Take one.- On life and change
I got it. We are short of sex, drugs and rock and roll yet again. And we want to laugh, or at least smile, as well. My posts are only about problems and quandaries. Things are certainly not looking good -but who needs a pessimist to remind us? After all we should not forget we are human beings. As Mark Twain said, “denial (sounds like but) is not a river in Egypt”. It is a behavioural pattern embedded in the human standard ADN. And partnering our life with it won’t make us happy -if we live a time of change.
But denial is always the initial reaction to any perceived problem. Society lives in denial right now. The good times will come back. Debt will be repaid. I will buy a third car again, as soon as this is over. My readers are yelling at me: “I promise I will read you again, but please, please tell me everything is going to be OK. I desperately need some hope”.
I will try hard. But the times they are a-changing. I can’t change that. Nobody can (not even omnipotent central bankers). So what if we change horses, sacrifice “denial”, and ride “Audacity” or “Intrepid”. They are beautiful horses, even if somewhat brisk. What if we look at the future challenges as an adventure. What if we pull ourselves together and just relax. It’s hardly the first time humanity confronts serious change.
As Von Mises (not me) clearly stated more than sixty years ago, there is no way out of a credit expansion. The only alternative is whether we take the bitter medicine now or later. And yes, I know, later is always the preferred option. Not mine: I’d rather get done with it. There will be a bright future, but only if we do our homework first. Isn’t that what we tell our kids at home?
Be careful with indefinite postponement. The lyrics of Bob Dylan are hard to ameliorate. This song was written in 1963! It is a masterpiece. Superb. If somebody was able to write this, it surely is a reason to be optimistic. Unfortunately it does not offer an alternative to change. It just says: do not obstruct it. Go with the flow.
Come gather ’round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You’ll be drenched to the bone.
If your time to you
Is worth savin’
Then you better start swimmin’
Or you’ll sink like a stone
For the times they are a-changin’.
Come senators, congressmen
Please heed the call
Don’t stand in the doorway
Don’t block up the hall
For he that gets hurt
Will be he who has stalled
There’s a battle outside
And it is ragin’.
It’ll soon shake your windows
And rattle your walls
For the times they are a-changin’.
The line it is drawn
The curse it is cast
The slow one now
Will later be fast
As the present now
Will later be past
Your old road is
And the first one now
Will later be last
For the times they are a-changin’.
Things are changing, and it will be a hefty change. That is a fact. What if we try to adapt and survive? Melancholy and ecstasy are very seductive, but hardly practical. We’ve done what we’ve done, and now it’s time to clean up the mess.
Take two.- The currency parity arena. Star Wars update by your war correspondent.
Markets implemented super Mario’s request for a lower EURUSD rate asap. New parity is around 1,2600 (give or take a round figure). Pushing the euro down was the agreed route forward -but not that fast. Currency appreciation is de facto tightening monetary policy in the US. It gives them time to postpone interest rate hikes, but it also generates legitimate concern. On the European side: too much of a good thing is a bad outcome after all. Memories of the 2012 euro crisis are still vivid. It took the “whatever it takes” wording by Dragui, to turn it around. Germans are particularly uneasy with press comments on the depreciation of the euro.
So I think it’s time for a break in the trade. I booked profits on 50% of my EURUSD shorts. The nearly-free ride is over for the time being. Yeah it was a good trade. Bias is still bearish, but risks are more balanced. We have to lighten up and wait (with a more moderate downward bias). A bounce all the way to 1,29 is likely. Still short, and will likely add again to my shorts, but not before taking some time to digest the new levels and take a good look around. Parity could easily be the final outcome, but we should not put the cart before the horse. The euro is in a deflationary environment and has a commercial surplus. That speaks for a stronger euro. The periphery is well past bankruptcy but that was also the case in Japan, and it didn’t prevent the yen from achieving an 80 yen per dollar quote.
Still short big time in EURCHF. Too small a profit to take in here. We are up only one per cent since may, because the SNB did not help at all. So I will stay pat with my shorts (CHF longs). Maybe it’s just because I like the Swiss people, and Jordan and I are close friends (I’m kidding on the Jordan friendship of course). Realistically, I think the next euro depreciation tranche is going to be too much for the SNB. They increased their currency reserves by 10 billion last month. Unsustainable, no matter what he or his lieutenant want to say. Their moral reasoning is not as strong as it was in 2012. They are “begging their neighbours” up to 10% of their GDP, and still intervening the currency (increasing the balance sheet and selling gold against foreign currency reserves).
Why the rest allow them to do so is increasingly suspect to me. Maybe the top officials in other countries have some interests in the Swiss banking system as well. They Swiss economy is small enough to get away with it (see why small is beautiful?). Next year’s award to the top currency manipulator goes to them (I’ve been told). The Chinese do not manipulate half as much (in relative terms) and they get all the bad publicity. Next chart shows what I mean.
The Riskbank took some lessons from the SNB a couple of months ago. They are a very open economy (50% of their output is exports, and 70% of the exports go to the EU), and love to tap European aggregate demand. So they brought their parity back to 2008 levels. Amazing tactics. The ECB needs a war “consigliere” or “sotocappo” asap. Sicilian headhunters have various candidates. We are a lame duck in the currency war. Everybody is taking shots at us.
I think the EURSEK is a strong short as well. But be alert because fx intervention is now done in a different way. It is a stealth intervention. They come in and out of the market and try to induce some volatility to decrease the VaR tolerance by speculators betting on their currency appreciation. It ought to be a criminal conduct, but they write the laws that suit them. Meanwhile the ECB stares like a deer in a spotlight, and still rejoices in “whatever it takes”. Talk of living in the past.
Last of all, let’s review the mother of all currency crosses today; the USDJPY. You want to be “long only” here. It is true that a risk off scenario can sink the price all the way down to 102. But that is your worst case scenario, and most likely 105 would be the new support area. The upside is preposterous. 120 could come in a matter of weeks, any minute, anytime. You cannot be a structural short there. You can trade or scalp the short side, but your macro options are either long, or stand aside.
Sizing the fx trade should take into consideration not only actual volatility, but the risk of a surge in volatility in difficult times. Very risky trade (much more than VaR readings would imply), but there is serious money to be made if you play the long side. The point of entry is always tough to say. If I knew, I would be buying a better racing yacht (and I am not).
Take three.- On equities and bubbles.
I love the simplicity and readiness with which we adopt euphemisms. You can name everything with anything but its real name. The last euphemism is that markets are only living a “growth scare”. As if anybody in the global equity or currency markets was concerned about growth. They couldn’t care less. Profit growth and financial and geopolitical stability worry equity investors. Growth doesn’t. At least not directly. Why is volatility surging?
The underlying grievance with growth is debt sustainability. Financial stability requires everybody to be fully convinced that debt will be repaid. Low inflation (or outright deflation) combined with low growth, sparks some serious doubts on the sustainability of debt. The real scare is debt sustainability. The common knowledge game foundations are faltering. Even herds take only so much gibberish. Stay tuned on that.
To make things worse, money printers are having some unexpected problems. Their continuity at the task is being compromised. Now, that is a scare! Our beloved leaders are terrified.
In the US QE is out for good, and there is really no way back to money printing from the end of this month onwards. In Europe the Germans are saying “nein” to QE, and we should be aware of the implications. If Dragui forces their hand, they might opt out as soon as their banks can handle the situation. They would be better off on their own. AfD (a German political party) reminds them every day.
In China credit concerns have soared (just look at the side chart), and sustaining a stop and go policy of liquidity showers every now and then is becoming implausible. So much for additional significant chinese credit expansion. Don´t count on it.
And then there is the Japanese issue. The main concern for money printers and followers. They cannot continue printing if the yen does not recover its stability. JPY weakness is a serious constraint for top money printer Mr. Kuroda. Watch the USDJPY.
By now, I think nearly everybody with an IQ above 90, understands that money printing and debt sustainability are the name of the game. Both pillars are wavering. So a rerating of equities is inevitable, unless those two factors (or at least one of them) regain some solid footing. You want to short or stand aside equities until the model reaffirms itself (or self-destroys on the said developments).
And yes, there is career risk to account for. As a professional portfolio manager I would be scared to death. But remember career risk works both ways; there is also career risk if you stay in the market. Remember the lyrics of the song: “the loser now will be later to win”. It’s tough on the fund manager. Damn if he quits playing, damn if he follows the herd. I said we should try to time the top. And consequently I have been implementing a medium sized short over the last few weeks. I plan to stick to it with a conceptual stop loss at previous market highs maximum (in some cases it has to be tighter for risk management reasons). I would like to go all in, but POMO desks can be nasty and will use Hong Kong police methods against us speculators and permabears. So I will keep it medium size.
Take four.- The last of the “Keynesians”
When the medicine doesn’t work, why not try more; surely it must be a problem with the dosage. Albert Einstein would assuredly qualify good old Larry Summers (the quintessential establishment lobbyist) and his FT article, as insane. Krugman is very upset because he feels he deserves the honours as the undisputable “uber keynesian maximus” (and he is jealous).
Larry stole the spotlight from him. He is economically insane. Most academic women in the USA would agree. It is comforting to remember that in a keynote speech at a conference on diversity, Summers hypothesized that the shortage of women in certain disciplines could be explained by innate differences in mathematical ability. In this world we live in, there is lies, damn lies, and statistics, and correlation is not causation. You can’t just read a statistic and hurriedly generate outsized categorical conclusions. And who is Larry Summers to validate or endorse criteria in an area of science outside his know how. Our daughters will be bossing our male children around soon. Just see this chart.
Maybe this background can justify (but hardly explain) his latest “insight”. He emphatically suggests that more fiscal spending in infrastructure with constant tax parameters (a.k.a. “greater fiscal deficits and more public debt”) is literally a “free lunch” (FT october 6th 2014). Witches and dragons I may still believe in. ¿But “free lunches”? Some Keynesians are going hyperbolic. When hallucination and frequent mirages make their appearance, the end must be near. ¿Free lunches? ¿Or do our children pay for them? ¿Or is he really suggesting that nobody is going to pay that incremental debt?
Lost the last slate left, so no more takes on this drama. Next week I will come back on the new tax structure we need. My advice in the meantime: listen to Dylan and remain short/flat the euro and the equity market. Short term tactical longs in some bonds, but no credit risk at all, and duration-wise keep on your toes. Careful longs in the dollar yen pair. Safe cash is an excellent choice. Just make sure it is really safe (try to scratch underneath the surface). You want to be financially alive when this is finished. Bargain hunting will be a great sport then (and you need the cash for that).