I got stopped out of my S&P 500 shorts -once again. Total costs of trying to short the market are mounting (3 to 4% of my portfolio over the last year), and the sequence of stopped out trades is testing the limits of my resilience. But my conviction is as high as it has ever been. I’m “bruised and battered” but, unlike Bruce Springsteen, I know how I feel, recognize myself fully, but want to stay the course. Undeniably hardheaded and stubborn, this is not an example of being unable to see the complexity, or the other side of the trade. I understand the bullish arguments embedded in the common knowledge game we are playing. And I sure know timing is tough because they don’t ring bells at tops -and this mother-of-all-bubbles is no exception.
In order to fish, you have to deplete your sardine stocks on board. Particularly if you are fishing for bluefin tuna. To balance things out, the expected reward tastes sweet. On top of the shot of high octane adrenaline, one catch can be enough for the day -if you are a small fishing boat. Financially I am a small boat, and the big short can save the year (and the decade) for me. Smaller drawdowns are conceivable with easier trades, but there is not that many available with the same degree of conviction and decent potentiality.
When we look back in ten years’ time (if we are alive), the trade will be seen as “glaringly obvious”. The timing is not. It never is. It’s tough enough to fine tune a top or a bottom, but in a rigged, herd driven market, it is almost impossible to get it right from scratch. At the very least you need to spend some money in various attempts. And that does not guarantee your success. See what the people in Saxo Bank have to say about shorting the equity market. Hardly encouraging. It shows just how distorted markets have been over the last decades. The past testifies to how unfrequent and short bear markets are. Optimists say this can go on forever. I will just add ¡Amen!
Stealth POMO desk interventions.-
I’ve already talked about this in the past (see how manipulation is evident in “what about some sex?“). It has been a long time since Central Banks decided to go for covert intervention. FOMC days are great for that. Coinciding with the press conference, they launch whatever strategy suits them best, pierce stop levels, and create the perception that market participants have valued the policy news in the way they want them to. The get a great bang for their buck. Stop levels help them make money, alter charts and technical levels and retracements, and set up a behavioural pattern in brainless inverstors and their brokerage and bank cheerleaders. Behavioural patterns are the way to conduct the herd to the right place: complacency.
I find it extraordinary that on a FOMC day (march 18th), in which in fact the word “patience” was weeded out of the communiqué, a triple Central Bank desired move in bonds, equities and the USD was generated. And the reasoning for the move, is the reduction of the “dot plot level” and the expectations implied. Amazing. Didn’t we all know the US economy had been falling off a cliff over the last two to three months? ¿Was that really “news”? See the new dots as summarized via the daily shot.
Or maybe not that amazing. As Mark St Cyr (via Zero Hedge) explains:
“It’s one thing for the perceived “risk off” or “safety trade” of bonds to display some strength during an equity market rally. Especially when that rally is held against a backdrop of deteriorating macro data. There’s always some divergent correlation for, or against, present within the markets regardless. However, to have both markets move (i.e., both meaning all; as in, across the board in both equities as well as long dated and short-term bonds) where everything rose in lockstep? That’s unsettling to say the least in my opinion. And the divergence in common sense price action didn’t stop there.“
In fact, I think the POMO desk in Manhattan only targeted the USD and bonds. I do not think they are trying to push up the equity indexes any more. Their problem is they can’t easily dissociate monetary messages and strategies that are dollar negative while engaging in equity neutral (or a touch bearish) equity announcements. They are clearly leaning against equity market further exuberance, but have to tame USD strength. As I have said before, a tightrope walker balancing act.
So we will have to wait for the aftereffects of this presumed stealth intervention (there is just no way to prove it) to simmer down. We need what the Fed discarded, patience, and the natural drivers for prices will move things back to place “as time goes by“. In the meantime we can enjoy the immortal song. As I write, I see the EURUSD countertrend reaction is not over. Speculative traders were caught short. So now we are squeezing the USD short squeezers. Take it easy and watch. We will have to wait.
Once the effects of this last intervention fade, the medium term scenario is unchanged.-
1.- The bias for a stronger dollar is still there. Nine trillion USD denominated bonds and loans outside the US are still haunting the USD. Unless you are a very short term trader, or have friends at POMO desks, steer clear of shorting the USD.
The US dollar remains the main currency of denomination for global trade, which results in a structural demand for dollar borrowing. And regardless of new flows, the outstanding stock has a major impact on financing conditions, as exchange rate and interest rate changes alter existing debt burdens. Here, the US dollar remains king, as more than $9 trillion in credit outstanding to non-banks outside the United States testifies; the euro is a distant second, at $2.3 trillion worth, mostly in the area’s bordering region. If so, a further US dollar appreciation, especially if coupled with a US monetary policy tightening, will, on balance, tend to tighten international financing conditions.
Clearly, preventing further USD appreciation seems to be in everybody’s interest. Coordinated stealth intervention might be here for some time. But unless the Fed engages in money printing again, the dollar will remain scarce, and the underlying structural problems in Europe and China will continue to stymie any stable solution for the GFC. Not that Japan or the US are a lot better off.
2.- The euro and the CNY are currencies to avoid. The euro is keen to be devalued (the ECB will bide its time in exchange for Fed favors), and long term fundamentals remain awful, but it is still oversold on a short term basis. The CNY is being manipulated by the PBOC to induce some volatility, with an inevitable downgrade in value in the medium term. For the first time their problems have been admitted by the ruling elite (daily shot)
3.- Buy JPY on valuation basis, but only if you are a Braveheart descendant, and in small size. Value matters, but it happens to be a very long term factor. On the other side, it is hardly comforting to buy the currency of a bankrupt country, just because it’s cheap.
4.- Only low credit risk bonds, and more of the corporate kind than sovereigns. Long bond duration only in the US and Australia, and then, with care. Wait for the debt meltdown, and try to pick up as much yield as you safely can. It might be a long wait, but deflation makes low yields bearable even if uninspiring.
5.- The SGD is the right currency to hold for a tranche of your portfolio. It is safe, and the yield curve is reasonable. The only risk is a continuation of the vicious short squeeze in the USD. If your portfolio is valued in euros, that risk is greatly diminished. The currency has improved its overvaluation substantially. It is still slightly expensive, but it probably deserves a price premium. It is a quality currency.
6.- The Riskbank board deserve a warm mention. I understand the kugmanite pressure on them -it surely doesn’t help when the Princeton sect engages in mob manipulation against you (insults included like labeling their policies as “monetary masochism” and similar “kind” comments) . But they should remember how Jordan and Danthine made fools of themselves. The Riskbank board is playing games that involve an ending close to that of drug addicts. It feels great to “beg your neighbor” because economic effects are seen immediately. But the long term prognosis is poor. They should ask the Fed, or the SNB, about the consequences of policies that paint them into a corner.
In the meantime they keep trying to push the SEK down harder for longer, with more words than facts. Lately they powered up their NIRP, and pushed forward the concept of QE as if it was comparable to that of the ECB (see chart). They are obviously trying to fool the herd.
Not that devaluing the SEK against the euro is unimportant to them. They are a very open economy indeed (Reuters chart). Maybe the 8 handle was too expensive to compete, but targeting nine fifty and above, is overdoing things.
Fortunately or unfortunately for them, this a healthy country (low debt, reasonable entitlements, good economic infrastructure) with a competitive exchange rate. A robust currency to park our savings in, with a medium term wealth preservation bias. No way I’m going to jump ship just because they want me to do so.
Timing-wise, we have to acknowledge that they have still got a lot more room to move than the SNB had in the final stages of their peg, but ultimately the actual intense currency price manipulation serves nobody well. I think the EURSEK pair is a strong sell (buying kronas) above 9.50, and a reasonable price expectation is nine even. We nearly got there a couple of days ago. We will visit that level again in all certainty. We shall use another chunk of the patience discarded by the FOMC.
7.- Last but not least, try to short the equity markets and particularly the S&P500.
Why are equities (and particularly US equities) a screaming short?
Remember the concept of valuation? It used to play a role, but that was before unlimited credit growth, QE and NIRP. Chasing value has not been a good idea over the last year, but I think buying value is the way to go, if we target survival post debt meltdown (whenever that takes place). The next chart sums up four valuation techniques. I feel no further comment is needed.
Zooming into Tobin’s Q.Finally let’s take a look at the herd’s favorite indicator, also courtesy of Doug Short. As he suggests, there is an obvious lack of correlation between trailing P/E and market performance. Who cares!
I will not even bother to comment on the Fed model. Using interest rates and ERP’s, or discounted cash flows that input them as a primary valuation vector, misses the value point. Value is a concept that cannot be arbitrarily subordinated to CB enforced, non Wicksellian market rates. The Fed model in fact prioritizes relative value. Great for the herd, but, right or wrong, I will stick to absolute value.
Euphoria is the name of the game in European Equities right now. I hope people are enjoying themselves. But look at the PE expansion over the last three years!Finished with the value overview. Let’s take a look at market and behavioral factors. First of all we have to acknowledge that “Long europe, and short the US is the trade of the year”. Perhaps. I don’t buy it. Wee what Bill Hester has to say about this. I quite agree with him.
2015 expected profit growth is nothing to get excited about. Downgrades have been “l’ordre du jour”. Sales growth is nonexistent in the US, and margin compression is finally present, after a decade moving in the opposite direction. See the downgrades in the chart, but don’t forget that equity markets have been listing new highs as the downgrades were taking place. The herd has gone bonkers. Do not place yourself between them and water -stampedes can be life endangering.Equity buy backs, round up the short term view. Corporates have proved their ability to be “excellent” timers doing this. They have bought everything they could lay their hands on over the last year or so. And they are paying with debt. Of course, just in case you didn’t notice, I am being openly sarcastic about their timing abilities.
We must not forget to talk about growth, the actual darling of most strategists and exuberant investors. When it comes to growth, you have to look at both the top line, and the bottom line. The top line does not look good this year, particularly for USD or CNY based companies. Europe and Japan should do well. But the medium term outlook does not have to be necessarily bad.
It is the bottom line that worries me. The one underneath labor costs, interest and tax expenses (net distributable profit). It is no secret that financial costs are a fraction of what they were. Cheap money won’t last forever, and the duration of an investment in US equities is up to around 50 years (Hussman did the math). Effective tax rates for listed companies have no other way to go but up. Sooner or later. Somebody has to pay for entitlements, and the population has run out of disposable wealth. Labor costs do not have a lot further to fall. Profit margins cannot continue to increase and peacefully coexist with stagnant salaries. All in all, I see mild negative growth in the bottom line of corporate America’s P&L account. Taxes, interest payments, and labor costs, are going to go all the way from tail winds to headwinds.
But everybody is betting it all on the Central Bank harmonized recovery. And in the meantime, equity buy backs, or equity investments, offer the illusion of wealth. Everybody feels there is a lot of risk out there, but is there any other alternative available? We have to be optimistic. Our Mount Olympus Central Bankers will enable perpetual prosperity, and endless NIRP. God save our central bankers.