As one dog said to the other, “it’s been a long seven years.” That dog year equivalent to human years captures the twists and turns of 2020 as every month seemed like an entire investing year. My trade recommendations in 2020 reflected those rapid shifts from riskon to risk-off, having put on 24 trades and closing 19 of them. The 19 closed trades represent nine unique themes. I had a positive realization of seven of the nine themes. The remaining five open trades are shown below, with their associated themes. These trades reflect a risk-on slant, similar to my positioning in December of 2019. My view is that the US economy will normalize and accelerate with the rollout of the COVID vaccine.
Retrospective of 2020
December 2019-Jan 2020
It all began in the late fall of 2019. I had set up several positions to capture an uptick in economic growth in the world. My thesis was that growth would rebound as economic uncertainty had fallen in the aftermath of the US/China Phase 1 agreement and the Tory victory in the UK election. I was long US, European, and Indian equities. Also, I added a European higher rates trade on as well. I released a three-part SOM on India’s upside at the beginning of Feb. Modinomics, I thought—and still believe—was a game-changer in India after his party had captured both houses of parliament. The world changed from a risk-on to a risk-off world with the first COVID wave in China and Italy.
I repositioned my strategies to consider the potential impact of COVID, closed out my long-risk trades, and replaced them with risk-off trades. I believed that COVID could wreak havoc on economies and asset prices, much as what happened during the Spanish flu. I formed this view after spending a good chunk of the first few weeks of February doing work on epidemics, reading studies on COVID, and finally modeling the epidemics using early data on COVID. I thought the market did not wholly believe what could happen. I outlined my views in my SOMs of “Corporates are the New Subprime,” “South Africa is the Next Turkey,” and “Strategies for Coronavirus” (aka COVID-19). I recommended being long CDS protection on South Africa and US IG, and long receivers on US rates. At the end of February, there were only 18 confirmed cases in the US and zero cases in New York. However, the disaster in Italy was already unfolding. As a result, the first COVID-related tremors in the last week of Feb. resulted in a 10%+ selloff in equities. However, that paled in comparison to what was to happen in March.
The first few weeks in March were bleak. COVID cases exploded, governments around the world declared national emergencies and started a wave of stringent lockdowns. The US and world economies plummeted; unemployment soared. US equities fell another 25%. The rush to cash dried up liquidity while short-term funding evaporated. The 75% sell-off in residential mortgage REITs reflected their exposure to funding and liquidity as well as concern about their exposure to mortgage credit. Sectors exposed to the service sector, such as airlines and hotels, suffered the same fate. Investors were concern that economies were faced with a long-lasting “Lehman” type worldwide event. At the time, I moved from risk-off to risk-on, believing the Fed and congress would act aggressively. I added a long US equities trade on March 11 to position for this stimulus-driven risk-on rally. Unfortunately, I was way too soon, as the equity market continued to sell-off and closed out the trade as it hit my down 5% stop. I also closed my long protection on US IG and the long receiver on US rates.
Along with the Treasury, the Fed stepped into the breach with a massive and wide-ranging intervention starting on March 15 that slowed the meltdown. At that time, I closed my long South Africa CDS trade but added a short USD trade vs. the Euro and Yen. I believed that the FED QE would weaken the USD and support EM growth and their Assets. Congress was also going to follow and pass the CAREs package. By the end of March, cases in the US had reached almost 200,000, with 4,330 deaths. NY went from zero cases to 77,000 and 1,600 deaths. It was going to get worse even with lockdown based on the model projections.
April and May
The epidemic reached its peak in April with 1mm cases and 60,000 deaths in the US. New York was a ghost town with 360,000 cases and 24,000 deaths. Fortunately, cases around the country started to fall, reflecting the impact of lockdowns and social distancing. Governments responded by creating a framework for loosing up the lockdowns to support the rebound in economies. However, in my April SOM, I argued that the rebound in the US economy would look more like a “U,” not a “V.” The second COVID wave would come as lockdowns were loosened up, pushing down growth even with massive fiscal and monetary support. A second wave, if not a third wave, would come without a vaccine. Having said that, I thought residential mortgage assets were very cheap in that they were pricing in an even worse housing price sell-off than what happened in 2009-10. Accordingly, I recommended buying residential mortgage REITs and single-B and double -B residential mortgage credit.
In May, I recommended buying consumer staples and selling consumer discretionary, arguing that the demand for staples in a U-shaped recovery would continue vs. tailwinds for discretionary from a V-shaped recovery. Also, I recommended long Indian equity vs. China equity trade, arguing the world would shift some of its offshore production to India from China. I also added to my short dollar trade but this time against EM commodity producer FX. Fed QE is a net positive for EM economies and their currencies, while a weaker dollar is positive for commodities.
June – October
The US economy slowly recovered as COVID cases continued to fall, and lookdown rules eased. I position for two themes: short the USD and go long US housing-related equities vs. being short S&P. The short USD worked well, and I continue to pitch the trade. I did put a gold variant on with a long gold miners short S&P. My thought process was that the miners were a leveraged play on gold and were very cheap because investors until thought they would repeat their debt issuance surge of 2010-11 to finance more gold mines. My view was miners were different this time around with more professional managers. My housing trade was based on the idea that the sector would rebound driven by a surge in home buying and homebuilding given historically low mortgage rates. I thought the potential issue from COVID-related delinquencies were not a significant issue given the build-up of home equity. I closed my long India equities vs. a short in China equities when it hit my up target. I also closed my long staples vs. a short in consumer discretionary had hit its stops—difficult to short Amazon! In September, I added a long CDX protection position to provide a general risk-off hedge given the upcoming election.
November – January 2021
During October and early November, the main event was the US election and the second COVID wave’s reemergence. However, the election passed with the senate continuing to be controlled by the republicans–at least at this writing. As I talked about in my SOM, “the US after trump And COVID,” Republican control of the senate is crucial, given Biden’s tax and economic policy’s potential impact. Both would have, in my view, a very negative effect on equities. The more important factor for going risk-on was the announcement in November of the Pfizer COVID vaccine’s success, followed by the Modera Vaccine, both more than 95% effective. The vaccine is a game-changer clearing a path to normalization by the second half of 2021. Accordingly, the markets will start to price that path. I am positioning for normalization with an OTM call on equities. As I outlined in my last SOM, “The Rise Of Inflation Risk,” the move to normalization could also create an upswing in inflation given the historical levels of money creation and a continuation of Fed QE. Both these factors could overwhelm the downward pressure on inflation from structural demographic and banking issues. Key to the upswing in inflation will be housing, which has historically been one of US inflation’s driving forces. In 2020, housing-related CPI dragged CPI down, but this could reverse with normalization.