Inflation has been among the most important concerns in 2021, after the world has been able to fight the virus to some degree after over a year and a variety of vaccines. The inflation concerns stem from two main sources, the increased liquidity provided from central bank interventions through quantitative easing and the stimulus packages from governments. These two major components are shown in Figures 1 and 2. The first figure shows the balance sheet of the federal reserve. Since Covid-19, the balance sheet has doubled to $8tn. Despite the increase being smaller on a relative basis compared to the global financial crisis, the absolute terms differ vastly. While during the global financial crisis in 2008, the balance sheet grew from $1tn to $2tn, which was seen as unprecedented and extremely large intervention, it is only a quarter of the interventions following the occurrence of Covid-19 in early 2020. This has several implications. It will substantially increase the liquidity provided to the financial market and if the balance sheet is reduced, it will likely cause more volatility, as it was the case at the end of 2018 when equity markets decreased substantially. This is under the assumption that Covid-19 is now and will remain at a stage it can be handled. The entire underlying assumption could change, if, for example, a new strain of Covid-19 would emerge that is resistant to the currently available vaccinations. Figure 2 shows the government stimulus packages provided to fight the economic impact of Covid-19, which has surpassed $10tn globally. Again, this provides additional liquidity to financial markets and there has not been a large wave of defaults, due to government guarantees and similar programs. It remains to be seen, how this evolves, once the government guarantees are withdrawn, which could trigger additional volatility in the market. These two indicators suggest that inflation is very likely to increase in the short-term with potentially long-term consequences. Furthermore, instead of only anticipating rising inflation, it started to effectively to show, as the US inflation rate in May has risen to 5% compared to only 1.4% in January 2021 and BoE’s Haldane has warns that inflation is expected to rise close to 4% in 2021. Figure 3 looks at inflation in recent years for selected US consumer goods and services, which have developed vastly different, even when disregarding the impact of Covid-19. For example, within the last twenty years, hospital services have doubled, whereas TVs have decreased by 90%. The overall inflation over this time frame was almost 55%. It seems to be the case that most industries that are substantially affected by the government have increased massively, whereas fewer regulatory inventions have led to decreasing prices of goods and services. However, this is not entirely objective, as three out of the four massively more affordable goods are tech related. For technological products and services, it is common that they are very expensive in the beginning but lose value very quickly and become cheap and widely accessible. In an environment, in which inflation is a huge concern, equities seem like a good way to hedge some of the inflation risk. But, its attractivity is limited, as stock markets have risen incredibly since the initial drawdown caused by Covid-19. The S&P 500, for example, is almost breaking its high on a daily basis with a high of 4,302 (as of 1st July 2021). This boom in the stock market, alongside the surge in valuations of mostly technology companies, has led to 5.2m new millionaires in 2020, as shown in Figure 4. Consequentially, equity hedge funds have done mostly very well last year, some (for example Long/Short US Equity Consumer, TMT, Healthcare) being up more than 60% in 2020. In 2021, the growth has slowed down, as our SMC Equity Strategy Index is up almost 6% as of May 2021. The best performing equity strategy is Equities US Activist Event Driven with a YTD of 26% in 2021.
Inflation is one of the most important topics in 2021. The rise in inflation is all but surprising given the central bank interventions of last year. Inflation is as high as it has not been for the past ten years. However, current inflation levels are not of huge concerns, but rather what levels could be reached given unprecedented money printing since Covid-19. Consequentially, many large investors have made moves towards gold and Bitcoin (BTC). Equity markets have also rising tremendously, perhaps already incorporating potentially high inflation in the coming year(s). Figure 1 shows the inflation rate in the US since 1915. In the last 30 years, inflation was rarely higher than it is currently, but the potential of ballooning is substantial. For example, inflation is only slightly lower than it was at the peak of the financial crisis in 2008, but the interventions this time were multiple times higher than back in 2008. Alongside, the more outstanding money, debt of government has also skyrocketed, as governments had to fight the devastating economic impact Covid-19 brought. Figure 2 shows the debt to GDP ratio of most countries. Most developed economies, except the Scandinavian countries and Switzerland, have surpassed a ratio of 50%. Another substantial number of countries have even surpassed the 100% mark, e.g. the UK, the US, and France. The highest ratio is from Japan with 257%.
Hedge funds are doing great in 2021. Hedge funds’ AuM has surpassed the $3.8tn mark in March 2021, which is backed by several reasons. The more negative view on hedge funds over the last five years have subsided, since they have mitigated the financial impact of Covid-19 and posted strong performances afterwards. This boosted the AuM through the performance as well as additional inflows caused by the good results. This is very likely to continue, since hedge funds have had their best Q1 return for more than two decades. Alternative investments in general did very well. Private equity was slowed down initially by Covid-19, but their recovery returns were extremely strong. The high valuations on the stock market certainly helped to achieve this return. Private debt did well too, although their initial recovery was slower. But due to the favorable interest rates, private debt seems attractive compared to public debt. Commodities are doing well too, especially considering their relatively bad performance over the last decade. Gold gained significantly since 2019, which was further boosted by the money printing following Covid-19 and surged to a record of $2k per ounce, but since then, it lost again and has been very stable at around $1.7k over the last months. Oil, which was hit very hard during the initial Covid-19 reactions, has reached its level prior to the crisis and continues to reach higher prices. Just in the last month, WTI crude oil gained more than 10% and is currently at $66 per barrel. Industry metals also have gained substantially in 2021 and due to their demand, it is likely that this will continue. Cryptocurrencies have gained again over the last two weeks. Bitcoin (BTC) was not that specular, as remains between $50k and $60k, despite dropping quickly below the $50k mark. Nevertheless, BTC is still up 91% in 2021 and its market cap remains above $1tn. The big mover was Ethereum (ETH), which was around $2,500 before its surge starting in early May. It peaked above $3,400 and is currently at $3,350. ETH is up 349% in 2021 and almost has a market cap of $400bn. Figure 5 shows the ETH price (in green) from 2020 onwards and its value in BTC (yellow line). During 2020, the two coins moved similar, but since 2021, ETH is outperforming BTC substantially. At the end of 2020, ETH was worth less 0.03 BTC, whereas now it is worth more than 0.06 BTC per coin. Other altcoins followed ETH, but not to same extent. Thus, the crypto market, of which 70% was BTC in 2020, known as “Bitcoin dominance” is shrinking. Currently, BTC only accounts for 45% of the market capitalization of the crypto market.
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