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Sunday
Dec072014

Getting Late, but Still Time for a Drink ...

One of the most widely discussed themes in the plethora of "2015 outlooks" that have passed my desk is where we are in the cycle. In itself, the question yields a number of important limitations on the level of insight [1], but it is a logical narrative to impose on the current market environment. The financial crisis is a distant, but still-potent memory, and the sovereign debt crisis in the Eurozone has been put on hold, but still has the potential to wreck the "timeline" for most investors if it were to rear its ugly head next year. 

Without getting into too much detail, the vast majority of big sell-side research house focus on two overall themes. Firstly, we are currently mid to late in the cycle and a constructive stance on the economy and risk premiums/assets. This view varies from very bullish versions (JPM and DB) to more cautious stories (MS). Secondly, the cyclical divergence which has characterised asset prices and monetary policy this year is in its infancy and will remain a key theme next year. A continuation of the bull market in the dollar, strong global excess liquidity are but some of the obvious themes that can be derived from this view. 

My view in the nutshell is currently close to the consensus perception of global cyclical divergence and mid-to-late cycle dynamics in the OECD, which is slightly uncomfortable but I can't really force myself to deviate too much from it. Risks around such a relatively benign call are well-known; a revival of the Eurozone debt crisis, an accident in China, a panicking Fed crashing the US economy, a severe crisis in one or more of the most vulnerable EMs. But all of these have been covered, debated and perused to almost desperation. As a betting man, I would still put my money on a crisis in non-financial corporate debt markets as the next big crash that pushes the global economy into recession. It will probably be a confluence of EM corporate USD debt and corporates in the U.S./U.K. But the dollar probably has to rise longer and harder as well as the Fed probably needs to start inching up rates before the reality dawns on this sector. I reiterate that the increasing stress in the US high yield energy sector is an important, if also by now widely recognized, threat to watch next year. 

The alternative global panic scenario is really the one that is almost too painful to contemplate. A failure of Abenomics and a loss of faith in one of the major OECD bond markets which pushes up yields faster and more violently than central banks can and will act (or perhas a loss in confidence of central banks themselves). It could happen, but no need to go to work every day expecting to be run over by a bus. We kind of know how this will look too, and any signs of Tapering Tantrum price action in the U.S., the U.K, the Eurozone or Japan would force me to hit the bunker quickly. 

Meanwhile, it is getting late, but keep dancing. You still have time for a drink before the bar closes.

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[1] - Asset price and economic cycles vary greatly across countries and markets and may even have seen a structural break since the crisis. I.e. the lenghth of the current cycle is an endongenous variable determined largely by the way you interpret the impact of the financial crisis and its long-run aftermath. Secular stagnation, full recovery etc. 

Friday
Nov282014

Keep Rotating

Either weak energy prices, a break down in copper, low iron ore prices etc are a sign of a deflation crunch in the making that will lead to a flush in all things risk related (Albert Edwards style). Or we are in a extermely powerful Goldilocks situation where low headline inflation finally lets the real economy release higher, and the market goes on towards a final mid-to-late cycle tantrum. I think that this is now the key choice that everyone must make before proceeding to call their broker on Monday morning. 

In the Eurozone, margins are getting squeezed and companies are being forced to cut prices to maintain market share. You need to tread carefully on cyclicals here, but on the other hand, many UK/Eurozone retail have already been crushed (and I admit I am donning the kevlar in some of these names). In addition, the market is probably underestimating the impact of private QE and TLTROs at the ECB, which is odd, but a natural consequence of the extreme obsession with when the ECB pushes the button on QE. 

On the US I it seems to me that in a world where you have disinflation and real GDP growth humming at 3% with ZIRP added to the mix, you can probably get some pretty spectacular runs in consumer oriented stocks. I would not discount that even as the run in Spoos seem to defy logic. Basically, low global headline inflation is allowing CBs to double down even as growth is not calamitously negative and this does extend the "Goldilocks" feeling noted above. We need to understand, though, that the UK and US economies are really running the show in terms of growth here ... if they fail, I think we are buggered! The question I am really asking myself now in relation to the puke in oil is how long this can go one before we see real debt distress in one or more US energy HY bonds. And when that happens, will this test the much debated "lack of liquidity in the non-fin corporate debt market" story?

My mantra, though, remains, as it has throughout the year ... sector rotation, sector rotation, sector rotation ... the big story for me this year is not the rally in Spoos but the alpha that you have been able to pick up this year being long/short the right sectors. We are talking risk neutral/adjusted returns of 20-30% on some cross-trades! I would expect the same next year based on what I am seeing now. As for the the perennial debate on the when the crash is coming, why bother. Polemic has done a good job explaining the issues here anyway. A friendly word of advice though, ignore Zero Hedge and similar proselytes to the altar of the Black Swan. It can be a lonely and frustrating experience marrying yourself to such a creature, most of the time it isn't there at all! When the crash comes, you won't be short, and don't be the guy or girl who waits endlessly to be able to say; "I called it!"

A couple of final points on leading indicators and the market in general. Firstly, China's LEIs are tanking here, with narrow money growth looking very weak. This is worrying me. Low commodity prices may be "benign" in one scenario but when you couple it with near-deflation, low narrow money growth, an no FX reserve accumulation in China you lose one of the big liquidity pumps of the last decade. PBoC easing will help at the margin, but the fact that they have to do it even as they have announced the desire to scale down the credit fuelled growth isn't exactly encouraging. 

Secondly, flat yield curves are customarily negative inputs into most cyclical models, but I would honestly strip them out now. The market has basically been conducting a huge Operation Twist in the past year, everywhere! I am not sure this is such a negative signal. But if the Fed is bullied into an aggressive move next year and/or the short end in the US goes crazy in some taper tantrum 2.0 I would obviously need to revisit that view. 

Safe trading out there, the week after giving Thanks is usually a sporty one. So, play it cool and keep rotating.

Sunday
Oct192014

Another Eurozone Crisis Ahead?

Calamities happen in financial markets, and usually when investors least expect and are least prepared for it. In the euro area, weak growth in the past six months and the inability of the ECB's measures to turn asset markets arounds have led investors to, once again, revisit their sovereign debt crisis playbooks. 

This is understandable, but also now raises a fundamental question. If we are about to tumble into round 2 (or 3?) of the sovereign debt crisis, Eurozone bears may still prevail holding on to the recent trend in equities. But if we are not, the only trade that currently makes sense is to buy equities and short benchmark bonds in the euro area. Narrow money growth and ECB easing would indicate this to be a good bet, but the lack of sovereign QE amid increasingly nervous price action in peripheral bonds point to investors staying firmly on their shorts. 

 Place your bets! 

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Picture is courtesey of Pantheon Macroeconomics and has also been posted on Twitter.