Risk Parity and the Gig Economy Both Under Threat

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March 15, 2020
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There is nothing so bad that politics can’t make it worse
Thomas Sowell

When the virus scare began we noted that there would be two important components to calling the bottom from a market perspective; first that the rate of growth of new cases would have to slow – the second derivative – and second, we needed to observe how despite this occurring, the market mechanics themselves chose to behave in the face of this. In the case of China, condition 1 was satisfied in mid February, but the switch of location to Europe, specifically Italy, meant condition 2 was not and indeed, the shift by long term investors from buying the dips to selling the rallies has been meaningful (to say the least). The Vix, the so called fear Index, but perhaps more prosaically thought of as the cost of put options hit 75 last week, levels not seen since the 2008 crisis. And now we hear of emergency rate cuts in the US to zero and more quantitative easing as the Fed acts as the buyer of last resort as risk parity blows up.

This is the second round effect of the first selloff. We mentioned previously the fragility of some of the risk parity models in these situations and thus note that Ray Dalio’s all weather fund has taken a big hit and redemptions are only going to make things harder as they trigger further position unwinds into illiquid markets. Deleveraging, particularly in fixed income strategies, is causing serious disruption.

This is not to dismiss the causus beli, the virus. As and when we see condition 1 met for Europe, we can hope to see markets stabilise and when they do so will be the time to invest, with a focus on quality and strength of balance sheets. Somewhat counter-intuitively the rise in the death rate is actually a sign that the situation is peaking as the numerator lags the denominator. However, the market needs to work out its distressed selling. The options expiry this coming Friday remains a key milestone in our view.

There will be a V shaped recovery for sure, but not all will survive, for like with the virus itself, the corporate fatalities will be amongst the weak and those with ‘pre-existing conditions’. In this case we mean poor balance sheets and an inability to withstand a lack of working capital. Listed companies should fair better than small enterprises on average simply down to size of balance sheet, but as with 2008 this is all about working capital and cash flow.

Nor should we dismiss the wider likely economic effects that will undoubtedly arise, as much from the governments’ actions as the virus itself. Here in the Chamonix Valley in France, where we have precisely zero cases of the virus, we were given three hours notice on Saturday night that the ski resort is to close over a month early and all bars and restaurants and non essential shops will be closed until further notice. At least that was slightly better than Austria where skiers in St Anton were given one hour to clear the resort in the middle of the day! From a bureaucrat or a politician’s perspective this makes sense, nobody can blame you in the media (social or otherwise) for any fatalities from now on, in the words of Dr Peter Venkman in the original Ghostbusters to the mayor of New York ” But if I’m right, and we can stop this thing, Lenny, you will have saved the lives of millions of registered voters “. Meanwhile, the state employee can work from home or self isolate and all is relatively OK. But from the perspective of anyone working in the private sector this is a massive blow and those in the gig economy it is little short of a disaster.

According to McKinsey there are around five million people in the UK working in the gig economy – around 16% of the workforce –  and that number can be up to 30% in the US and parts of Europe. Most of them are working in the shops, bars, restaurants, delivery companies and other ‘non essential’ areas that M Macron closed down on Saturday night and his equivalents across Europe have already shut down or are preparing to do so. This is going to cause real economic hardship and politicians who think they can avoid blame for the virus will soon find that they won’t be able to avoid blame for the impact on the private sector. We note that in some areas politicians are already referring to ‘Chinese Flu’ or ‘Wuhan Virus’ and there is even demand for compensation. As such we would fully anticipate another round of anti China stories all the way through to the US Election. As with the aftermath of the 2008 crisis running into the Obama presidency, when it was all about ‘greedy bankers’, the blame game for the economic mess is already beginning.

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Political Cicadas - no change in the product, just the sales team

The habit of spending long periods underground before re-emerging is not limited to the Cicada, for while this year sees the coincidence of the 13 year year Cicada cycle and the 17 year one, something that last happened 221 years ago, it is also 17 years sine Tony Blair was last in power and 13 since Francois Holland (likely PM in the French Hung Parliament) was. Both now look to be re-emerging to ensure continuity of policies that never really went away. The key sources of protest across Europe - crippling expensive wars against Russia and Climate change as well as uncontrolled immigration have only been addressed in the doubling down - the first thing UK PM Starmer did was fly to Washington to offer more money to NATO, while his Chancellor promised more money for Net Zero. Meanwhile, the left alliance put together to thwart Le Pen is even more pro immigrant than Macron. For markets, there is no prospect of lower spending and every prospect of higher taxes - the only 'Change' visible but not the one promised. The Technocrats and Globalists expecting this 'democracy' means that the populous will go quietly will be disappointed, especially with the arrival in the Autumn (once the Cicadas have gone) of the great populist, anti open border, anti net zero and anti war populist Donald Trump.

Market Thinking July 2024

The scorecard for the first half puts Equities, commodities and Gold in the top half of the table, with cash and fixed income in the lower half. This is consistent with the steady but uninspiring macro backdrop and positioning ahead of a tricky H2 from a political perspective. The anomaly of the Market Cap weighted SPX out-performing the equal weighted SPW by over 10% points tells us both that the SPX is no longer telling us anything about the US economy and that this excess return is for taking (considerable) concentration risk. Meanwhile, with Bond analysts 'pivoting from the Pivot' the fixed income markets have calmed down a little and leaving The Donald' rather thna 'The Fed' as likely the biggest policy influence on Markets over the next 12 months. In particular, we would look out for a 'Trump Plaza Acord" early next year, 40 years after the last one- something the FX markets aren't talking about, but the asset allocators seem to be (at least subconsciously) pricing in.

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