find a reliable way to do so.
• So long as it doesn’t lead to weird margin calls and forced selling, treasuries will rally first, but even in rates space liquidity will be in high demand so spreads can widen on swaps and off-the-runs
• Those spreads are some of the basis trade hedges i allude to. The basket is generally long liquidity on a spread basis in fx land and US or other DM curves. So US 3mV6m basis, on-the-run versus off-the-run etc.

Carry is usually cheap but need to be careful on basis with cash instruments as ability to roll shorts can dissappear or become very expensive

Small Nuggets

Big Tech

• FTC will examine prior acquisitions by Alphabet, Amazon, Apple, Facebook and Microsoft Not helping tech names into the close. Even though it was expected, FTC decision to look into this was largely off people’s mind lately.

US Politics

• How Trump Rewired the Electoral MapInteresting, shows geographical and, due to the electoral college system, state level consequences of political realignment in the US where the GOP is now the party of the uneducated whites and the Democrats that of educated suburban middle classes.

EM Debt

• Largest risk for markets are Issuers of EM $ debt .. in need of rollover. $11tr EM rollover risk (not all in ‘20, but soon enough)
• Africa has strong linkages with China and weak health systems
• EMs more fragile. You have all that USD corporate debt esp in China
• May be another channel of transmission to advanced economies

UK

• British universities face long shutdown of Chinese campuses as virus spreads This is “UK” campuses in China
• Of approx 500,000 students in Full Time Higher Education in the UK 15-20% are from mainland China
• So we are just about to see some unintended consequences in UK education system

Tesla

• Fed repo vs Tesla

• Who would short Tesla? interesting article offering a few other perspectives on the price action in Tesla shares, the most fascinating of which seems to be that the company itself might have ended being short through the hedging of its convertible bonds.
• Tesla passes Apple as No. 1 holding on SoFi as young investors rush into surging stock

Useful references

• The Economic Effects of the 1918 Influenza Epidemic*
• How the Wealth Was Won: Factor Shares as Market Fundamentals
• US rail shipments data are available on BBerg, and can be used alongside the POLB container data. Check ALLX RAIL and then intermodal. There are also subcategories for chemicals and metals that I used to use as proxies for manufacturing activity.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(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.)