“Can you tell me where my country lies?”
said the unifaun to his true love’s eyes.
“It lies with me!” cried the Queen of Maybe
– for her merchandise, he traded in his prize.
“Paper late!” cried a voice in the crowd.
“Old man dies!” The note he left was signed ‘Old Father Thames’
– it seems he’s drowned;
selling England by the pound.
Citizens of Hope & Glory,
Time goes by – it’s the ‘time of your life’.
Easy now, sit you down.
Chewing through your Wimpey dreams,
they eat without a sound;
digesting England by the pound…
I found the title of one of the early Genesis masterpieces particularly appropriate today. It was a long time ago, but I must have listened to the music at least a hundred times. Peter Gabriel, the unequivocally Brit lead singer and flutist, who was to leave the band months after the promotional tour, suggested the title and wrote the lyrics -as (nearly) always was the case. It is a metaphorically loaded lament on the destruction of the UK’s cultural heritage. At the time, the “enemy” was Americanization -but it could very well have been directed against Germanization or Europeanization nowadays. Colossal singing for the first two minutes, followed by impeccable, but somewhat aged, British-flavored homemade rock.
The “Brexit” referendum victory was hardly a smart vote. But it was a wise vote -even if entirely for the wrong reasons. Populism, Xenophobia, Class war, and tabloid supported nationalism implicit in headlines like “I beLeave in Britain”, are hardly desirable drivers for any vote, and those emotions were key to the outcome. Of course, if you are on the lookout for some evidence of voter wisdom, it pays to remember that famous Churchill quote about the main argument against democracy (a five-minute conversation with the average voter). That is what democracy has to offer, and it is not a prerogative of the UK voter. Look at your own country for more of the same. Democracy is one of our global problems. Up to now, nobody has come up with a palatable solution.
Some more pain is still to come, and the City has been placed in the proverbial spot between a rock and a hard place. But it was, nevertheless, a wise long-term vote. I can cite two basic motives (that most standard UK voters are not even aware of) to support the “wisdom” epithet.
In the first place, the EEC is a sinking ship, and the euro disaster that must take fault as the main cause for the inevitable shipwreck is undoubtedly not Britain’s responsibility. So, why should they tie themselves to the ship deck and go under for something they were not even a part of. The euro is a huge Ponzi scheme where exporters lend importers the money, in exchange for keeping the buying up. Everybody is happy in the short run, but layers of irredeemable debt accumulate, until the total bankruptcy of the system. You are better out of that as soon as possible. Yet it is understandable that it makes the rest of the players uneasy about their own exit before it crumbles. Still, you want to go before the vortex of the sinking ship sucks you down with it. It is not an act of cowardice, but rather an act of prudence.
Brits did not suggest the euro, and never wanted anything to do with it -or with the credit boom and the macro disequilibrium, it generated in the periphery. And they did not profit from it either. If anything Sterling’s PPP has always come up as expensive relative to the euro cross, for the last couple of years. That shows in their trade balance -showing a deficit not far from 5% of GDP in their trade with the rest of the Union. They not only refrained from begging any of their neighbors, but are being used by their neighbors as a convenient goods market (services, and particularly financial services, are another matter).
Decoupling and navigating away from the Eurozone is a wise financial move. The Club Med countries are a postponed bankruptcy (they were a basket case long before that anyway). It makes sense to move away, annoying as it must be for Germany -that would like others to share the problem of financing the subsidies in the south. Why should Brits cooperate? After all, it is Germany’s interest to maintain their export markets, and preclude an episode of abundant German Banks going under together with the periphery bust. Think Deutsche Bank.
What does bear mentioning, is the inevitable angst the move is bound to generate in the periphery, as soon as the fog clears. The vote is disastrous for the European periphery. If it weren’t for the stupidity of investors (unaware of the fact that the Eurozone southern countries are in fact the first prospective casualty of Brexit), and the ECB’s awesome manipulation of the Eurex sovereign bond contracts, the periphery’s sovereign risk premiums would be stratospheric right now. Sooner or later they will be, we just don’t know when.
Second, but also as a very important point, comes the fact that, as a country, Brits are becoming a smaller economic and social unit. If they can withstand the temptation to isolate as the island they geographically are, small will turn out to be beautiful. Supranational structures like the EEC are not only not accountable to citizens, and very expensive, but also very inconvenient because of their inflexibility in times of change. That doesn’t mean we should shun free trade, but it does mean that we do not need costly, rigid and inefficient international infrastructures to trade freely. Easy, multilateral trade agreements suffice.
Small, lean, and agile, are essential virtues for a society’s survival at the time of a fourth turning. Flies and most insects survived evolution, while all the Jurassic Park brontosaurus and other behemoths did not make it. Brexit is showing us the way forward: we have to split into smaller units, dismantle international infrastructures, deregulate internally, and play adaptation. More exits and country splits are sure to follow, disrupting markets as they take place, but guiding the world towards the inevitable future. We can try to prevent trade wars, and we must make sure we succeed at that, but allowing for smaller countries, and less rigid area rules, is necessary, and we should even favor the process.
The British itinerary describes the right course to sail, in spite of being adopted by most voters for the wrong reasons. That is the truth, however inconvenient for the establishment and “extend and pretenders” it may be. No, I am not a nationalist (flags and national anthems do not move me at all), but a country, corporate and institutional downsizer and deregulator. Unfortunately, I have to share the desire for spin-offs with nationalists -while remaining as distant as possible to the emotional components of their desires. I do not share nationalist sentiment at all, but I think we all have to exit plenty more country and supranational regulatory overhead. We need small and efficient political and economic units that trade between equals on the basis of coordination and not large supranational costly overheads that use subordination to move forward. I am fed up with Juncker. Hierarchical structures belong to the previous centuries.
The Brexit vote will end up being proved wise for Britain, but only when the waters calm down -after the turbulence of the first two years. Still, it is a serious drawback for the developed world. The demographics of the vote are daunting. Social class, age and education characteristics showed up as a clear cohesive pattern on both sides. It is an obvious breach of the social contract in developed economies. And it is not just a local affair. We have the same underlying pathology elsewhere.
Economic inequality is atrocious on a planetary scale. As one voter told The Guardian (hat tip Satyajit Das),”if you’ve got the money you vote in (Bremain) …if you don’t you vote out (Brexit)” Class warfare has just begun, and it will get nastier if we persist in this inequality generating business model. I find it crazy to continue blowing bubbles that only benefit the top 1% of the population while printing, “nirping”, and allowing for a debt build-up to pay for entitlements to the disenfranchised.
So we can see that the social consequences of this vote are dire. Other have-nots in different countries have made a note of this, and we shall soon see them follow up in various ways throughout the developed world. To make matters worse, the Chinese population is also uneasy underneath the surface. Inequality has created a social, time ticking bomb.
What are the financial consequences of this vote?
A year ago I suggested that inequality might be one of the drivers of the always postponed financial reset, the other being the final admission of the unsustainability of debt. If we get a couple more relevant social upheavals, this factor in itself is perfectly valid as a catalyst for the final reset. In this respect, last month I wrote:
“Three different kinds of events could be the catalyst for financial disaster.
- A prominent systemic bank or sovereign default. Unlikely to be allowed by the establishment, but a game changer if it happens. Debt sustainability would be questioned.
- A global recession (it does not have to be a depression, at least initially). Inevitable, at some point. It would visualize the unsustainability of welfare states and sovereign debt. When?
- A worldwide relevant social disruption. You never know. It could be anything that relevantly breaks the global social contract. Maybe Brexit? (color emphasis now)“
I think it was clearly expressed, even though I was at the time still skeptical about the chances of success of the Brexit vote. What we don’t know, or at least I don’t, is if this will be a strong enough catalyst (think Lehman), or it will only be a warm up catalyst (Bear Sterns). Nearly a decade later, CBs have improved their market manipulation capabilities significantly. They very well might be able to deal with the shock and keep their boot on market prices using their plunge protection teams or POMO desks.
We will have to find out how it goes, as it goes. That is, learn the hard way, and try to minimize our losses if our positioning at times happens to be wrong. We have to remain nimble, humble, and flexible, but, at the same time, respect a clear long-term strategy in our positioning. What underlying strategy? Sorry to look back again, but reading what I said nearly two months ago (and has been a leitmotiv for nearly a year now), I think it is still fully applicable.
- The last stream of hawkish messages from FOMC members validates my USD bullishness. They will try to control the upside, but EURUSD is a short, and USDCNY a cautious long. I would not use heavy leverage because this is a CB controlled market and they can move the dollar in any direction fast. Anyway, no USD shorts for me, save for very short term trading windows.
- Choppy, sideways action in most currency pairs is set to continue. SNB and Riksbank will continue to devalue their currencies as much as they can. The SNB could push EURCHF all the way to 1.15 but the Riksbank does not have as much leeway. I think 9.50 is a top, and if you are patient nine even is still a commonsensical target.
- No credit risk or duration risk at this stage. No duration shorts either. Short term expect more flattening of curves, but long term, a system reset would bring back “normal” rates.
- I still think credit spread wideners are a (long term) great trade. I made some decent money in my bund-OAT/BTP spread widener while playing counterpart to one of Goldman Sachs trades of the year, and I am still there.
- Shorting equities is a standard routine for me. I am constantly trying to position myself for the big short, but I am permanently on my toes. “Sell and hold your shorts” is incompatible with decent sleep. Any minute a wave of easy freshly printed money can project us above the July 2015 market top.
- The real economy is not doing well. China, Japan, and southern Europe are an accident (a serious one) waiting to happen. The US economy would not be able to cope with any of those black swans. They are not that well off themselves.
I am, above all, a disciplined investor, and I stick to plan and always respect my stop loss levels. Nonetheless, I will confess to allowing my inner trader to take control occasionally. I have respected my investment roadmap as outlined before, but on the two days preceding the Brexit vote I thought sterling’s appreciation (in cable) had gone too far. So I sold sterling short, at 1.4754, for 50%+ of my AUM. Obviously, I made a killing on that trade and I am up in the double digit area for this difficult year. Waiting for the fat pitch is sage advice by Warren Buffet. It has always helped me make money. I am, naturally, particularly happy now. I hope I can make that feeling last.
Of course, the outcome might very well have been Bremain, and I would be right now painfully working my way out of some losses. Any case, I felt the upside was limited from those levels (Bremain was already well baked into cable on the twenty-third). As it turned out, my financial batteries have been recharged fully, and I will use accumulated energy to stick to my core investment strategy.
Paraphrasing Churchill, Brexit is, “malheureusement”, only “the end of the beginning”. Even the Fed now explicitly allows for relevant equity overvaluation (about time). In fact, it is a lot more than “relevant”, it is egregious. Prices will have to come down a lot more, particularly in US equities. Sooner or later. I think the bullet points for investment I have copied above are still valid, including the constant building of short positions in equity. If anything, the market is getting more and more expensive as profits continue to fall.
Once again we have to wait and see. That is what life is about, so let’s not forget to live in the meantime. Waiting for the next fat pitch becomes intolerable if you don’t enjoy yourself while you wait. Best of luck to everybody because, may I further insist, we are all going to need it.