Beatings WILL continue until morale improves

This week we got a clear example of how central bankers will continue to beat us until the morale (inflation) improves.

In a previous post I applauded the governor of the BOJ Kuroda for his actions taken towards the end of last year by not increasing his QQE (quantitative & qualitative easing programmer) but actually promising incentives for management of companies who invest in their people and innovation. In this author’s opinion a far better use of time and effort, as it actually touches on blending monetary policy with fiscal policy.

“What I did like recently was Kuroda attempt to throw a twist into his QQE (quantitative and qualitative) programme by saying that he will invest roughly $3bln into companies who invest in human capital. This is important, it is a signaling mechanism to say that the BOJ is behind companies who not only hire more but invest in their people to incentivize them to work more or more importantly innovate more. Once this message filters down appropriately to the top/middle management in Japanese companies who are probably invested in the company they are going to push for more hiring, better wages and hopefully empowering their employees to be more innovative.”

This week saw a far more direct and tried and tested approach. However we must remember just because it is tried and tested does not mean it will work.

Kuroda has now moved the BOJ to negative interest rates or NIRP. Not content with a near ZIRP for approx. 16 years, Kuroda now feels that had that just been a tiny bit lower inflation would have achieved the magic 2% mark that central bankers seem to repeat like a religious mantra so oft.  The best quote I read from a money manager in japan was that the carrot has been abandoned and now we are working with the stick.

japanIR

 

Japan is renowned in the macro world for being the “widow maker”- i.e. plenty of macro fund managers have gone broke over the years betting on a return to form of inflation and growth not seen since the magic 80’s in Japan when they arguably dominated the scene for consumer electronics in a fast changing world. The below shows the inflation rate in japan over time and what’s more striking is that around the time they adopted the ZIRP policy  while there may have been periods of above zero inflation there were also plenty of periods of deflation.

JIR

 

So Kuroda has now resorted back to usual tricks by central bankers. Instead of trying to foster a culture change of risk taking and “animal spirits” he is just going to try and force money to float around the system by charging institutions for extra reserves held at the BOJ. I am not sure why Kuroda thinks that this move will have any effect greater than the already very loose monetary policy that has been shown not only in Japan but also around the world.

But let’s look at what potentially triggered such a decision and whether Kuroda has shot an intentional arrow or merely just reacted aggressively to current events.

What where big headlines in Japan less than a week ago was the resignation of the minster for Economy Akiri Amari for alleged dubious practices regarding brown envelopes. This, he has of course not admitted too but doing the honorable thing and not allowing suspicion to fall on the party. The very next day Mr. Kuroda who up until a week ago had denied contemplating lowering interest rates through the zero barrier suddenly had a change of heart. This would certainly seem like a strategy to divert headlines away from the scandal and allow us all too simply forget about Mr. Amari’s alleged transgressions. It seems a little too coincidental to me but would also caveat by saying I doubt Mr Kuroda would make such a rash decision. So this has been a tool (or arrow) in his arsenal for some time and he has just been waiting for the right time to do it must be the only explanation.

Why then, is now the right time outside of the reason above? Again the obvious answers don’t cover Kuroda in glory either.

Recent movements in markets have seen what is known as “RISK OFF” this is a general term that I have discussed before (here). As most of the market was unwinding their foolish “ carry trades” which is when you borrow a low yielding currency and invest in a high yielding currency the Yen found itself being in an awkward position for the BOJ. In a regime when you are desperately trying to devalue your currency and the rest of the market cannot see beyond their red flashing PNL on their screens. The best evidence of this is the AUDJPY cross or if you want to be super sexy (risky) you could have borrowed Yen and invested in equities just because leverage is fun right?

USDJPY was fast approaching a level of ¥115/6. i.e ¥115-¥116 Yen to the USD. I work as a trader and can spot areas of price levels that if broken can cause enormous amounts of volatility and pain (in the financial sense), If little old me can spot these obvious areas you can be dam sure the BOJ and all its army of advisors etc can also and put ¥115/6 as a line in the sand. An implicit put if you will. And by the way it’s not rocket science, look at chart attached below and tell me that ¥115/6 level is not important. It may not look like much to you know but imagine how many people, traders, highly levered options traders, structured products,fund managers, algos, quant finance models, businesses etc etc draw these “lines in the sand”. When a line in sand breaks, there are reactions, just ask the FX traders back in the day who used to make a great living (some still do) “running the stops”

USDJPY

Kuroda has come out and defended the ¥115/6 level with the only thing he could use to ensure it would hold- negative deposit rates. A move so bold that it forces everyone in the market to respect (for a while). Why do I think this is such a poor strategy? It reduces the BOJ to nothing more than a technical analyst, developing monetary policy according to charting techniques. Don’t get me wrong I’m a firm believer in TA just not so sure I would like my monetary policy to be dictated by it.

Also, now the market knows it weakness. It knows how to force a decision out of Kuroda. The Master –servant relationship is a complicated one in macro finance. Sometimes the market is beholden to the Central bank and sometimes the central bank is beholden to the market. Kuroda I believe now is firmly in the hands of the market, it may appear the other way but not so. When the market wants something it knows how to get it- fundamentals be dammed.

Where have we seen this type of behavior before? I.E negative rates for a currency. Well one that is close to my experience is of course Switzerland. The Swiss currency has had negative rates for some time now (Dec/Jan 2015).

SIR

Now you would assume that if this was an effective tool of monetary policy that inflation should be around the magic 2% mark in Switzerland, right? Wrong? The official Swiss inflation rate is even worse than the Japanese rate, and what you may note is that the below chart shows negative inflation or deflation throughout a period where oil prices were trading around the $100 mark so, don’t just say the very lazy and defeatist comment of…… “ Yes, but oil …………….”

SIR2

 

In a race to devalue currencies all around the world the Swiss central bank (SNB ) commonly known as the world’s biggest hedge fund did the only thing they could do to devalue their currency. Pegging it to a level didn’t work EURCHF ( 1.20) to hold back the tide of those who rush into buying CHF in times of strife, so they famously abandoned it and all hell broke loose as the leverage in the system in that particular pair unwound itself. Now the USDCHF is back to the very level it was before that move, EURCHF is not owing to the ECB’s concerted campaign to drive the Euro lower, but USDCHF has found its way back and is looking to go lower higher ( implying a weaker CHF ). Why is this? Negative rates are such a drag man. Is inflation any higher in Switzerland? No, arguably its lower.

So Kuroda had me last year with some policies and now he has lost me. His negative rates may succeed in devaluing the currency and (therefore assisting in debt reduction strategy which is a whole other blog post) but he will not succeed in achieving anything close to a 2% inflation level.

And while this goes on it seeks to develop the idea that central banks are indeed out of carrots (arguably they had never had any in the first place) so the stick will be used in Japan and every other major economy around the globe ( US & EU ) until morale improves.

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No two crises look the same but they often rhyme

The US Consumer is important. US transitioned from an industrial to a services economy many years ago,  and up until the global financial crisis (GFC) was the mainstay of global economics. Once the US consumer caught a cold the whole world caught the flu.

At the moment the US economy appears to be ticking along just nicely, not enough for people to be 100% confident in it but also not bearish enough to hit the panic button just yet.

If you follow the stock market you may have noticed that a lot of the better performing stocks currently all have a consumer edge to them. Nike have grown top line revenue at a staggering pace, Amazon, Apple, Netflix, Facebook, google etc etc etc all have been performing very well and sucking up cash so that even now Facebook can boast having a larger market cap than none other than JP. Morgan.

That is quite astounding, it is reflective of certain issues in the banking sector that are being ironed out but the thought of a social media company having a larger market capitalization than one of the oldest and most successful banks in the world is quite something and marks a radical shift in trends in financial markets. Not to be outdone,  Apple’s market cap is also roughly equal to the three largest banks in America. Simply amazing stuff.

Anyhow back to more prescient matters- this should give you confidence that the US economy is right on track and doing well but lets have just a brief look under the hood.

US consumer borrowing is now larger than it was before the GFC. Below is a chart of consumer lending and while volatile you can see an aggressive rebound from the GFC days in 08.

Capture

Now lets look at Visa’s Share price, not too shabby right, albeit they were IPO’d in 08 and markets have rallied strongly since, Visa has appreciated and rode the wave of consumer borrowing with barely a look in the rear-view mirror.

VISA

Bearing these two in mind lets look at this chart. This is the participation rate of employment in the US. i.e What percentage of the ‘able to work’ are actually working.

PT

Now you will see that although the US official unemployment rate has returned back to a more healthy level of circa 5% it has been done so as much less people are actually participating in the workforce.

It does not seem right to me that less people are working yet more short term credit is being extended to the US population. Remember that consumer credit is often high interest bearing credit if left un-attended. (I will dig into this i.e repayment rates in a future post)

What sectors are benefiting the most from this rapid extension of credit? Most are pointing to the US auto industry and student loan industry at the moment as over-indebted. This is good and bad, people need an education and often in US a car to work so it can be seen as a productive investment (that is rose tinted glasses way of looking at it).

If you look at the rise in consumer related stocks as noted above, you could also say that people are squandering money on what is known as Consumer Discretionary items, or in other terms, we are buying things we dont need but we like the look of.

For the final chart just have a look at US average hourly earnings and notice the trend, or lack thereof to be more precise. Although it looks volatile it effectively points to zero growth in earnings or wages for the average american.

HE.JPG

So to conclude we find ourselves in the following situation:

  1. The US consumer is borrowing more short term financing
  2. To buy things they dont necessarily need but do covet
  3. Wages/earnings have not grown to the extent that borrowing has
  4. Interest rates are starting to move up
  5. Credit Card/ direct lending and predatory payday lending companies are doing well.

 

I do not want to say we are in bubble territory as consumer purchases are often much easier to finance than mortgage repayments which caused the last crash but to me its a worrying trend, and proof that no two crises look the same but they often rhyme.

Jeff

 

 

 

 

 

 

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China in your hands

Earlier this year China swooned, or to put it more correctly the price of the SHCOMP index swooned. I.e the valuation at which investors attached to the equity market within China.

Media was full of prophetic statements and most simplified it down to whether China was having a hard landing or soft landing. Hard landing sounded so much better as the charts showed a market in mark down mode.

Now that things have calmed down and the media have other things to write about lets take a quick look at China after their top level management just met and delivered (unofficially of course) their summary on the economy and how things might look going forward.

According to unofficial sources (as that is often the best you can get from China) ministers agree on what I have been thinking for some time.

If you build them they will come.

China engaged in a very ambitious and fast paced infrastructure spend that kept the world and specifically the resources sector ticking over during and in the aftermath of the financial crisis. Commodities sector was ablaze and now we are witnessing what happens when a powerhouse steps off the bid. Oil, metals etc are all suffering from serious price drops that is challenging the fabric and design of the industry.

China needs to look after China, and now plan to fill all these apartments, shopping malls, railway links, highways etc etc etc. They have built the foundations of creating a better standard of living and life for their citizens and now the focus is on transitioning their economy to be more diversified.

The Chinese leaders understand they cannot exist and prosper in the future by relying on being the manufacturing base for the world. we all know production always seeks the cheapest conditions. They can still maintain a world beating manufacturing industry as PART of their economy and always will but much the same way that America was once a manufacturing powerhouse this simply will not last as a competitive advantage for years to come and therefore China must transition itself.

You may question their human rights issues (which exists in all countries to varying degrees and acceptability) in China but you have to hand it to them for their foresight and management, it may still all blow up, but at least there is a plan.

Chinese leaders speak of an “L” shaped recovery, perhaps this is the best approach to take. i.e. static steady growth for the next X period of years. And certainly seems to be a more sensible approach than trying to satisfy Markets and shooting for + 8% growth year on year which is unsustainable.

China is like watching a human being growing up, we have gone through its infancy, seen it grow big and tall through its puberty and now we are witnessing them graduate into the big leagues. they have learnt lessons along the way and it is up to them to implement and grow into them.

My guess is that by the time I retire China will be akin to what America was. A powerhouse economy that shapes the world direction. An educated, hard working workforce that simply wants to improve their lives. Unpopular thing to say but mix a bit of communism with capitalism and manage it correctly and it seems to go a long way.

Some useful tips  for thinking about China:

  1. America did not just wake up one day as the most powerful economy it took time and plenty of boom and bust before it happened.
  2. Stop debating about the Official growth rate or being skeptical about the figures given out the by the government bureaus- if you think you can do a better job of estimating the official GDP figures in China, knock yourself out, otherwise stop wasting your time.
  3. The price and more importantly fluctuations of an index designed to track equity prices IS NOT AN ECONOMY. it is a numerical value created to track equity prices.
  4. China is a large complex beast, they will have up and downs like any country, just because you dont understand it, never been there or haven’t a clue about the language does not mean the economy will crash.
  5. They more than likely do have relatively lower standards of corporate governance that the regulators need to resolve before investing there is “safer” for the average joe, so buyer beware.

http://www.wsj.com/articles/china-set-to-unveil-economic-blueprint-for-2016-1450691139

 

 

 

 

 

 

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Seminal leaders in finance thoughts for 2016

OK, so not quite a seminal leader thoughts, but my own musings on the year gone by and the year to come, the very fact you clicked on the link however will further prove my theory on Trump ’16, keep reading to find out, prize at the end of the blog post for you.

It is around this time of year that most of us like to take stock of the year we have just experienced and more importantly we like to pontificate about what the coming year has in store for us. Many in my industry engage in what is often a useless art form of prediction of what is to come and how the landscape might look for investors or the world in general.

First off let’s have a quick look at the major themes in the financial arena this year. 2015 looked a lot like previous years gone by where investors were primarily concerned with a few major topics. These topics have been beaten to death by commentators and the media alike so I won’t go into depth on them but safe to say the main themes were the following:

  • The FED and if/when the committee were going to raise rates
  • The ECB and if/ how much QE they were going to deliver
  • Greece, the never ending saga – came to the forefront once more
  • Geo-political tensions – Russia aggravated, Syria intensified and ISIS became a household name
  • Energy and commodities in general were one way traffic
  • China swooned and everyone temporarily lost their bloody mind

While these were the major themes of 2015, I would struggle to say that we resolved any of these major issues. Greece was again given a lifeline but for how long that lasts is anyone guess, the ECB delivered on QE but now investors are going into 2016 with nothing but MORE on their mind. Energy is still in the toilet and leaving central bankers wondering who they got to “sleep with for a little inflation round here.” Metals are also at multi year lows as China fresh from a rout in its stock market are apparently taking a breather from single handled support of the global construction market.

One thing you could say is “resolved” is that finally the FED have raised rates for the first time in nine years. You can argue until you are blue in the face about whether this is a good or bad idea but can we just all agree to disagree and at least accept the notion that it has finally been done. After 7 years of ZIRP and easy money policy the cost of capital has risen by 25bps, when you say it like that it doesn’t sound so bad does it? How the FED intends to proceed is now the argument for 2016 and I just cannot wait to be saturated with all that content.

What might be the big macro themes of 2016?

  • Path of US rates will be talked about ad nauseum
  • How will other major central bankers respond to the new FED policy, mainly the BOE and RBA, RBNZ?
  • US presidential elections-
  • Volatile energy prices – weakness with intermittent bids coming through in WTI/Brent
  • EM markets and how they will cope with a stronger dollar and low commodity prices
  • How will major super powers combine to deal with ISIS if at all?
  • Will we see any inflation in the Euro area
  • Regime changes- US presidential (circus/cycle), monetary policy- creates uncertainty.

 

What might equities look like?

Currently as I write this a little shiver is going through the equity markets. The ECB failed to enlarge their QE programme, the BOJ did not enlarge either and the FED stopped theirs a year ago and have just raised rates. Some people are literally losing their mind calling for Armageddon etc. Let’s all stop and take a breather. Yes, it’s fair to say that equity markets are due a pull back. Most equity people are somewhere between two camps of thought on QE.  You either believe that QE was mildly supportive in getting us out of the financial crisis and at some point over the last few years actual fundamentals took over and drove equities to all-time highs or you are full on zerohedge type reader and accuse the central bank of the largest Ponzi scheme perpetuated on the American people that makes Madoff look like a boy scout.

Im going to sit on the fence and say that QE was supportive of equity prices and drove required rates of return lower therefore making equities look more attractive to the average investor who had to turn in monthly results in order to get paid. At some point fundamentals did take over and some companies prospered and some didn’t. But either way if you accept that stimulus affected the rally then it stands to reason that once removed there are some withdrawal effects that any addict must suffer through before they are free to prosper.

So in short I would assume that throughout 2016, European and Japanese equities will outperform US equites, for the wrong reasons. EU equities are still supported by an accommodative monetary policy and a cheap currency, what they lack is a solid banking system so it will take time to recover fully, but the headline risk of being short Europe is too much to handle mentally for investors who are so used to large sharp rallies occurring in equities under an easy monetary policy regime.

What I did like recently was Kuroda attempt to throw a twist into his QQE (quantitative and qualitative) programme by saying that he will invest roughly $3bln into companies who invest in human capital. This is important, it is a signalling mechanism to say that the BOJ is behind companies who not only hire more but invest in their people to incentivise them to work more or more importantly innovate more. Once this message filters down appropriately to the top/middle management in Japanese companies who are probably invested in the company they are going to push for more hiring, better wages and hopefully empowering their employees to be more innovative.

I think this is important as what we saw in the US was share price appreciation from a lot of financial engineering like buybacks, instead of this wouldn’t it be better for companies to have issued cheap debt and invested in their actual company?? Anyway it remains to be seen how it works but I think in theory, I like it, and I commend Kuroda for trying new tactics and learning from the US QE programme. On the subject of recent disappointment that he did not enlarge the QQE programme I think again he should be commended, what is the point when energy prices are in the toilet, it would be like flogging a dead horse, I think better to wait for an uptick in inflation and then squeeze it- hard, so glad he saved his bullets (or arrows).

US equities are going to trade like a baby foal learning to walk. But that is because technically it is learning to walk again on its own with no stabilisers, there will be a few bumps along the way, maybe even some dramatic falls, I think those that are waiting to help it back up after one of these falls will do just fine.

If you are a stock picker I think 2016 will be your year as fundamental stock picking will be back in style in the US. Momentum investing will have to be more granular and I think that applying a big picture macro view of just being “long or short “stocks in general will not pay off as it may have in the last few years.

The US will start 2016 with two major regime changes in the mix, one is monetary policy. While I feel that a fed rate of only 50bps is still extremely accommodative it is a change of policy from previous few years (nearly decade) investors will have to come to terms with this and be comfortable that this is not the start of an aggressive tightening policy. Also the US presidential elections creates uncertainty. While I refuse to engage in that process as it is a total circus I do have some words of advice on a certain Donald trump.

If you are relatively sane individual you will view Trumps momentum as farcical, embarrassing, shameless and many other words that are not fit to print here. The problem is Trump is the perfect person to run in a US presidential race. He can fund himself, he understands how to wind people up, to get attention and he has no problem uttering factual inaccuracies. But perhaps most of all his modus operandi fits in very well with the current set up of the media. US elections are a media frenzy, the current distribution platforms used by media is to compete for clicks. Donald Trump spews “clickbait” from his mouth at every opportunity.

The only way to stop Trump is to take away his power- the media- stop clicking. Trump feeds off the theory that there is no such thing as bad PR, the current landscape and architecture of the media’s distribution machine is literally single handledly supporting Trumps bid- Clicks mean revenue for the media- when we stop clicking on Trump related content – he will go away. If we continue to click, he will continue to gain momentum and sadly while most people can’t fathom him in the White house just remind yourself that “Wubya” was voted in TWICE.

Two sectors that will be in the news almost every day I think will be the most obvious ones as they are already there now. Energy will be a huge suckfest for most of 2016, price wars are not fun and even less fun when you are a small competitor going up against a deep-pocketed monstrosity of an army. I’m not just talking about Saudi Arabia here, Im also talking about the large Oil players, the likes of BP, Exxon etc etc. these guys have every incentive in the world to assist Saudi in driving out the small oil shale players and picking up the pieces when the blood is literally scattered all over the floor.

We are not there yet – I think we are one or three quarters away from seeing some decent casualties and my thoughts will not be on the spot oil price but I would rather see downward movement further out the curve to really put pressure on the small players. The inability to hedge 1-2 yrs out will seriously affect the cash flows of these companies, coupled with repayments due on A LOT OF BONDS and you see why all the big cash rich oil companies have to do is sit and wait and pick up these companies for pennies in the dollar. Big oil companies do not like to invest in their own infrastructure, and even less likely to do so when oil is trading sub $50, therefore it seems much easier to grow through acquisition and when better to make those acquisitions than when the industry is in disarray and you are sitting on a pile of cash. (See what Warren Buffet did with both BAML and GS back during the financial crisis)

We are already seeing in the resources sector capital raising (Glencore) and dividend cutting AAL & potentially BHP. This is for two reasons either A: Shore up a balance sheet, or B: to make acquisitions. I will be happy to call a low in the SXEP or energy sector in general when I see an audacious play by one of the big oil names, if even one of them cuts their dividend to finance an acquisition then it will be the beginning of the end so to speak.

The other sector will be biotech. Biotech has probably been the major benefactor of the easy money policy over last few years and dare I say certainly looked like a sector in bubble territory. This has been the classic momentum trade over the last few years and like anything that has attracted large amounts of investment dollars so too has it attracted large amounts of scoundrels and “innovative” ways of making money.

We have already encountered two high profile cases, one large scale scandal with Valent and some questionable business practises (which remain to be fully investigated etc ) and another smaller one in a certain Martin Shrkeli, who has recently been accused of some dodgy practises also. In my humble opinion this is down to one thing and one thing only, a sector that has attracted so much $$$ is now seeing mission creep. Biotech is a sector that is supposed to advance society’s needs and make people a ton of money in the process. It does not need to have companies run by hedge fund managers. I think you will see a lot more dirty linen been aired and scrutiny on the sector from political, legal and regulatory officials which will knock the wind from investors sails for the time being until things have been cleaned up a bit.

Technology I think will continue to steam roll, not sure you will see the lofty valuations for IPO’s or VC funded deals as we have over the last two years. FB has dominated the social media space to the point that a credible competitor in TWTR is really struggling to innovate and come up with something meaningful to distinguish itself. FB holds the power in this space, what was once a very dynamic and ever changing niche is starting to look like all things Facebook at the moment- see the most recent mobile app for LNKD and you will see what I mean- almost an exact replica.

NFLX is in a great spot I think and as long as can still fund and create organic content like house of cards, OITNB etc etc then will remain like a gym subscription for most people, either you use it every day and get way more than your money’s worth or you use it occasionally when it’s raining outside. Certainly if they get into streaming live sports then this could be a very dominant company.

Apple, Amazon, google etc will all continue to be dominant in their relevant niche(s) and make some serious bank which they can either return to shareholders or dangle in front of them threatening acquisitions and inorganic growth either way you are going to have to come up with a very special product to knock these guys from the top spot. Apple in particular is receiving some attention from naysayers specifically about the I-watch.

There is literally no point in listening to the opinion of someone over the age of thirty as to whether the I-watch is a good idea or not. Apple are designing products for the future and could care less what a +30 yr old thinks of their watch. They care what a 16 yr old thinks about the watch. So in short when it comes to the tech space- your opinion is worthless if you are old like me, ask someone younger, much younger.

The rise of ETF’s will probably continue and with it stupid acronyms like FANG, BAGEL etc, hopefully someone will create one called HAVESOMERESPECTFORYOURSELFANDSTOPCREATINGSTUPIDACRONYMSFORCOLLECTIVE INVESTMENTSCHEMES…….. might be a bit long though. ETF’s are a financial product like anything else, they do not mitigate risk at all, the liquidity is determined by the liquidity of the underlying products.

Do your homework on them but as I think with nearly any financial product they are as dangerous and as safe wholly down to the people holding them. If they continuously get pushed down the throats of retail traders or causal investors then yes at some point we will have a problem.  I always say that when people dabble in the stock market then it is akin to me trying to wire up my house, it would probably be safer for all involved if I just called an electrician.

 

What might Commodities look like?

As per above you probably already guessed my view on commodities for 2016, in short I continue to expect weakness in oil with some severe snap backs in price. We have a situation where speculators are short and commercials are long. Speculators are aligned with the desires of the power brokers of the industry i.e the Saudis and big oil.

The commercials, specifically small mid cap US shale players are long and wrong (by design) and struggling to breathe. However when speculators are short in decent size it always leads to horrible snap backs in the price, remember speculators need to produce monthly returns and therefore subject to profit taking at given moments. I will be watching the longer end of the curve to see downward movement there at a faster rate than spot to see when things are really pinching and that will be my hat tip to when things are looking like a recovery is due. If I were to play pin the tail on the donkey I would say getting long end of Q2/Q3 wouldn’t be the worst idea but that is pure magic 8 ball type thinking.

In the metals arena I will stop at saying for gold and silver, who cares? I never have and never will see the attraction of investing in them. Also I believe in moderate USD strength. If you believe that FIAT money or paper money has no intrinsic value, then I don’t understand why you think Gold has any intrinsic value. It’s just a shiny lump of metal, it only has value because someone else says it does, much like paper currency. If Armageddon ever happens having all the gold in the world will not help you. I will not accept your bars of gold for my food and water, and finally if gold is such a good investment why is it that goldbugs are always at pains to try and sell it to you??!

Copper, platinum and iron ore I think might stage a very modest recovery over the course of 2016 but I don’t think it will be all that significant. China have built a lot over the last few years, I think their agenda is to now fill that space before they go ahead and do it all over again and I can’t think of another country in the world that has the financial resources, demand or frankly their shit together to embark on a massive infrastructure spend to support global metals industry again. In saying that some of the steel supplies look uber cheap, if you are a balance sheet guru and don’t think these guys are going bankrupt then they look attractive on a longer term basis.

In the Ags space I have little value to offer apart from there is always natural supply and demand for so it’s more of a traders market, buy when prices are low and sell when they are high, easy really.

 

What might FX look like?

In simple terms I don’t think that next year will look all too different from the latter half of this year. I believe in moderate USD strength, a split camp between further rate rises and less rates rises will keep the DXY trading in a range around the 100 level. We have seen a roughly +20% rally in the USD since QE ended and now that rates have risen a whopping 25bps eventually I think that things will calm for a while and we are not likely to see any huge dollar rallies. That will help stabilise matters for a while in emerging market currencies.

It remains to be seen if Draghi wants to step on the gas with QE and further devalue the Euro, I don’t think he will, for the simple fact that he has already been very effective, don’t forget the euro has dropped from 1.40 in about a year and a half and bond yields are frighteningly low in Europe, so on the two most important factors Draghi is a success.

Inflation is stubborn but largely due to oil prices, Im willing to give him benefit of doubt and say he has done a marvellous job of creating conditions for Europe to prosper, we just need the political structures in place to be as dynamic and responsive and we might actually stand a chance! Also as I referred to before with Kuroda, no point in spitting out bullets on QE when oil is wreaking havoc on inflation, things will settle over the next two quarters and then you stand a better chance of your actions having an impact.

I would think we see one more rate rise next year in the US, more likely in H2 and more likely to the latter half of H2. What will be an interesting cross to trade will be GBPUSD. For now you should expect weakness in GBP but it remains to be seen if Carney will follow the FED, I don’t think he will for a few more quarters to be honest but I think it will be newsworthy stuff for the foreseeable and therefore a trader’s friend.

 

What might Volatility look like?

Due to innovations in financial products volatility can be seen as an asset class in its own right now. Be long it not short it, shorting vol is sooooo last year. But if you want to learn how to trade, then this is the asset class for you. Volatility by its nature is “whippy” unless you can dedicate your time to timing and getting and getting out at right time, then step away from this space, its not for you and you are fighting the pros who have much bigger resources and smarts than you do. Just accept it and move on.

 

What might Credit look like?

Ugh, tough one, Im tempted to say it’s a bubble blah blah but that’s too easy and I am far from a credit expert. Bonds in general have been the pension fund managers friend for the last thirty years, there is so much money out there with a clear mandate to invest in bonds that it makes it difficult for me to believe to they will crash, burst or whatever Armageddon scenarios some have painted for that market. It will take a structural change in markets for investors to switch their mandates from investing primarily in bonds to other alternative assets (which is occurring, but ever so slowly and not even a fraction of the wealth that is managed through bonds).  If we see some inflation next year then yes there might start to be some rotation, but if your view is that inflation will be steady or even declining then don’t panic.

In short this is what you will most likely see:

Government bonds of states involved in QE will remain bid with intermittent stages of panic approaching important meetings, QE looks to be staying for a while in EU and Japan so there is no reason to assume a major reversal of yields in these areas.

US Treasury yields may rise a little, they have gone nowhere this year, and the US ten year so far has reacted like an uninterested French man so far to the rate rise. With inflation in the toilet owing to energy prices it will be a case of if US investors feel that low oil prices will lead to a consumer boom such that is enough to counteract the deflative powers of low oil prices, which I feel the jury is still out on.

High yield credit has already gone through something of a reversal of late, owing to a bit of panic recently over liquidity issues. This will provide opportunities for high yield investors if continues, which If you feel that there will be weakness in stock markets may just prove to be the case. Much like my thoughts on the US stock markets this will give rise to opportunities in the high yield space for those with a calm head and deep pockets.

 

If you stuck with me all the way to the end then your reward will be that this blog goes on no longer, you will also be one of the very few people who actually read an article in its entirety, another side-effect of the media bombardment these days, but that’s a whole other blog post ……………

 

Happy Holidays and good luck in 2016

 

Jeff

 

 

 

 

 

 

 

 

 

 

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Volatility- The punishment for Group-Think

If you can keep your head when all about you are losing theirs…….
Rudyard Kipling
Not only is IF by Rudyard Kipling a great set of words to have in the back of your head but it can also prove worthy in financial markets. Volatility is what causes men and women around the world to lose their minds, it is the manifestation of fear being played out in front of you like a particularly gruesome Quentin Tarantino scene.
People like to think they can control their environment, most people are process driven and tend to fall into routine very easily and with that brings comfort. Calmness is comfort.
When volatility strikes there is a disruption to this environment and things tend to morph from black and white to 50 shades of gray (sorry couldn’t resist). It is within this environment that fortunes are made and lost in financial markets.
When markets go through a period of intense volatility, like we have recently in the equity world particularly, it essentially creates an environment of risk transfer. It is the punishment for group-think. Risk gets transferred from the weak to strong, or from the sheep to the wolves.
Most good investors (wolves) will relish periods of high volatility as it creates an environment of rich pickings to enter investments on better terms than they could the day before. If they pick their opportunities correctly they know that the current environment will not last long, i.e. investors move from calm to fear and back again in relatively regular cycles.
Most bad investors or willing participants in Group-think (sheep) will hate periods of high volatility as it creates a stressful environment that they are not in control of anymore, or rather it is in control of them.  They will actively engage in this volatility and actually in an ironic twist serve to increase it by shedding risk or cutting positions. The shedding of this risk is designed to put them back into their comfort zone, and will only stop when they have achieved this. In the meantime they have just transferred all their risk to the wolf , on the wolf’s terms not theirs.
I like volatility as it creates this process of risk transfer and changes the status quo. Group-think is often manifested in markets as an accumulation of investors in similar positions/ assets. the benefit of this is often great comfort to the investor, ” I must be right, if everyone else thinks so” and so over time this permeates more and more. Volatility punishes this attitude with relatively swift precision.
For the last few years equity markets have grinded higher and higher, all the while I have barely heard a positive word spoken about the rally, Investors moaning about the action of the FED causing a bubble in this, that and the other. Investors bemoaning the ZIRP of the FED, that it causes distortions and not leaving any room for further monetary policy actions. However despite all this moaning and push back, investors have generally been long equities or mainly assets that are prone to move higher in price with inflation, and as the saying goes ” don’t fight the FED”
This group-think has just been punished. the FED stopped QE nearly a year ago, and is on course for a rate rise sometime in the next few months, the global economy is experiencing much lower inflation than desired (mainly due to oil prices) so one by one assets that have been the pro inflation trade are crumbling, first gold. then oil, property prices seem to be stalling in some major economies or at least not rising with the same wreckless abandon for the last few years.
Those in concentrated risk positions just got punished, those who embraced the volatility and picked their opportunities will benefit in the medium to long term.
Below is a chart of the VVIX index, this is a measure of the VOLATILITY OF VOLATILITY , i.e. not only do we measure the volatility of asset prices, but we measure how volatile this volatility is!!! I think its a great indicator of where investors head are at.
As you will see from the rough line I drew horizontally across the chart we are currently in fairly unchartered territory. What this means is that the previous two weeks has seen the most amount of volatility (and remember that brings risk transfer) that we have seen since this index was created, and considering what has gone on over the last eight years that is saying something.
vvix
However despite this extreme volatility, see how, when we do experience these spikes, they always settle back down to a more normal or average level, you could call this mean-reversion if you want. I like to think of it as risk transfer, or Darwinian-esque. The strong hands came in a settled the market from the weak hands, those who embraced volatility versus those who ran from it played out.
To sum up, it is not volatility that scares good investors, its the opposite – calmness. Calmness indicates you are with the herd, and while that can be comforting at times, it ultimately leads to some very scary moments and dealings with wolves.
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Risk off / Risk on

Often in the media you will hear the term Risk off or Risk on. Its more likely you will hear the term Risk off as financial media revel in the days where markets or risk assets go down in value and attempt to create as much sensationalism as possible to garner attention.

There was a time where during the financial crisis as the markets both tumbled and rallied each day with wreckless abandon that as a trading desk we were calling ” risk on ” ” risk off ” almost every hour.

The terms risk on and risk off relate to a portion of time in markets where investors are keen to either push their positions or the exact opposite and cut them. They are usually obvious in nature as markets become ” fast” or rapid price changes of a directional nature.

Here is where I get particular about the definition of risk off though. Risk off does not assume that investors just dump all risky assets and fly to safe assets. This often gets misconstrued in the media.

Global markets are made up of hundreds and thousands of investors, some very big and some very small. Everyone has different styles, risk tolerances, approaches, favourite asset classes and mandates for investing. What they do have in common though is that they all have risk of some sort. Positions to be more exact. They are either long or short an asset. Generally there is a long bias in the market for many reasons that I wont go into now but the important fact is that all these investors have money at stake in some shape or form.

Over time the collection of these positions will drift in price higher or lower and at some point cause a tipping point where there are too many over invested or under invested. This will generally lead to a reversal of fortunes good or bad for that asset.

When things get volatile like they have recently, investors are forced to consider the nature of their positions, some will be happy and do nothing, some may want to add to their positions but most will get caught up and look to de-risk and reduce their exposure.

Risk off is this process, it is the reduction of an investors exposure to the particular risk they are in.

That may sound general but please focus on the ” risk they are in”.  It is not an automatic move to buy less risky assets, if anything that would increase their risk as they are taking more risk on board.  It is a reduction of  the risk/ trades that investors are in.

This is always the most interesting part of markets as Warren  Buffet says ” it is only when the tide goes out you see who is swimming naked.”  Or to put it another way it becomes plainly obvious where investors have concentrated their risk exposure when things start to go against them.

It was noteworthy that a few days ago this exact situation happened. We just experienced a bona fide “risk-off ” situation where investors rushed to reduce their exposure to equities in particular. But while the equity market was causing all the excitement and carnage a few other assets were also giving a huge hat tip as to how people are/ were positioned.

Example one: EURUSD – The euro rallied VS the dollar: Traditionally the USD has been thought of as a safe haven currency- in times of strife, people move to cash and sit out in the USD as it still is the most used currency in the world. One would expect a large USD rally in such a panic situation then, however the absolute opposite happened. Why is this? There has been a large build of of investors who are already long dollars and more importantly short Euros. Therefore when everyone moves at once to reduce their own individual risk they are looking to sell their USD or cover their Euros.

Example 2: Oil rallied- Buying a commodity in a risk off situation in the past would lead to a one way ticket to bankrputcy as these are often considered the riskiest of assets. However the poor performance of oil over the last year or so has led to a build up of short positions. Again that means alot of individuals risk is in SHORT OIL. So a risk off move materialises in oil rallying.

There would be a myriad of examples in the equity markets of late whereby stocks that you would think are total dogs ended up rallying or at least out performing the quality names, again this is the same principle, the majority of investors would be short the ” dogs” and long the ” star performers” so much as they love/hate their risk, any move to reduce these risks will leave quite a few scratching their head.

In summary Risk off is a confusing time for the best of us, but if you can rise above the noise and look for clues that the market gives it will give you valuable insight into where investors are positioned across the markets. Also if you happen to be invested in something it is always good to assess where you think the broader market is positioned in your investment. If you feel they are with you then this can be a good thing but in times of risk off it should trigger a warning that you need to have a very itchy trigger finger to avoid the mess.

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Blame Game

The search for a scapegoat is the easiest of all hunting expeditions.

Dwight D . Eisenhower

After the two weeks we have just had in global markets the hunt for a scapegoat and someone to blame for the plunging of equity markets around the world has been a fertile area. Most have pointed the finger in China’s direction. The usual suspects have pointed the finger at the FED and of course the second plunge in oil has raised a lot of questions also.

Ideally when things go wrong we like to appoint blame to someone else to shift the weight of guilt or blame off our shoulders, it much easier and comforting to believe that someone else has inflicted this on you instead of analyzing your own role to play in the situation.

Equity markets didn’t just collapse circa 10-15% because of one factor, rather it is the accumulation of many factors built up over time that has led to a viscous snap back in prices. Investors around the globe needed a shake up. For five years we have complained and complained ad naseum about the role of centralized planning and QE induced rally. At times it has felt like a zombie market as it just continued to grind higher as everyone repeated the mantra “Dont fight the FED, Dont fight the FED, Dont fight the FED.”

Well the FED stopped buying assets some time ago – nearly a year now, they have kept interest rates low throughout this period. So if it was a FED induced rally then yes you would expect when the punch gets removed for everyone to start coming off the buzz and start to feel the hangover effects. THIS IS A GOOD THING.

Markets are hopefully getting back to a normal footing whereby prices rise and fall based on normal supply and demand conditions from informed investors. We are not there yet, it takes a while to ween the patient off this mentality. For five years now the FED has made most investors lives very easy, very simply they have pushed you into riskier assets in the hope to stir animal spirits and create inflation and growth.

You can argue over the effectiveness of their strategy all you like, but at the heart of it underlies the assumption that the FED manipulated the market higher. If this is the case as it was the same argument five years ago then who is to blame? The FED or the investors. The FED set out its agenda, it was then up to you what you wanted to do with this information.

If your decision was to shift into historically risky assets to align yourself with the FED’s policy then that is your decision to do so. But to do so blindly and ignoring the inherent risk in doing so is almost certainly your fault. The argument that ” a bigger boy made me do it rarely washes in the schoolyard let alone financial markets. You made that choice and you acted on that choice, now that you are experiencing pain it is not the FED’s fault, it is your fault.

All through this period of equity markets rallying across the globe has been through a period of soft data – the only real growth consistent winner in terms of data has been US employment rate which has got down to a lot more healthier 5.3% although the participation rate certainly calls these figures into question. GDP growth has been muted to declining in most parts of the world, inflation has fallen in most things (ex-real estate).

Investors around the world have abandoned previous risk parameters in the hunt for a safe yield. The same investors that were so spoilt with a robust bond market rally for the last thirty years have become so accustomed to simply investing money and picking up a safe guaranteed return that the rise of alternative investments is no coincidence. Starved of the traditional return from government bonds these investors have scoured the globe causing mini bubbles in assets in their wake as they feel can replicate the returns of a bond.

This is where we go full circle in the blame game, these people can only do this as they are cash rich and can borrow money for ALOT less than the likes of you and I. This is of course enabled by guess who ….the FED. The cash reserves built up at the FED from the major US investment and retail banks as I referred to in a previous post underlies that it is not the banks causing this asset price inflation directly.

excess reserves

The FED ZIRP policy allows big balance sheet investors who are often cash rich already to borrow for very little and invest in assets that provide a yield. As long as those assets are yielding at least on paper in excess of say 5% then its a no brainer in this current environment.

Now when you take this concept and apply it to equity markets who can provide either a yield, capital gain or in an ideal world both its an obvious place for these funds to look to boost returns. I cant stake the validity of the chart below but look at the growth of Hedge fund AUM since ’08. A roughly 85% growth in AUM over a 7 year time period is reflective of investments activity leaving the banking industry and just converting to the Asset management industry.

hedgefundAUM

*source http://www.barclayhedge.com/

This industry’s purpose is to create a return, some will be successful and some will not but that is an awful lot of growth in an industry whereby your job is to invest and put capital to work, especially if you are often constrained in where you can put that money to work.

This leads to an inevitable overcrowding into positions. the famous ” buy the dip” or BTFD mentality has not come from the FED, it has come from the titanic amount of money that needs to “go to work” in this industry. When you get overcrowding in positions it is only a matter of time when you are eventually going to get a snap back or reaction like we have had recently. Investment funds spend a varying amount of time deciding on how to get INTO  a position depending on their mandate and style, however it almost always looks something like this when they decide to get OUT of said position.

exitstrategy.jpg

We are in an era of cheap money, and even if the FED raise interest rates to 1-2% over the next year or two we are still in an era of historically cheap money. What investors and people choose to do with that is their decision but if and when it goes wrong dont go pointing the finger but rather give yourself the same criticism on the way down as praise on the way up.

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