Pricing dislocations in Europe, performance dispersion across the credit spectrum and shifts in the political landscape should likely provide abundant opportunities for select hedge strategies in the year ahead, according to K2 Advisors. The team shares some macro themes and questions its focused on, and shares its outlook for various hedge strategies.

Macro Themes We Are Discussing

Are Sector and Geographical Rotations Likely to Continue in 2020?

We expect a rotation from those equity market sectors that formally had strong earnings growth into sectors that have lagged in the past few years. We believe this sector rotation should benefit equity hedge fund alpha1 as managers look to buy past laggards while using past leaders as market hedge positions.

Likewise, cyclical sectors and value factor-sensitive securities may outperform defensive and growth-oriented sectors. Much of the negative economic and earnings growth news may be priced into European and emerging market equities, while much of the positive news is potentially priced into US equities and the US dollar. A rotation into non-US equity markets may become evident in 2020, and many macro commodity trading advisors (CTAs) and equity long/short managers may benefit from this shift.

Are Investors’ Global Inflation Expectations Too Low?

We wonder if consensus inflation expectations are too low given global growth seems to be stabilizing. If wage or price inflation surprises to the upside, the Treasury yield curve may steepen in 2020, and some bond markets may come under pressure as interest rates rise. Credit long/short hedge fund managers should benefit from this scenario, in our opinion, as the performance variance between bonds in different countries or sectors should offer alpha opportunities.

Has the Rally in Global Government Bonds Gone Too Far?

According to Bloomberg, as of December 30, 2019, the Federal (Fed) funds futures market is forecasting the US Fed funds rate to be near 1.39% as of December 2020. This is not much lower than the current level of 1.55%. It seems to us that interest rate cuts might mostly be priced into bond valuations. We wonder if a potential selloff in global bond markets may present a good hedging scenario for managers in the relative value, event-driven, and macro/CTA strategy categories.