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DigOpp Newsletter - September 2023
Taking a Moment to Review Traditional Markets, Macro Liquidity, and Risk Asset Positioning
Often in crypto, the volatility and pace of innovation in our asset class can create a form of tunnel vision. It is easy to forget about the macro forces at work and consider how they may impact our nascent industry.
Here, I give my thoughts on a few US macro-related variables, considering where we sit in the business cycle and the current positioning in risk assets given this macro backdrop.
The inverted yield curve is beginning to steepen, which historically has signaled approaching recession.
Given what the yield curve is saying, what are liquidity conditions looking like? I zoom in on conditions for consumers. Consumers have been a bright spot due to strong wage growth, but we are starting to see tightening liquidity conditions due to:
Slowing pace in labor growth
Credit conditions rapidly tightening
Declines in savings
With the aforementioned conditions in mind, which are powerful medium term forces, how are market participants positioned? Equity futures, which we can use as a gauge for a risk-on mood, show that positioning has cooled a bit after flirting with “overheated” levels.
1. The Yield Curve Has Gone From Inverting to Beginning to Steepen, Which Has Historically Signaled Approaching Recession
The chart below shows the difference between US 3-month treasury yields and US 10-year treasury yields. Historically, this spread going negative has been a signal for approaching recession. When the curve goes from inverting to beginning to steepen, this has signaled a recession is nearer.
If we extend our data back a bit further, by looking at this chart from JP Morgan, we can see that in the late 60’s the curve inverted and a recession did not immediately follow… but still came about three years later (see the left hand of the chart around `66). A similar pattern occurred around `97.
2. The Picture For Consumers is Trending Toward Tightening Liquidity
US consumers have been a macro bright spot due to wage growth, but we are seeing tightening conditions across a number of metrics.
Post-Covid wage growth has been very strong, however even this data is beginning to cool off.
Savings rates have rapidly declined post-Covid. The savings rate is similar to the 2006 period. Less savings means less money to spend, which means tightening conditions.
Consumer credit has also begun to massively tighten.
Again, like savings, less credit means less money to spend, which means tightening conditions.
3. Risk Asset Positioning Has Been Flirting With Extreme Levels, But Door is Open to Short Term Buying Pressure
Given this macro backdrop, what does positioning in risk assets look like among large institutions?
To get an idea, we can take a look at net positioning in equity futures.
The CFTC breaks down longs/shorts for different clusters of market participants in COT data (Commitment of Traders). We can use this data to gauge how “extreme” positioning in assets are for different cohorts of investors.
Here, we take a look at net positioning among asset managers in S&P 500 futures. Asset managers includes pension funds, mutual funds, that kind of thing (i.e., structurally long market participants).
You can see that we’ve passed the median long positioning for asset managers and briefly flirted with “overheated” territory.
The chart below shows the performance of the S&P 500 based on how long asset managers are. The more longs there are (higher quintile), the more people there are to sell and the less buyers there are. You can see once you get into the upper range, the positioning starts to matter a lot.
Currently we’re sitting in the third quintile.
Measuring S&P 500 past performance following COT data is noisy. We’re only looking at averages here. There is a wide distribution around what has happened in the past. So take this measure with a grain of salt. Since positioning has cooled off from “overheated” territory, there could be room for short term buying pressure. Especially if other structural buyers enter the picture (like CTA/Trend Followers purchasing equities if price momentum turns to the upside).
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