Thursday’s ECB meeting is important in the context of recent market moves and statements regarding the level of the euro. Citi notes that the rise in short-dated vol indicates considerable investor focus on the meeting. Expectations have been building that ECB President Draghi may offer a more cautious tone to ‘talk down’ the moves seen in the short-term rates and FX. In light of President Hollande’s advocation of an exchange rate policy aimed at ‘safeguarding competitiveness’, Draghi will likely face further questioning on FX. However, Citi does not believe that he will reverse his position and explicitly talk the currency down. Goldman also notes that while 'Taylor-Rule' users might infer a 30-50bps lowering of rates (thanks to growth, FX, and inflation) the improvement in 'fiscal risk premium' balances that dovishness leaving Draghi likely on hold. However, he is unlikely to stand 'idly by' without some comment on the ensuing currency wars.
Profits and leverage are locked in a deadly embrace. There is a time-honoured tradition in statistics: whipping the data until they confess. Bullish and bearish equity analysts are equally guilty of this practice. It would seem that statistical conclusions are merely an ex-post justification of a long-held prior belief about equity markets being cheap or overpriced. Clearly, consensus, notably among sellside analysts, is bullish. GLG's CIO Jamil Baz presents the bullish view before discussing the bearish counterpoint - consensus disregards leverage. In the short term, it is clear that central banks need to entertain the illusion of viable stock market valuations by pulling rabbits from a hat. But as high-powered money reaches ever higher levels, the probability of accidents looms large.
Just when one thought the old overnight futures levitation on a surging EURUSD regime was over, and was replaced by some semblance of normalcy, here comes Europe, sending the EURUSD screeching higher by some 100 pips from a support threatening 1.3460 on no news, with absolutely nothing changed, and pushing US futures to virtually unchanged from yesterday morning wiping out the entire day's losses in 3 short hours of near-zero volume overnight trading.
There was a time when Goldman's Tom Stolper lost money for Goldman's clients with such speed and fury, it left people's head spin (see here when he was closed out in a matter of days). There was also a time when Stolper was supposed to be stopped out but refused to do so until the EURUSD cross actually closed trading inside his stop zone (which it eventually did). Today, however, the second the EURUSD touched above 1.3700 the Goldman strategist decided to get the hell out of dodge and has picked up his 400 pips since putting on the long EURUSD reco several weeks ago. With that last reco, Stolper has modestly redeemed himself, and all those who had listened to his previous recos have made some 400 pips, which hopefully should compensate for some 5000+ pips in cumulative downside to date.
"Return = Cash + Beta + Alpha": An Inside Look At The World's Biggest And Most Successful "Beta" Hedge FundSubmitted by Tyler Durden on 01/23/2013 22:31 -0400
Some time ago when we looked at the the performance of the world's largest and best returning hedge fund, Ray Dalio's Bridgewater, it had some $138 billion in assets. This number subsequently rose by $4 billion to $142 billion a week ago, however one thing remained the same: on a dollar for dollar basis, it is still the best performing and largest hedge fund of the past 20 years, and one which also has a remarkably low standard deviation of returns to boast. This is known to most people. What is less known, however, is that the two funds that comprise the entity known as "Bridgewater" serve two distinct purposes: while the Pure Alpha fund is, as its name implies, a chaser of alpha, or the 'tactical', active return component of an investment, the All Weather fund has a simple "beta isolate and capture" premise, and seeks to generate a modestly better return than the market using a mixture of equity and bonds investments and leverage. Ironically, as we foretold back in 2009, in the age of ZIRP, virtually every "actively managed" hedge fund would soon become not more than a massively levered beta chaser however charging an "alpha" fund's 2 and 20 fee structure. At least Ray Dalio is honest about where the return comes from without hiding behind meaningless concepts and lugubrious econospeak drollery. Courtesy of "The All Weather Story: How Bridgewater created the All Weather investment strategy, the foundation of the "risk parity" movement" everyone else can learn that answer too.
The Real Interest Rate Risk: Annual US Debt Creation Now Amounts To 25% Of GDP Compared To 8.7% Pre-CrisisSubmitted by Tyler Durden on 01/13/2013 18:32 -0400
By now most are aware of the various metrics exposing the unsustainability of US debt (which at 103% of GDP, it is well above the Reinhart-Rogoff "viability" threshold of 80%; and where a return to just 5% in blended interest means total debt/GDP would double in under a decade all else equal simply thanks to the "magic" of compounding), although there is one that captures perhaps best of all the sad predicament the US self-funding state (where debt is used to fund nearly half of total US spending) finds itself in. It comes from Zhang Monan, researcher at the China Macroeconomic Research Platform: "The US government is now trying to repay old debt by borrowing more; in 2010, average annual debt creation (including debt refinance) moved above $4 trillion, or almost one-quarter of GDP, compared to the pre-crisis average of 8.7% of GDP."
The crowds are slowly starting to fill up Times Square, and despite the imminent countdown to New Year’s, Washington still has not conjured up a resolution to avoid the fiscal cliff. Over the prior two months we have leveraged game theory, Venn diagrams, option “greeks,” and basic investor psychology as tools to decipher the ultimate path of the crisis and subsequent market reaction. Alas, regardless of all the analysis we and countless others have supplied; the short, intermediate, and long term prospects for stocks rest exclusively on headlines. More poignantly, the fate of the U.S. economy, global equities, and net incomes for hundreds of millions now depend upon the decision making of a group so small, its numbers can be counted with one hand.
While many believe that with the output gap so wide that inflation is not an immediate threat, longer-term, as UBS notes, excessive money printing could indeed generate inflation and that inflation expectations are unusually volatile and could quickly be dislodged. This inflation hedges are a very valid concern. An oft-cited reason for owning stocks is that they have an implicit inflation hedge, however, just as with many market myths, UBS finds that, in fact, equities do not look like a compelling hedge against rising inflation. Indeed, they provide an appropriate hedge to rising inflation only in a limited number of cases. In short, equities provide only a partial hedge – one which works only for small positive inflation shocks.
By now there can be no doubt that due to Bernanke et al's endless intervention in any and all capital markets, the "market" is no longer a mechanism that discounts the future in any way. In fact, instead of predicting the future, all the market has become is a backward looking race in which collocated algos respond to historical data - flashing red headlines - and attempt to out run each other in who can buy or sell more free for all, knowing full well at least one other greater fool will be behind them to pick up the pieces. Sadly, fundamentals as a driver to valuaton no longer exist. But such is life under central planning. Yet there is one thing that the market responds to - it is politicians and the uncertainty that political risk brings with it. This certainly includes that most political of organizations, the Federal Reserve, whose stimulative intervention into capital markets two months before the presidential elections was without precedent. Yet even here, the market has managed to decouple from reality, and is trading at level far greater than what political uncertainty risk implies. As the chart below from Citi's Matt King shows, a correlation between BBB spreads and a broader proprietary uncertainty index, there is currently a roughly 50% political risk premium that is not being priced into stocks.
Citi's Robert Buckland explains: If policymakers really do want to encourage stronger economic growth (and especially higher employment) then we would suggest that they take a closer look at the equity market's part in driving corporate behaviour. Despite high profitability, strong balance sheets and ultra-low interest rates, any stock market observer can see daily evidence of why the listed sector is unlikely to kick-start a meaningful acceleration in the global economy. A recent Reuters headline says it all: "P&G Plans to Cut More Jobs, Repurchasing More Shares". If anything, low interest rates are increasingly part of the problem rather than the solution. Perversely, they may be turning the world's largest companies into capital distributors rather than investors.
Senator Reid’s frustration that progress had stalled as he blamed the Republicans for not bargaining fairly in trying to iron out a compromise signaled to Speaker Boehner that the Democrats will play hardball as well. However, yesterday’s Wall Street Journal article, via quotes from Erskine Bowles, claimed the White House will be flexible when proposing a raise to the top marginal tax rate. This perceived increase in the probability of a near term accord appropriately rallied stocks aggressively. We question why Mr. Obama would leak his best alternative to a negotiated agreement (BATNA) so early in the process, for classic bargaining strategy suggests keeping that information close to the vest as long as possible. Complicating matters, Mr. Obama declared a preference to strike a deal by Christmas which approximates the Friday, December 21 “zero barrier”. Ironically, if the Republicans acquiesce to yesterday’s posturing by Mr. Bowles, then the likelihood of a Moody’s and/or Fitch downgrade rises, for the ratings agencies would almost assuredly be disappointed by a lower than anticipated level of incremental revenues.
The S&P 500 achieved its anticipated 4-5% bounce off the recent 7-10% pullback, most of it accomplished in a very light holiday trading week. Much of the gains were attributed to overly effusive optimism over the prospects of resolving the fiscal cliff. Ironically, with Washington abandoned the past ten days for Thanksgiving, we have not heard anything substantive on the negotiations since Senator Reid and Speaker Boehner spoke jointly on the White House Lawn on November 16. The returns in equities that resulted from this perceived positive outlook has likely run its course as the blue chip index has regained the levels from the morning after the Election. Certainly, the mundane increases in open interest for the futures and the outperformance by the blue chips versus smaller capitalization names on a beta adjusted basis hint at such vacuous motivation for the upward move.
Several weeks ago, when sharing his latest outlook at the Economist's Buttonwood gathering, Hugh Hendry had this to say about gold miners: "I am long gold and I am short gold mining equities. There is no rationale for owning gold mining equities. It is as close as you get to insanity. The risk premium goes up when the gold price goes up. Societies are more envious of your gold at $3000 than at $300. And there is no valuation argument that protects you against the risk of confiscation.” For those confused, what he means is quite simple: the higher the price of gold goes, the greater the temptation of those extracting it (usually mined in various locales where worker satisfaction with labor conditions is less than stellar - see recent events in South Africa) to strike and demand higher wages (i.e., lower EPS), or of host government to nationalize it. The end outcome is a collapse in the extracting miner's cash flows and profitability, if not outright liquidation. The paradox is that the fewer actual global miners in operation, the better for the price of the actual hard commodity, as less supply means lower price, means greater probability of more miners suffering the same fate, means even higher gold price and so on. But back to the topic of gold miners. Below, for those still confused, is a simple story courtesy of the BBC in 10 pictures, summarizing the bitter dispute over Kyrgyzstan's gold production.
I was a super bull of long-term bonds. I stated my case over 3 years ago with a yield target on 30-year maturities of 2.5%. Back then, the timing and structure looked right for another run to new highs. Discussions about hyperinflation were premature.
One of the most commonly cited 'bullish' memes for stocks is the so-called Fed Model (or Equity Risk Premium) or more simply - the fact that earnings yields are not catching up to Treasury yields (i.e. why put your money in government bonds at such low rates when there is a smorgasbord of yummy equities with 'attractive' dividend yields). There are three key problems with this perspective: 1) No concept of 'risk' is imbibed in this return-based differential (as we have discussed before here and here); 2) Longer-term historical context is critical (as we discussed here - must read); and most importantly 3) Financial Repression breaks the 'Fed Model'. As Barclays shows in the following three charts (and we pointed out recently) normalization of the equity risk premium will not occur until Financial Repression ends. Brings a whole new meaning to 'Don't Fight The Fed' eh?