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Date
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Research

Macro and hedge fund Q1 2020 outlook

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Soft manufacturing surveys are bottoming out, pointing to a turn in hard data. Monetary accommodation and less uncertainty on most trade fronts have been key contributors to this inflection, as well as front-loading ahead of the September tariffs.

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Macro and hedge fund Q1 2020
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Assuming confirmation of trade hopes, a modest global economic bounce in Q1 seems credible for several reasons. First, the manufacturing recession hasn’t reached the point of no return, as proven by resilient services and consumption. Second, global liquidity will remain supportive, boosting credit, capex and consumption. Third, while stabilization in Chinese real activity has been delayed by September tariffs, stimulus efforts and a possible rollback of some tariffs are paving the way for a modest bounce. Finally, a Brexit deal would also modestly boost EU/UK investment.

Prospects of a modest economic bounce, but unconfirmed trade hopes for now, an early stage of inflection, and few
cheap assets are puzzling investors either facing the pain trade or vulnerable to speculative risks. In response, we feel appropriate to stand around market weight on a majority of assets with a selective set of affordable cyclical tilts.

In the US, we expect the Fed to remain on hold with a defensive bias, and we thus favor short duration. We are neutral on equities where potential mostly depends on P/E multiples expansion and which price limited risk from US elections. We continue to favor HY as long as liquidity conditions remain ample, despite deteriorating metrics. We see the dollar in a trading range.

In Europe, we anticipate a mild cyclical upside making room for modest Bund normalization. We also favor HY, which offers an attractive carry and where spreads have room to compress. We are neutral on equities but we see more potential in cyclical tilts. In particular, we favor cyclical vs. defensive, as well as small vs. large sectors.

In Japan, an export and tech-driven economic bounce, along with a fiscal package, would make up for sluggish consumption. BoJ would stay on hold. We are overweight equities: sales growth and margins would recover if the trade wars do go on hiatus.

A bottom in global trade and the Chinese economy, and still healthy global liquidity—three key EM markets drivers—would help their economies recover. But the bounce would not be strong enough to lift all boats. We are neutral EM equities, with more opportunities at a country level and with lower risk in EM Debt and FX.

Finally, we see oil prices in a trading range, supported by recovering demand, but dragged by rising non-OPEC output, with OPEC+ production and geopolitical risks as the main variables in the equation. We still see gold as an appealing hedge to protect from trade disappointments.

The active investment backdrop—particularly for hedge funds—is steadily improving. Soaring policy uncertainties and monetary liquidity flows in the first part of the year proved challenging for fundamental investors picking assets with distorted valuations and speculative catalysts.
With central banks likely to stay on hold, receding uncertainties and signs of a modest inflection, we expect more economic discrimination and greater focus on micro trends, as well as on finding affordable value assets.

Liquidity for longer, value at affordable price, and economic dispersion were our driving hedge fund themes.

Accordingly, we overweight Special Situations, very value-oriented styles, with an extra tilt towards smaller caps. We continue to favor L/S Credit strategies—which are likely to further benefit from global liquidity—with rising dispersion as credit metrics start to deteriorate. We would also overweight EM-focused Macro strategies to benefit from rising economic and market dispersion and from a variety of distinct themes. We still favor Merger Arbitrage strategies which provide uncorrelated carry.

In contrast, we would downgrade L/S Equity neutral strategies, vulnerable to further swings in momentum and market sentiment. Moreover, their overall bias is less appealing in our base case scenario.

Otherwise, we would balance Macro and CTA strategies. They tend to be more volatile at macro inflection points, which are notoriously challenging to time and capture.

While a majority of L/S Equity directional managers missed the recent “pain trade,” their reduced exposures now offer protection. They also have dry powder to exploit a larger pool of fundamentally driven opportunities, aligning with our expectations.

Distorted bond valuation would make relative arbitrage more volatile. We are neutral on FI multi-strategy styles.

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