O’Connor Global Multi-Strategy Alpha Quarterly Letter

How to be dynamic and respond to a rapidly changing macro environment when market performance has been turned upside down.

Hedge funds 02 May 2023 6 min read
Casey Talbot Bernie Ahkong

For anyone travelling over the Easter holiday, labor strikes and weather disruptions served as a reminder that the best laid plans don’t always work out and you have to be flexible and adaptable.

The events and performance of financial markets this year have delivered a similar message to investors as we need to be dynamic and respond to a rapidly changing macro backdrop. For example, looking at Q1 2023 S&P 500 returns by sector, compared to 2022, we can see how performance has been largely turned upside down - a scenario that few were predicting at the start of the year.

Chart 1: 2022 vs. Q1 2023 S&P 500 returns by sector

Figure 1 shows the 2022 vs. 2023 Q1 S&P 500 returns by sector, which illustrates performance of many sectors are inverse.

The collapse of Silicon Valley Bank (SVB) and turmoil in the wider banking system illustrate that the rapid monetary tightening cycle of the last few quarters has significant consequences for financial markets. The MOVE Index of Treasury volatility hit levels in March last seen during the GFC, although we have seen a rapid sell-off in volatility across asset classes in subsequent weeks. That said, we do think the speed at which authorities have been willing to intervene to stabilize markets in potentially critical situations like this one has been noteworthy and limits contagion risk.

Chart 2: Treasury volatility reaches highest levels since Global Financial Crisis

Figure 2 shows the MOVE Index of Treasury Volatility from 2005 to 2023, which reaches levels in March last seen during the GFC

We are mindful of, and in some strategies positioning for, the future fallout of these recent events. Even prior to SVB’s collapse, we have been seeing a tightening of financial lending standards which will continue to impact parts of the economy like manufacturing directly. The C&I loan survey moving higher indicates banks tightening credit, which typically leads ISM new orders lower.

Chart 3: C&I Loan Survey—Banks tightening credit

Figure 3 shows the C&I loan survey, 3m lead versus ISM Manufacturing New Orders Index from 1990 to 2023, indicating that both Commercial & Industrial loans and ISM Manufacturing New Orders Index levels are rising as financial lending standards are tightening.

In the recent National Federation of Independent Business (NFIB) survey conducted during March 9% of US small businesses reported their last loan was harder to get than in previous attempts – the most significant deterioration in over two decades.

Chart 4: National Federation of Independent Business (NFIB) survey—Loans are harder to get

Figure 4 shows the NFIB survey as a % of respondents reporting that credit was harder to get than last time from 1973 to 2023, while illustrating that in March 9% of US small businesses reported their loan was harder to get.

When you compare the actual interest rate paid on short-term loans by small- and medium-sized business (SMB) borrowers to the high yield index coupon rate, rarely has the spread been wider. Such instances have often coincided with more painful economic periods.

Chart 5: Spread widening between NFIB Actual Interest Rate Paid on Short-Term Loans by SMB borrowers and High Yield Index Coupon Rate

Figure 5 shows the NFIB Actual Interest Rate Paid on Short-Term Loans by small- and medium-sized borrowers versus the High Yield Index Coupon Rate from 1990 to 2023, which indicates recent periods saw a larger spread.

One problem for the future development of the US economy is the tightness in the country’s labor market is being exacerbated by the hiring needs of smaller businesses: SMB labor demand is nearly four times of larger companies.

Chart 6: Job Openings and Labor Turnover Survey (JOLTS) – Small- and medium- sized business labor demand is higher than larger businesses

Figure 6 shows the Job Openings and Labor Turnover Survey (JOLTS) as a ratio of job openings for 1-249 employee firms to job openings for 250+ employee firms.  As of February 2023, small- and medium- sized business labor demand is nearly four times that of larger companies.

In some of our equity strategies we have been expressing a more cautious view on names more tied to the US economy, as we see pockets of weakness appearing in credit card data and corporate commentary. Industrials and materials companies – companies reliant on low- and middle-income consumers or the easy availability of credit – are specific focal points. In contrast, we continue to see strength in the high-end consumer areas like luxury, which are supported by China’s reopening and related travel trends. We also see opportunity in cyclicals, especially within energy transition, where there appears to be visible and de-risked earnings growth for the coming years.

The recent divergence between the German DAX Equity Index and German Bunds intrigues our European team. We are finding more interesting opportunities on the long side in more defensive bond proxy subgroups like consumer staples, infrastructure and utilities, while worrying about 2023 and 2024 revenue and margin expectations for a number of German industrial cyclicals.

Chart 7: German DAX Equity Index and German Bunds Index levels are diverging

Figure 7 shows the DAX Equity Index and the German Bunds Index from 2002 to 2023. Recent periods show a divergence between the indices.

In credit, the US regional banking issues are leading to tighter and higher priced credit, and a greater dispersion in the availability of credit for corporates, which we believe should help our strategies. Credit and credit betas have underperformed equities, and at a single issuer level that also presents interesting relative value opportunities. Companies are spending more time scrutinizing their debt stack and financing plans – which we think can help some of our idiosyncratic situations in convertibles as issuers look to buy back certain maturities. Furthermore, we have seen how recent M&A activity can also catalyze value for our holdings.

In broader merger arbitrage, we have seen a notable pickup in recent weeks of both strategic- and PE-led activity, and some more favorable deals close amid anti-trust news flow. Yet the complexity of many deals lately has meant a blanket approach to harvesting merger arbitrage risk premia has not been straightforward, and requires a more discerning and discretionary approach.

We continue to expect a rapidly evolving macro landscape with varying ramifications for different industries and corporates, which empowers our teams’ idiosyncratic alpha generation process. The exact journey for markets from here remains uncertain, plans will need to be changed and adjusted – but we are prepared to react and adapt quickly.

As always, we thank you for your continued support.

Related insights

Contact us

Make an inquiry

Fill in an inquiry form and leave your details – we’ll be back in touch.

Introducing our leadership team

Meet the members of the team responsible for UBS Asset Management’s strategic direction.

Find our offices

We’re closer than you think, find out here