Tag: Volatility (page 1 of 27)

Think Bitcoin Is A Bubble? Here’s Your Chance To Short It

Has the fact that the price of a single bitcoin has risen nearly eight-fold so far this year prompted you to turn bearish on the world's most valuable digital currency?

Well, here’s your chance to short it. 

A Swiss asset-management firm called Vontobel launched a new futures product on Friday that will make it easier for retail investors to short bitcoin.

Bitcoin of course recently bounced back to all-time highs after a more-than $1,000 drop last week. Traders who were short made a killing on their positions. But cashing in on the drop would’ve been far easier with new futures products designed to let customers bet against the bitcoin price.

The contracts, which will trade on the SIX Exchange, will enable investors to profit even if the currency – which has proven vulnerable to vicious selloffs – falls in value. According to Reuters, the company will release two mini futures, a type of derivatives instrument that represents a fraction of the value of standard futures, making it easier for retail traders to access the market.

According to Eric Blattmann, head of public distribution of financial products at Vontobel, the news comes at a time when traditional traders are simply looking for more options when it comes to trading cryptocurrencies.

Swiss investment solutions provider Leonteq Securities AG also announced the launch of a separate product. Leonteq’s product has a two-month maturity, while Vontobel’s is longer, but investors can of course exit their positions early since each product will trade on an exchange.

He said in statements:

"We have seen big demand for our long tracker certificate from investors interested in playing the upside potential of bitcoin and now they have also the possibility to hedge their position or go short."

Manuel Durr, head of public solutions at Leonteq, said clients appreciate being able to open long or short positions in bitcoin.

“The initial feedback has been extremely positive,” said Manuel Dürr, head of public solutions at Leonteq. “Clients do very much appreciate the possibility of choosing between a long or a short investment in bitcoin.”

The move comes after US derivatives exchange CME Group announced it would start trading bitcoin derivatives next month.

Already, New York-based startup LedgerX is offering live cryptocurrency futures trading, with $1 million traded in its first week.

While some exchanges have allowed customers to open short positions on margin, the Vontobel contract has become the easiest way for retail traders to short the digital currency. We wonder: Could this help inject more two-way volatility and slow, or perhaps even reverse, bitcoin's meteoric rise?

But if you’re looking to short the world’s most valuable digital currency, The Vontobel mini-futures are probably your best bet.

http://WarMachines.com

“People Ask, Where’s The Leverage This Time?” – Eric Peters Answers

One of the Fed’s recurring arguments meant to explain why the financial system is more stable now than it was 10 years ago, and is therefore less prone to a Lehman or “Black monday”-type event, (which in turn is meant to justify the Fed’s blowing of a 31x Shiller PE bubble) is that there is generally less leverage in the system, and as a result a sudden, explosive leverage unwind is far less likely… or at least that’s what the Fed’s recently departed vice Chair, and top macroprudential regulator, Stanley Fischer has claimed.

But is Fischer right? Is systemic leverage truly lower? The answer is “of course not” as anyone who has observed the trends not only among vol trading products, where vega has never been higher, but also among corporate leverage, sovereign debt, and the record duration exposure can confirm. It’s just not where the Fed usually would look…

Which is why in the excerpt below, taken from the latest One River asset management weekend notes, CIO Eric Peters explains to US central bankers – and everyone else – not only why the Fed is yet again so precariously wrong, but also where all the record leverage is to be found this time around.

This Time, by Eric Peters

“People ask, ‘Where’s the leverage this time?’” said the investor. Last cycle it was housing, banks.

 

“People ask, ‘Where will we get a loss in value severe enough to sustain an asset price decline?’” he continued. Banks deleveraged, the economy is reasonably healthy.

 

“People say, ‘What’s good for the economy is good for the stock market,’” he said.

 

“People say, ‘I can see that there may be real market liquidity problems, but that’s a short-lived price shock, not a value shock,’” he explained.

 

“You see, people generally look for things they’ve seen before.”

 

“There’s less concentrated leverage in the economy than in 2008, but more leverage spread broadly across the economy this time,” said the same investor.

 

“The leverage is in risk parity strategies. There is greater duration and structural leverage.”

 

As volatility declines and Sharpe ratios rise, investors can expand leverage without the appearance of increasing risk.

 

“People move from senior-secured debt to unsecured. They buy 10yr Italian telecom debt instead of 5yr. This time, the rise in system-wide risk is not explicit leverage, it is implicit leverage.”

 

“Companies are leveraging themselves this cycle,” explained the same investor, marveling at the scale of bond issuance to fund stock buybacks.

 

“When people buy the stock of a company that is highly geared, they have more risk.” It is inescapable.

 

“It is not so much that a few sectors are insanely overvalued or explicitly overleveraged this time, it is that everything is overvalued and implicitly overleveraged,” he said.

 

“And what people struggle to see is that this time it will be a financial accident with economic consequences, not the other way around.”

http://WarMachines.com

We’re Living In The Age Of Capital Consumption

Authored by Ronald-Peter Stöferle via The Mises Institute,

When capital is mentioned in the present-day political debate, the term is usually subject to a rather one-dimensional interpretation: Whether capital saved by citizens, the question of capital reserves held by pension funds, the start-up capital of young entrepreneurs or capital gains taxes on investments are discussed – in all these cases capital is equivalent to “money.” Yet capital is distinct from money, it is a largely irreversible, definite structure, composed of heterogeneous elements which can be (loosely) described as goods, knowledge, context, human beings, talents and experience. Money is “only” the simplifying aid that enables us to record the incredibly complex heterogeneous capital structure in a uniform manner. It serves as a basis for assessing the value of these diverse forms of capital.

Modern economics textbooks usually refer to capital with the letter “C”. This conceptual approach blurs the important fact that capital is not merely a single magnitude, an economic variable representing a magically self-replicating homogenous blob but a heterogeneous structure. Among the various economic schools of thought it is first and foremost the Austrian School of Economics, which stresses the heterogeneity of capital. Furthermore, Austrians have correctly recognized, that capital does not automatically grow or perpetuate itself. Capital must be actively created and maintained, through production, saving, and sensible investment.

Moreover, Austrians emphasize that one has to differentiate between two types of goods in the production process: consumer goods and capital goods. Consumer goods are used in immediate consumption – such as food. Consumer goods are a means to achieve an end directly. Thus, food helps to directly achieve the end of satisfying the basic need for nutrition. Capital goods differ from consumer goods in that they are way-stations toward the production of consumer goods which can be used to achieve ultimate ends. Capital goods therefore are means to achieve ends indirectly. A commercial oven (used for commercial purposes) is a capital good, which enables the baker to produce bread for consumers. 

Through capital formation, one creates the potential means to boost productivity. The logical precondition for this is that the production of consumer goods must be temporarily decreased or even stopped, as scarce resources are redeployed toward the production of capital goods. If current production processes generate only fewer or no consumer goods, it follows that consumption will have to be reduced by the quantity of consumer goods no longer produced. Every deepening of the production structure therefore involves taking detours.

Capital formation is therefore always an attempt to generate larger returns in the long term by adopting more roundabout methods of production. Such higher returns are by no means guaranteed though, as the roundabout methods chosen may turn out to be misguided. In the best case only those roundabout methods will ultimately be continued, which do result in greater productivity. It is therefore fair to assume that a more capital-intensive production structure will generate more output than a less capital-intensive one. The more prosperous an economic region, the more capital-intensive its production structure is. The fact that the generations currently living in our society are able to enjoy such a high standard of living is the result of decades or even centuries of both cultural and economic capital accumulation by our forebears.

Once a stock of capital has been accumulated, it is not destined to be eternal. Capital is thoroughly transitory, it wears out, it is used up in the production process, or becomes entirely obsolete. Existing capital requires regularly recurring reinvestment, which can usually be funded directly out of the return capital generates. If reinvestment is neglected because the entire output or more is consumed, the result is capital consumption.

It is not only the dwindling understanding of the nature of capital that leads us to consume it without being aware of it. It is also the framework of the real economy which unwittingly drives us to do so. In 1971 money was finally cut loose entirely from the gold anchor and we entered the “paper money era.” In retrospect, it has to be stated that cutting the last tie to gold was a fatal mistake. Among other things, it has triggered unprecedented instability in interest rates. While interest rates displayed relatively little volatility as long as money was still tied to gold, they surged dramatically after 1971, reaching a peak of approximately 16 percent in 1981 (10-year treasury yield), before beginning a nosedive that continues until today. This massive decline in interest rates over the past 35 years has gradually eroded the capital stock.

An immediately obvious effect is the decline in so-called “yield purchasing power”. The concept describes what the income from savings, or more precisely the interest return on savings, will purchase in terms of goods. The opportunity to generate interest income from savings has of course decreased quite drastically. Once zero or even negative interest rate territory is reached, the return on saved capital is obviously no longer large enough to enable one to live from it, let alone finance a reasonable standard of living. Consequently, saved capital has to be consumed in order to secure one's survival. Capital consumption is glaringly obvious in this case.

It is beyond question that massive capital consumption is taking place nowadays, yet not all people are affected by it to the same extent. On the one hand, the policy of artificially reducing the interest as orchestrated by the central banks does negatively influence the entrepreneurs’ tasks. Investments, especially capital-intensive investments seem to be more profitable as compared to a realistic, i. e. non-interventionist level, profits are thus higher and reserves lower. These and other inflation-induced errors promote capital consumption.

On the other hand, counteracting capital consumption are technological progress and the rapid expansion of our areas of economic activity into Eastern Europe and Asia in recent decades, due to the collapse of communism and the fact that many countries belatedly caught up with the monetary and industrial revolution in its wake. Without this catching-up process it would have been necessary to restrict consumption in Western countries a long time ago already.

At the same time, the all-encompassing redistributive welfare state, which either directly through taxes or indirectly through the monetary system continually shifts and reallocates large amounts of capital, manages to paper over the effects of capital consumption to some extent. It remains to be seen how much longer this can continue. Once the stock of capital is depleted, the awakening will be rude. We are certain, that gold is an essential part of any portfolio in this stage of the economic cycle.

 

http://WarMachines.com

Hunting Angels: What The World’s Most Bearish Hedge Fund Will Short Next

It's not easy being "the world's most bearish hedge fund", a description we first conceived nearly three years ago, and one look at Horseman Capital's returns over the past three years confirms it: after generating market-beating returns for much of its existence, things went bad in 2015, and much worse in 2016…

… when the Fund had a record net short equity position of over -100%, just as the market ripped higher after the Trump election.

That said, 2017 has been much better for Horseman and its CIO Russell Clark, who correctly timed the year's two big short trades so far: the mall REIT and the shale shorts.

Unfortunately, his other positions stood in the way, and as of the end of October (a good month with 2.04% in P&L), the fund is just 0.25% up on the year. Worse, after a period of calm, steady, upward grinding monthly performance for much of the previous several years, Horseman's sharpe ratio has cratered, as the monthly return variance surged, with a -6% month following two +7% months as a result of gross leverage that has never been higher, even if the net equity position – while still largely short – is far more manageable than it was in 2016.

Still, having been well ahead of the pack on the two big shorts of 2017, most money managers are always curious what if anything Clark – and Horseman – are shorting next. Well, they are in luck, because in his latest letter, he unveils the answer: according to Clark, the next major source of alpha will be shorting fallen angel bonds.

In his November letter to clients, Clark explains why he is hunting for soon to be "fallen angels", and where he got the idea from. And after more fund managers read the following excerpt, we have a feeling that the next big leg lower in not only junk, but also crossover credit, is imminent:

Mifid II will come into force soon, and a lot of research that used to be free, will need to be paid for. This has been a reason to ask ourselves some serious questions, namely what research do I read, and what has made me the most money. Strangely the research that has been most profitable for me, will remain free even post Mifid II as it is publicly available. The International Monetary Fund produces Global Financial Stability Reports. The stand out report for me was the April 2008 report that highlighted Eastern European banks vulnerability to wholesale funding. I shorted many of the banks named in the report. Most fell 70% to 90% subsequently.

 

What does the most recent issue of the Global Financial Stability Report have to say? It notes that BBB bonds now make up nearly 50% of the index of investment grade bonds, an all time high. BBB bonds are only one notch above high yield, and are at the greatest risk of becoming fallen angels, that is bonds that were investment grade when issued, but subsequently get downgraded to below investment grade, or what is known these days as high yield. It then points out that investors have never been more at risk of capital loss if yields were to rise. In addition, it notes volatility targeting investors will mechanically increase leverage as volatility drops, with variable annuities investors having little flexibility to deviate from target volatility. Another interesting point was that mutual fund share of the high yield market in the US have risen from 17% in 2008 to 30% today, and notes that investors outflows have become much more sensitive to losses than they used to be.

 

So my favourite research (love the price!) is telling me that US investment grade debt is very low quality, and could produce some large fallen angels. It then goes on to tell me that mutual funds are much larger in the high yield market than they used to be. It also tells me low rates means the capital losses are much higher than they used to be. And that investors in high yield mutual funds are much flightier than they used to be! Essentially the IMF are telling me that if you get a large enough fallen angel, the high yield market will freak out, and volatility will spike causing volatility targeting investors to dump leveraged positions. Sounds good to me – but with growth so good and the market so strong, how on earth would we get a fallen angel?

 

To find a potential fallen angel, I looked through the holdings of investment grade bond ETFs to find large BBB bond issuers. The biggest of the BBB issuers happened to be the large telecommunication companies. The sector has over USD300bn of BBB rated debt compared to a high-yield market of USD 1tn. I am not a debt specialist, but I have noticed that falling share prices tend to be good lead indicators on debt downgrades, and the US telecommunication sector has not been participating in the market rally this year. The story looks good to me, and it comes via my favourite research source. US debt markets look in trouble to me, whether that has any effect on broader equity markets remains to be seen.

Aside from this rather original idea, some other notable changes in Horseman's industry exposure are noted: while both the retail and E&P shorts are still there, they have been notably tamed, and of note are two other major shorts (both in the US): one in real estate (we assume this is a play on the adverse impact of rising rates on real estate valuations), and the healthcare sector, a short whose thesis is quite interesting and we will reveal tomorrow.

For those wondering, the top 10 positions by % of NAV are the following:

Needless to say, we wish Horseman much success with a prompt realization of his BBB-short, especially since it appears that his LPs are starting to get cold feet, and the fund's AUM has shrunk by half from $2.8 BN  one year ago…

… to less than half, or $1.2BN currently.

http://WarMachines.com

Yale’s Endowment CIO Has Some Really Bad News For Public Pensions…

Public pensions all around the country like to play a clever little game that allows them to drastically understate the current value of their future liabilities and therefore pretend that their ponzi schemes are something other than insolvent frauds.  Of course, we’re talking about the artificially high discount rates that pension boards consistently use to understate their net underfunding levels…a topic that we’ve written about frequently over the years.

Alas, at least in the opinion of Yale’s Chief Investment Officer David Swensen, those 7.5% annual returns that pensions love to rely on, even if they’ve never managed to actually achieve them, are going to be increasingly difficult to hit over the coming years.  As Swensen told Bloomberg, despite achieving a 13.5% annual return over the past 32 years, he is now preparing university officials for much lower returns averaging around 5% for the foreseeable future.

The investment chief, who was interviewed by former U.S. Treasury Secretary Robert Rubin, also said he’s expecting lower returns for the university’s endowment, which he’s run for 32 years with a 13.5 percent average annual rate of return.

 

For the past 12 to 18 months, Swensen said he has been warning university officials to expect much lower returns in the future, as little as 5 percent annually, which would be down from previous assumptions of 8.25 percent.

 

“It’s not a very popular change,” he said. “We’re victims of our own success.”

Swensen

Meanwhile, as we pointed out a couple of months ago (see: Pension Ponzi Exposed: Minnesota Underfunding Triples After Tweaking This One Small Assumption…), the state of Minnesota recently provided a beautiful illustration of exactly what happens when public pensions decide to ditch their inflated discount rates for more realistic assumptions…their net underfunding tripled to $50 billion…here’s more
from Bloomberg:

Minnesota’s debt to its workers’ retirement system has soared by $33.4 billion, or $6,000 for every resident, courtesy of accounting rules.

 

The jump caused the finances of Minnesota’s pensions to erode more than any other state’s last year as accounting standards seek to prevent
governments from using overly optimistic assumptions to minimize what they owe public employees decades from now. Because of changes in actuarial math, Minnesota in 2016 reported having just 53 percent of what it needed to cover promised benefits, down from 80 percent a year earlier, transforming it from one of the best funded state systems to the seventh worst, according to data compiled by Bloomberg.

 

The Minnesota’s teachers’ pension fund, which had $19.4 billion in assets as of June 30, 2016, is expected to go broke in 2052. As a result of the latest rules the pension has started using a rate of 4.7 percent to discount its liabilities, down from the 8 percent used previously. As a result, its liabilities increased by $16.7 billion.

Unfortunately, lower returns was only part of the bad news that Swensen had for U.S. investors as he described the current disconnect between “fundamental risks that we see all around the globe with the lack of volatility in our securities markets” as “profoundly troubling.”

David Swensen, Yale University’s longtime chief investment officer, said the lack of market volatility in the current geopolitical environment is a major concern and warned that another crash is possible.

 

“When you compare the fundamental risks that we see all around the globe with the lack of volatility in our securities markets, it’s profoundly troubling,” Swensen, 63, said Tuesday during remarks at the Council on Foreign Relations in New York. That “makes me wonder if we’re not setting ourselves up for an ’87, or a ’98 or a 2008-2009,” he said, referring to previous market crises.

 

“The defining moments for portfolio management” came in those years, “and if you ignore that you’re not going to be able to manage your portfolio,” Swensen said.

 

Asked why Yale’s uncorrelated assets are higher now than in 2008, he said, “I’m not worried about the economy so much, what I’m concerned about is valuation.”

Of course, we’re sure these warnings will provoke pension managers all around the country to promptly reassess their optimistic return assumptions and adjust future pension benefits accordingly to preserve the solvency of their funds for future generations of pensioners…

http://WarMachines.com

UBS Reveals The Stunning Reason Behind The 2017 Stock Market Rally

It’s 2018 forecast time for the big banks. With Goldman unveiling its seven Top Trades for 2018 earlier, overnight it was also UBS’ turn to reveal its price targets for the S&P in the coming year, and not surprisingly, the largest Swiss bank was extremely bullish, so much so in fact that its base case is roughly where Goldman expects the S&P to be some time in the 2020s (at least until David Kostin revises his price forecast shortly).

So what does UBS expect? The bank’s S&P “base case” is 2900, and notes that its upside target of 3,300 assumes a tax cut is passed, while its downside forecast of 2,200 assumes Fed hikes in the face of slowing growth:

We target 2900 for the S&P 500 at 2018 YE, based on EPS of $141 (+8%) and modest P/E expansion to 20.6x.

 

Our upside case of S&P 500 at 3300 assumes EPS gets a further 10% boost driven by a 25% tax rate (+6.5%), repatriation (+2%) and a GDP lift (+1.6%), while the P/E rises by 1.0x. Downside of 2200 assumes the Fed hikes as growth slows, the P/E contracts by 3x and EPS falls 3%. Congress is motivated to act before midterm elections while the Fed usually reacts to slower growth; so we think our upside case is more likely.

Why is UBS’ base case so much higher than what most other banks forecast? According to strategist Keith Parker, the reason is a “Valuation disconnect”: Higher rates are priced in, while higher expected growth is not. He explains:

We model the S&P 500 P/E based on select macro drivers. The S&P P/E is 5x below the model implied level, which points to solid returns. More specifically, the 2.8% Fed rate target is priced in (worth 1.3x) but higher analyst expected 3-5yr growth is not (worth 3.7x). The P/E has been 2-4x above the implied level at the end of each bull market and the model has been a good signal for forward S&P returns (20-25% correlation). High-growth (most expensive) and deep-value (cheapest) stocks are cheap on a relative basis; the price for perceived safety is high. We focus on risk-adjusted growth + yield.

On the earnings side, this is how UBS bridges its 2018 rise to 141:

Following the 2014-16 earnings recession, S&P 500 EPS returned to growth in 2017 on the back of improved economic momentum globally, a commodity recovery, and rising margins. While a tax plan would significantly impact our growth assumptions, our base case EPS forecast excludes any tax upside given the degree of legislative uncertainty.

 

For 2018, we expect the earnings recovery to continue and forecast 8.3% EPS growth, driven by solid economic growth, offsetting margin drivers and higher interest rates. To control for the volatility and different drivers for certain sectors, we model financials and energy separately, with a buyback tailwind applied at the index level (1% assumed in 2018). 

 

We forecast S&P ex Financials & Energy earnings to grow 7% in 2018. Top-line growth is a function of 2.2% US real GDP and 3.8% RoW GDP growth, a relatively stable USD, and slightly higher growth in intellectual property products (“IPP” or tech) plus business equipment spending (less structures spending). Margins are adversely impacted by rising unit labor costs of 1.9% and boosted by a 1% improvement in productivity, with a negative net effect. Finally, flat US GDP growth means that earnings do not benefit much from operating leverage.

 

We expect Financials earnings to grow 7%, with return on assets improving on the back of a rising 3m Libor rate to 2.2% by YE 2018, two Fed hikes in 2018, a stable financing spread (delta between total bond market and Financials OAS spreads) and no rise in delinquencies (modelled using change in unemployment).  Asset growth is estimated using a beta of 1.35 to US real GDP growth.

 

We expect Energy sector earnings to continue to rebound, growing 28%. Energy accounts for less than 4% of total projected S&P 500 net income. Given the inherent volatility in earnings over recent years, we model sales growth as a function of oil and natural gas, which explains 97% of the sector’s top-line growth. We assume that margins recover as D&A and other overhead is leveraged

Here we have some bad news for UBS: none of the above will happen, for one simple reason – the driver of earnings growth in 2017, China’s record credit injections, has slammed shut, and if anything is now in reverse. This is bad news not only for China of course, but for fungible global markets, all of which are reliant on the world’s biggest marginal creator of crerdit in the financial system, Beijing. And, as we discussed yesterday, starting, well, two weeks ago, China is in active deleveraging mode. 

The implications for corporate profits will be adverse.

* * *

Yet as we stated at the beginning, none of the above is surprising, or even remotely remarkable: it’s just another bank’s forecast, and with the benefit of hindsight one year from today, we will have some laughs at its morbid, late cycle optimism.

What is very striking, however, is an little noticed analysis from UBS inside the projection, which seeks to explain where virtually all the market upside in 2017 has come from. In a statement that one would never hear on CNBC, or any other financial medium, as it destroys the narrative of new money entering the market, UBS argues that the entire 2017 rally was just one giant short squeeze! In its own words:

Short covering fuelled the YTD rally; retail and foreign should continue to buy. YTD US equity ETF+MF flows have been -$17bn as short covering in stocks and ETFs of $83bn has supported the rally.

 

 

And as the shorts get decimated, the final buyer emerges before the whole house of cards comes crashing down: the retail investor. Some more details:

US equity demand model: short covering has fuelled the 2017 rally

 

We have developed a simple model of US equity demand, from the major sources of potential buying using higher frequency data. Figure 101 shows the cumulative “demand” since 2010, and the broad US equity market has tracked the measure well. Since the beginning of the year, US equity ETF+MF flows have been -$17bn as short covering in stocks and ETFs of $83bn has supported the rally (Figure 102). We see the rally transitioning to the next phase where inflows into MFs and ETFs need to take over with short interest as a % of market cap near the lows.

 

 

Retail and foreign buyers drive the last phase of a bull market. Following on the point above that flows to MFs and ETFs need to take over, we find that the retail and foreign buyer are typically the marginal buyer during the last phases of a bull market (Figure 103). Indeed, we see that US households have been increasing their ownership of US equities (ex MFs, ETFs, pensions), which has happened at the end of prior cycles. Additionally, the foreign buyer stopped selling and could start becoming a net buyer, with Asia money flow the key with ~$40tr sitting in M2.

 

In UBS’ most bizarre admission, the Swiss bank also notes that “the last part of a bull market is typically fuelled by retail and foreign money, which has been the case of late.” And yet, even more inexplicably, UBS believes that there is enough “dry powder” behind the short squeeze to push the market to not just 2,900 but potentially 3,300.

Which, if UBS is right, means that there will be a lot of suicidal shorts in the coming months as the world’s biggest short squeeze proceeds to its inevitable conclusion. But the worst news is for the last bagholder left: Joe and Jane Sixpack, aka US retail investors, as institutions dump all their equity holdings to the last bid remaining, something JPM first warned about in February when it wrote that “Institutions, Hedge Funds Are Using The Rally To Sell To Retail” and which everyone appears to have forgotten.

http://WarMachines.com

10 Reasons To Worry

Via LPLResearch.com,

One of the oldest market sayings is: “markets climb a wall of worry” – needless to say, it is sometimes good to be cautious.

We listed some of our worries recently in What Might Scare Markets, but the action in the S&P 500 Index over the past year—and so far in November—has that list growing.

Here are 10 reasons to worry (in no particular order):

  1. On a total return basis, the S&P 500 has been up 12 months in a row.
  2. The S&P 500 has only pulled back (from peak to trough) 2.8% over the past year.
  3. Junk bonds have weakened relative to equities over the past few weeks, and historically this has been a warning for equities.
  4. The yield curve is the flattest it has been since 2007.
  5. The S&P 500 hasn’t closed lower by 0.5% or more for 50 consecutive trading days, the longest streak since 1968.
  6. The S&P 500 hasn’t finished red three days in a row for more than three months, the longest streak in seven years.
  7. The S&P 500 hasn’t corrected 3% from its all-time high for over a year, the longest streak ever.
  8. The average daily change (absolute value) for the S&P 500 in 2017 is only 0.30%, the second smallest range on record behind 1964.
  9. Transports have been very weak recently, a historical indicator of weakness under the surface.
  10. November is historically one of the strongest months going back to 1950, but over the past 10 years the second half of the month has been weak.

Per Ryan Detrick, Senior Market Strategist,

“It has been a long time since we’ve seen some volatility. Many small cracks are starting to form, and we wouldn’t be surprised if this opens the door for a modest correction. The good news is that with the global economy as strong as it is, this would likely be a nice chance to add to positions.”

For more of our thoughts on why next year could see a continuation of the bull market, be on the lookout for LPL Research Outlook 2018: Return of the Business Cycle in late November.

http://WarMachines.com

Deutsche: The Swings In The Market Are About To Get Bigger And Bigger

One week ago, on November 9 something snapped in the Nikkei, which in the span of just over an one hour (from 13:20 to 14:30) crashed more than 800 points (before closing almost unchanged) at the same time as it was revealed that foreigners had just bought a record amount of Japanese stocks the previous month.

As expected, numerous theories emerged shortly after the wild plunge, with explanation from the mundane, i.e., foreigners dumping as the upward momentum abruptly ended, to the “Greek”, as gamma and vega stops were hit by various vol-targeting (CTAs, systemic, variable annutities and risk parity) funds. One such explanation came from Deutsche Bank, which attributed the move to a volatility shock,  as “heightened volatility appears to have triggered program trades to reduce risk”, and catalyzed by a rare swoon in both stocks and bonds, which led to a surge in Nikkei volatility…

… and forced highly leveraged risk parity funds and their peers to quickly delever. As DB’s Masao Muraki explained at the time:

[the] increase in stock (or stock and bond) volatility might trigger position cutbacks when hedge funds, CTAs, and others engage in trading with higher leverage. In fact, stocks and bonds weakened from about 13:20 in the Japanese market on 9 November

The involvement of risk-parity funds in the Nikkrash was hardly a surprise, because as we noted in “Global Stock, Bond Selloff Accelerates Amid Risk-Parity Rumblings” risk parity proxies had just suffered their worst day since July:

In good news for “market stability targeting” central banks around the globe, that moment of sheer risk-parity turmoil was confined to that day, and in a follow up note released today Muraki writes that Japanese equities “have broadly returned to our model as of the 15th (there was a small volatility shock on that day as well).”

This is also confirmed by the performance of risk parity funds, which have rapidly “normalized” in the past few days.

There were some not so good news too, and as the Deutsche strategist wrote, “we will be closely monitoring whether the Japanese stock market returns to moving in tune with US equities, interest rates, and forex, or again diverges.” Why? Because with volatility already at or near record lows across most asset classes, vol spikes – recall the beta of spot VIX is now over 19 – will become increasingly greater, leading to even more aggressive “buy the dip” reversals, largely as a result of retail investors entering the vol-selling space:

We have noted a historical pattern of moderate volatility decline followed by sudden dramatic increase (normalization) in volatility. There is possibility of greater volatility amplitude than in the past because of the participation of less experienced retail investors along with hedge funds as the traditional sellers of volatility.

And the punchline:

Funds with volatility targeting strategy are growing to the largest ever. If the influence of such funds expands, the buying pressure on risk assets would increase in low volatility phase, and the selling pressure would increase in high volatility phase.

The conditional framing of that statement was redundant, because as DB also shows both Var. Annuity and CTA funds have been growing by leaps and bounds in recent years, and while there is no definitive size for the risk parity universe, we do know that roughly half of the world’s biggest hedge fund is one giant risk-parity strategy. It is not alone.  In other words, the “influence” of vol-targeting funds has never been greater, and it continues to grow with every passing day.

Meanwhile, even more troubling, the leverage of an indicative vol-targeting fund (with a 12% vol target) likewise continues to grow, meaning that any vol spike could have devastating consequences for the fund, and the market, as it would be virtually impossible to deleverage in time.

Which means that as the DB thesis plays out, the swings in the market will continue to get increasingly bigger.

And while in the good old days one would be able to at least hedge partially by buying VIX futs or calls, now it is the vol complex itself that is suppressed, making hedging not only impossible but assuring that future vol surge episodes will be even sharper, faster and more acute.

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Goldman Reveals Its Top Trade Recommendations For 2018

It’s that time of the year again when with just a few weeks left in the year, Goldman unveils its top trade recommendations for the year ahead. And while Goldman’s Top trades for 2016 was an abysmal disaster, with the bank getting stopped out with a loss on virtually all trade recos within weeks after the infamous China crash in early 2016, its 2017 “top trade” recos did far better. Which brings us to Thursday morning, when Goldman just unveiled the first seven of its recommended Top Trades for 2018 which “represent some of the highest conviction market expressions of our economic outlook.”

Without further ado, here are the initial 7 trades (on which Goldman :

  • Top Trade #1: Position for more Fed hikes and a rebuild of term premium by shorting 10-year US Treasuries.
  • Top Trade #2: Go long EUR/JPY for continued rotation around a flat Dollar.
  • Top Trade #3: Go long the EM growth cycle via the MSCI EM stock market index.
  • Top Trade #4: Go long inflation risk premium in the Euro area via EUR 5-year 5-year forward inflation.
  • Top Trade #5: Position for ‘early vs. late’ cycle in EM vs the US by going long the EMBI Global Index against short the US High Yield iBoxx Index.
  • Top Trade #6: Own diversifed Asian growth, and the hedge interest rate risk via FX relative value (Long INR, IDR, KRW vs. short SGD and JPY).
  • Top Trade #7: Go long the global growth and non-oil commodity beta through long BRL, CLP, PEN vs. short USD.

As Goldman’s Francesco Garzarelli writes, “these trades represent some of the highest conviction market expressions of the economic outlook we laid out in the latest Global Economics Analyst, as well as in our Top 10 Market Themes for 2018. Some of the key market themes reflected in our trade recommendations include:

  • Strong and synchronous global expansion. We forecast global n GDP growth of around 4% in both 2017 and 2018, suggesting that next year’s global economy will likely surprise on the upside of consensus expectations.
  • Relatively low recession risk. Given the low inflation and well-anchored inflation expectations across DM economies, we think central banks have little reason to risk ‘murdering’ this expansion with the kind of aggressive rate hikes that would have historically been warranted to fight the risk of inflation becoming entrenched.
  • But relatively high drawdown risk. Even if growth remains strong in the coming year, markets are still susceptible to temporary drawdowns, especially given the high level of valuations. We think the two most prominent risks to markets in 2018 are (1) pressures on US corporate margins from rising wages and 2) a swing in market psychology around the withdrawal of QE, which could lead to a faster re-pricing of interest rate markets than we assume.
  • More room to grow in EM.While most developed economies are currently growing well above potential, most emerging market economies still have room for growth to accelerate in 2018.

More from Goldman:

Our Top Trade recommendations reflect our Top Ten Market Themes for the year ahead. To capture the gradual normalization of the bond term premium and position for a more hawkish path of the Fed funds rate than the market currently expects, we recommend going short 10-year US Treasuries. Given our expectations of a ‘soggy Dollar’ in 2018, we think investors should position for a rotation into Euro area assets and continued Yield Curve Control from the BoJ by going long EUR/JPY. We expect EM growth to accelerate further in the coming year and suggest going long the EM growth cycle via the MSCI EM stock market index. At the same time, the EM credit cycle appears ‘younger and friendlier’ than the ageing US credit cycle, so we recommend going long the EMBI Global against US High-Yield credit. The combination of solid global growth and supportive domestic factors should help the Indonesian Rupiah, the Indian Rupee and Korean Won rally in 2018, while we expect the low-yielding Singaporean Dollar and Japanese Yen to underperform. Since the strong global demand environment should also help the commodity complex perform well but commodities as an investment carry poorly, we recommend going long BRL, CLP and PEN to gain diversified exposure to the commodities story.

And some more details on the individual trades:

Top Trade #1: Position for more Fed hikes and a rebuild of ‘term premium’ by shorting 10-year US Treasuries

Go short 10-year US Treasuries with a target of 3.0% and a stop at 2.0%.

We forecast that the yield on 10-year US Treasury Notes will head towards 3% next year, levels last seen before the decline in oil prices in 2014. By contrast, the market discounts that 10-year yields will be at 2.5% at the end of 2018, a meagre 20bp above spot levels. Our view builds on two main assumptions. First, QE and negative rate policies conducted by central banks in Europe and Japan have amplified the fall in  the term premium on bonds globally and have contributed to flatten the US yield curve this year – a central ingredient in our macro rates strategy for 2017. As a result of this, we think that US monetary conditions are too accommodative for the Fed’s comfort in light of the little spare capacity left in the jobs market. This will likely lead the FOMC to deliver policy rate hikes in excess of those discounted by the market (Exhibit 1). On our US Economists’ baseline projections, Dec 2018 Eurodollar futures, trading at an implied yield of 2.0%, will settle at 2.5%.

Second, we expect a normalization in the US bond term premium from the current exceptionally low levels over the coming quarters (Exhibit 2). This will reflect the compounding of two forces. One is an increase  in inflation uncertainty as the economic cycle continues to mature. The other reflects the interplay of the lower amount of Treasury bonds that the Fed will roll over (quantitative tightening, QT) and higher Treasury issuance. We expect these dynamics to come to the fore particularly in the second half of the year.

* * *

Top Trade #2: Go long EUR/JPY for continued rotation around a flat Dollar

Go long EUR/JPY with a target of 140 and a stop at 130.

Although most economies are sharing in the upturn in global activity, there remains scope for divergence in capital flows and therefore FX performance. Among the major developed markets, we think this is particularly true for the Euro and Yen. We expect both currencies to head back to one twenty—1.20 for EUR and 120 for JPY—over the coming months. We therefore recommend that investors go long the cross, with a target of 140 and stop of 130 (Exhibit 3).

We interpreted the run-up in the Euro in 2017 as a kind of ‘short-covering’ rally. Euro area growth picked up, national politics trended in a favourable direction, and the ECB began to turn its attention away from monetary easing and towards the eventual normalisation in policy by tapering bond purchases. Against this backdrop, many investors seem to have decided that Euro shorts were no longer appropriate—especially given estimates of long-run ‘fair value’ for EUR/USD of around 1.30. Direct measures of investor positioning bear this out. For instance, net speculative Euro length in futures swung from a short of $9bn at the start of the year to a long of $12bn as of last week. These portfolio shifts seem to have more room to run: bond funds remain long USD in aggregate, and FX reserve managers have not started to  cover their substantial EUR underweight. Continued inflows into Euro area assets should support the EUR currency, even as interest rates remain low.

The opposite holds true for the Japanese Yen. Because of the Bank of Japan’s Yield Curve Control (YCC) policy, USD/JPY has remained highly correlated with yields on long-maturity US Treasuries (Exhibit 4). As a result of the recent general election—in which the LDP won another supermajority—a continuation of YCC appears very likely for the time being. Although the policy is beginning to bear fruit—in terms of improving price and wage trends—we suspect that Governor Kuroda (or his possible replacement) will judge these favourable signs as well short of what is needed to consider reversing course. Therefore, with global yields pushing higher on the back of solid growth, we think USD/JPY can again approach its cyclical highs.

* * *

Top Trade #3: Go long the EM growth cycle via the MSCI EM stock market index

Go long EM equities through the MSCI EM Index with a target at 1300 (+15%) and a stop at 1040 (-8%).

As we outline in our Top Themes for 2018, we expect strong and synchronous global growth to continue into 2018. We prefer to own growth exposure in emerging economies, which we think have more room to grow. When EM growth is above-trend and rising, equities typically outperform on a volatility-adjusted basis.

From an earnings perspective, we see much more scope for EM corporates to surprise to the upside, driving equity performance in 2018 (Exhibit 6). MSCI EM EPS have rebounded quite quickly from a six-year stagnation and, in local currency terms, EM earnings per share (EPS) has repaired the ‘damage’ of the 2010-2016 period. We expect MSCI EM EPS to rise another 10% in 2018, which should drive the bulk of the upside in this trade.

From a valuation perspective, EM equities are not cheap relative to their own history (they are currently trading in the 86th percentile of the historical P/E range), but they are cheap relative to US equities (38th percentile of historical relative P/E range), which should hopefully offer some cushion in a global risk-off event. We find that the relative valuation of EM to DM equity is largely influenced by the growth  differential between the two regions; and we forecast this differential to widen another 60bp next year, which in turn should drive EM valuations to expand relative to DM by around 3%. To be sure, a long-only EM equity trade carries significant ‘pullback risk’, especially given the current entry point. Accordingly, we have set a stop on the recommended trade at -8%, which provides enough buffer to accommodate for a shock similar to the EM equity sell-off around the US election. Although EM equities have had a good run in 2017, we do not view the asset class as over-owned. Indeed, the cumulative foreign flow into major EM equity markets is still tracking below historical averages.

* * *

Top Trade #4: Go long the inflation risk premium in the Euro area via EUR 5-year 5-year forward inflation swaps

Go long EUR 5-year 5-year forward inflation with a target of 2.0% and a stop at 1.5%.

We recommend going long Euro area 5-year inflation 5-years forward (henceforth 5y-5y) through EUR inflation swaps, for an target of 2.0% – levels last seen in mid-2014 ahead of the fall in crude oil prices. The rationale for the trade is the following.

First, the risk premium on Euro area forward inflation is currently depressed, offering an attractive entry point. A low inflation risk premium can be inferred from the flat term structure of inflation swap yields. The difference between 5-year inflation, which is priced roughly in line with the expectations of our European Economists (Exhibit 7), and 5y-5y forward is near the lowest levels observed since the 2011 crisis.

Second, the inflation options market assigns high odds to Euro area headline inflation staying at or below 1% over the next 5 years. Against this backdrop, the ECB has reiterated its determination to keep monetary policy accommodative in order to encourage a rebuild of inflationary pressures. With the expansion in activity and job creation likely to continue, we expect the inflation risk premium to increase.

* * *

Top Trade #5: Position for ‘early vs. late’ cycle in EM vs. the US by going long the EMBI Global Index against short the US High Yield iBoxx Index

Go long EM USD credit through the EMBI Global against US High-Yield credit through the iBoxx USD Liquid High Yield Index, with a 1.5×1 notional ratio, indexed at inception to 100, with a total return target at 106 and a stop at 96.

The EM credit cycle is ‘younger and friendlier’ relative to an ageing US corporate credit cycle. With the improvement in macro fundamentals across EM, namely better current account balances, dis-inflation and FX reserve accumulation, we do not see a near-term risk of Dollar funding concerns. While EM credit spreads are not cheap per se, we see relative value against the US High-Yield market. In addition to the growing exposure of the latter to secularly challenged sectors, with the US cycle maturing and profit margins potentially eroding, we see more fundamental concerns in US High-Yield than in the EMBI (of which 70% of the constituents are sovereign bonds and the remainder in ‘quasi-sovereigns’).

Unlike most EM trades, long EM credit vs. US High-Yield has yet to fully recover from the sell-off following the US election. Since the ‘taper tantrum’, EM has generally outperformed with the exception of a few sharp risk-off events that had specific negative-EM implications (such as the sharp decline in oil prices and Russian recession in late 2014/early 2015, and the 2016 US presidential election). However, other risk- off periods, such as the Euro crisis in early 2011, saw EM credit outperform US high-yield.

The relative performance of EM vs. US High-Yield consistently tracks the EM-DM growth differential (Exhibit 10). We expect the general trend of EM outperformance to continue in a pro-risk environment and see the entry point as attractive, albeit admittedly slightly less so following the recent High-Yield sell-off. Finally, this trade is positive carry and should perform well if global spreads move sideways to tighter. We have set the stop at -4%, which coincides roughly with the bottom reached after the US election.

* * *

Top Trade #6: Own diversifed Asian growth, and the hedge the interest rate risk via FX relative value (long INR, IDR, KRW vs. short SGD and JPY)

Go long an equal-weighted basket of INR, IDR, KRW against an equal-weighted  basket of SGD and JPY, indexed at inception to 100, with a total-return target at 110 and stop at 95.

INR, IDR and KRW provide diversified exposure to the strong global growth we forecast in 2018 and specific idiosyncratic factors that should support their currencies in the year ahead. The combination of commodity exporting (IDR) and commodity importing (INR and KRW) currencies on the long leg of the recommended trade offers some protection against swings in commodity prices. By funding out of SGD and JPY, not only do we take advantage of their low yields, but JPY underperformance should also provide a hedge should the move higher in US yields lead to wobbles in the currencies where we recommend being long. The overall trade carries positively to the tune of about 4% over the year.

Country-specific factors in India, Indonesia and South Korea should boost their currencies, on top of the strong global growth environment we expect next year. Specifically:

India’s bank re-capitalization plan should impart a powerful positive impulse to investment in the coming year and should break the vicious cycle of higher non-performing loans, weaker bank balance sheets and slower credit growth. As the drags from GST implementation and de-monetization also fade, we expect growth to move from 6.2% in 2017 to 7.6% in calendar 2018. In addition to the three hikes we expect the Reserve Bank of India to deliver by Q2-2019, the high carry, FDI and equity inflows should also be supportive for the INR. We have moved our 12-month forecast for $/INR stronger to 62.

We continue to see Indonesia as a good carry market. As the drag on domestic consumption from the tax amnesty fades in 2018, we expect economic growth to move up to 5.8% in 2018 (from 5.2% in 2017), while the current account, inflation, and fiscal deficit should remain stable. We think Bank Indonesia is done easing and should move to hike rates by 50bp in H2-2018. We also expect Indonesia to be included in the Global Aggregate bond index, which could prompt one-off inflows worth US$5bn in Q1-2018 (vs. US$10bn bond inflows YTD in 2017). We have moved our 12-month forecast for $/IDR stronger to 13000. Finally, Indonesia, like India, has accumulated reserves over the past year that now stand at record high levels and should help mitigate volatility.

We expect the KRW to outperform other low-yielding Asian peers in 2018. The strong memory chip cycle should extend at least through H1-2018, while the government’s income-led growth policy provides a fiscal boost. Together with the boost from improving exports, this should allow the Bank of Korea to withdraw monetary accommodation in the face of rising financial stability concerns, with three policy rate hikes to 2.0% penciled in by the end of 2018. The thawing of China/South Korea relations and rebound in Chinese tourists should also help the travel balance. Overall, we expect the current account to remain stable at around 5% of GDP in 2018. Further deregulation in outbound capital flows could temper KRW strength over the medium term, but might not pass the National Assembly in the near future given  fragmentation in the legislative body. Our 12-month forecast for $/KRW is now stronger at 1060.

On the funding side, not only do SGD and JPY offer a low yield, we expect them to underperform in the year ahead. While we expect the Monetary Authority of Singapore to steepen its appreciation bias in October, we do not expect any significant SGD appreciation versus Asian peers given that the SGD is already trading on the strong side of the policy band. Meanwhile, we forecast USD/JPY at 120 in 12 months. With the BoJ controlling the yield curve as US rates move higher, JPY should continue to weaken, especially if US rates move higher than the forwards discount, as we expect.

* * *

Top Trade #7: Go long the global growth and non-oil commodity ‘beta’ through BRL, CLP, PEN vs. short USD

Go long a volatility-weighted basket of BRL, CLP and PEN (weights of 0.25, 0.25 and 0.5) against USD, indexed at inception to 100, with a total return target of 108 and a stop at 96.

The ongoing strength of global growth should continue to support a rally in most industrial metal prices. Our seventh Top Trade recommendation aims to capture this dynamic by going long the ‘growth and metals beta’. All three currencies on the long side have reliably responded to upswings in global trade and external demand over the past two decades. Moreover, each has performed particularly well in the pre-crisis decade, a period that also featured strong global growth and buoyant industrial metals prices. CLP offers direct exposure to a particularly encouraging story in copper, while BRL and PEN provide more varied metals exposures. The recommended trade has a positive carry of roughly 2.5% a year, and our 12-month forecasts are stronger than the forwards in all cases: we forecast USD/BRL at 3.10 in 12 months, USD/CLP at 605 in 12 months and USD/PEN at 3.15 in 12 months.

Beyond these global factors, our recommended Top Trade allows for diversified exposure to an encouraging Latin American growth recovery. Not only should growth in Brazil pick up as it recovers from a deep recession (and a recent BRL sell-off, creating an attractive entry-point), but BRL screens as strongly undervalued on our GSFEER currency model due to a combination of contained inflation and current account rebalancing, making BRL an attractive high carry currency. Meanwhile, PEN – the low-vol ‘tortoise’ of Andean FX – offers exposure to one of the most attractive valuation stories in the EM low- to mid-yielder space. Last but not least, CLP – the ‘hare’ of Andean FX – has moved quickly in 2017, so sends a somewhat less attractive valuation signal, but provides direct exposure to our most encouraging metals view, copper, and what opinion polls suggest is likely to be a market-friendly outcome in the upcoming Chilean election.

Finally, although it is designed for our global base case of strong growth, our Top Trade #7 can perform well in other external environments, potentially including a global growth disappointment. In particular, while BRL is a high-yielding and ‘equity-like’ currency, CLP and PEN are each lower-yielding and more ‘debt-like’: they have historically shown relatively resilient performance vs. the USD during periods of both declining growth and falling core rates.

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Futures Jump, Global Stocks Rebound From Longest Losing Streak Of The Year

After five consecutive daily losses on the MSCI world stock index and seven straight falls in Europe, there was finally a bounce, as investors returned to global equity markets in an optimistic mood on Thursday, sending US futures higher after several days of losses as global stocks rebounded following a Chinese commodity-driven rout. 

The House is poised to vote, and pass, on tax legislation although what happens in the Senate remains unclear. European shares rebounded for the first time in eight sessions, following Asian stocks higher as the global risk-off mood eased. The euro, Swiss franc and yen all weakened as the dollar edged higher. “After five or six days of steady selling you have got people coming back in looking for bargains,” said CMC Markets' Michael Hewson. “I think it’s temporary though. We haven’t had a significant sell off this year and the fact of the matter is that equity markets have done so much better than anyone dared to envisage.”

As Bloomberg echoes, "investors seem to be regaining their appetite for risk after several days of global declines in stocks and high-yield credit that had many questioning whether the selloff could become a rout."

Still, investor concern over the progress of a massive U.S. tax reform plan showed no sign of abating as two Republican lawmakers on Wednesday criticized the Senate’s latest proposal. U.S. President Donald Trump hit back, tweeting that “Tax cuts are getting close!”

“If we look at what the markets are focusing on, it’s still very much the tax cut debates in the U.S., and how much progress there’s going to be on this front,” Barclays' Mitul Kotecha told Reuters.

Indices in Tokyo, Shanghai and Hong Kong and Seoul all rallied overnight, while London, Frankfurt and Paris started 0.3-0.4% higher as cyclical stocks which had driven the sell-off made a comeback. In Japan the Topix index ended its longest losing streak in a year, rising 1% with technology stocks providing the biggest boost, and the Nikkei 225 advances 1.5%. The ASX (+0.2%) also managed to shake off its early losses, closing higher with the energy sector outperforming as consumer staples and utilities weighed. Chinese stocks edged lower despite a massive cash injection by the PBOC, while the Hang Seng moved higher. Hong Kong stocks rebounded from their worst day in four weeks, as insurers led by Ping An Insurance Group Co. jumped on optimism that rising bond yields will boost investment income. Tencent Holdings climbed after posting its fastest revenue growth in seven years.

China’s sovereign bonds finally rebounded, advancing after the central bank boosted cash injections by the most in 10 months, fueling speculation that the authorities are looking to stabilize sentiment after a debt selloff. Having flirted with 4% in recent days, the yield on 10-year government notes dropped 3 basis points to 3.95%; the 5-year yield fell 1 basis point to 3.95%. The 10-year yield surpassed 4% this week for the first time since 2014. The People’s Bank of China added a net 310 billion yuan ($47 billion) through reverse-repurchase agreements on Thursday, bringing this week’s open-market operation additions to 820 billion yuan, also the most since January.

European stocks bounce back from a seven-day rout – the longest losing streak of the year – that had erased almost 400 billion euros ($471 billion) from the value of the region’s benchmark. The Stoxx Europe 600 Index adds 0.7%, following gains in Asia and climbing from a two-month low. All national benchmarks in the region are in the green, except those in Italy and Greece. Most industry groups also rise, with automakers rebounding from an eight-day slump on data showing European car sales grew in October. Financial services firms and builders were among the biggest gainers in the broad advance of the Stoxx Europe 600 Index.

There was some relief too that oil prices had pulled out of what had been a near 5 percent drop and that upbeat U.S. data on Wednesday had helped the dollar halt the euro's sharp recent rise.

In currencies, the pound fluctuated as Brexit rhetoric rumbled on, and data showed U.K. retail sales barely rose in October. Concerns about Brexit continue to mount: an article in 'The Sun' newspaper, stated that UK PM May, could increase her divorce bill offer to the EU in December; deal would add GBP 20bln to the GBP 18bln said to already be on offer. Source reports indicate that EU is said to reject UK bid for `bespoke' trade deal, according to Politico. BoE's Carney states that the Bank will do whatever they can to support the UK economy during the Brexit transition period. Chancellor Hammond said to stick to fiscal rules and resist demands for spending surge in upcoming UK budget. Michael Gove is reportedly facing a Conservative party backlash as he is accused of using the cabinet to audition for UK Chancellor

The dollar index was slightly higher on the day at 93.828 having hit four- and five-week lows against the yen and euro. The euro was down around 14 ticks at $1.1760 retreating from a one-month top of $1.1860 on Wednesday. Havens underperformed on Thursday, with gold trading little changed, and the yen and Swiss franc among the worst-performing major currencies. The Swiss franc decreased 0.3 percent to $0.9918, the largest dip in more than two weeks.

Commodities largely stabilized as China’s central bank boosted the supply of cash in the system by the most since January, though oil eventually reversed a gain. Gold edged 0.1% lower to $1,277.29 an ounce. It reached $1,289.09 overnight, its highest since Oct. 20. Oil prices gained despite pressure after the U.S. government reported an unexpected increase in crude and gasoline stockpiles. They had lost ground to this week’s International Energy Agency (IEA) outlook for slower growth in global crude demand.

European government bonds took their cue from the U.S. benchmark, turning lower as the yield on 10-year Treasuries increased. Bond markets saw a broad rise in yields after mostly upbeat U.S. economic news on Wednesday had added to expectations the Federal Reserve will hike interest rates again next month as well as multiple times next year. Two-year Treasury yields US2YT=RR crept to fresh nine-year peaks in European trading, though significantly the U.S. yield curve remained at its flattest in a decade. European yields nudged higher too but the standout there was a fall in the premium investors demand to hold French debt over German peers to its lowest in over two years, almost to record lows.

Wal-Mart, Viacom, Best Buy and Applied Materials are among companies due to release results. Economic data include initial jobless claims, Philadelphia Fed Business Outlook.

Market Snapshot

  • S&P 500 futures up 0.4% to 2,574
  • STOXX Europe 600 up 0.7% to 384.61
  • MSCI Asia up 0.8% to 169.14
  • MSCI Asia ex Japan up 0.7% to 555.93
  • Nikkei up 1.5% to 22,351.12
  • Topix up 1% to 1,761.71
  • Hang Seng Index up 0.6% to 29,018.76
  • Shanghai Composite down 0.1% to 3,399.25
  • Sensex up 1% to 33,095.23
  • Australia S&P/ASX 200 up 0.2% to 5,943.51
  • Kospi up 0.7% to 2,534.79
  • German 10Y yield rose 1.3 bps to 0.389%
  • Euro down 0.1% to $1.1779
  • Brent Futures down 0.03% to $61.85/bbl
  • Italian 10Y yield rose 0.7 bps to 1.57%
  • Spanish 10Y yield rose 1.1 bps to 1.561%
  • Brent Futures down 0.03% to $61.85/bbl
  • Gold spot down 0.02% to $1,277.91
  • U.S. Dollar Index up 0.1% to 93.91

Top Overnight News

  • After a month of discussions, German Chancellor Angela Merkel faces a self-imposed end-of-week deadline to unlock coalition negotiations
  • British PM Theresa May saw some support from officials of her German counterpart Merkel
  • Manfred Weber, who leads Merkel’s Christian Democrats in the European Parliament and is a self-proclaimed skeptic on Brexit, changed his tone dramatically after meeting May saying the U.K. had a “credible” position and there was a “willingness to contribute to a positive outcome”
  • Sterling came under pressure after a Politico report said the EU’s Chief Brexit Negotiator Michel Barnier’s team flatly reject May’s bid for a “bespoke” trade deal
  • Fed officials are pushing for a potentially radical revamp of the playbook for guiding U.S. monetary policy. With inflation and interest rates still low, the central bank has little room to ease policy in a downturn
  • U.S. Treasury Secretary Steven Mnuchin is trying to persuade businesses and the Republican faithful to get behind a proposed tax overhaul from the Trump administration that so far lacks broad public support
  • The tax plan has provisions that may affect coverage and increase medical expenses for millions of families
  • President Robert Mugabe’s refusal to publicly resign is stalling plans by Zimbabwe’s military to swiftly install a transitional government after seizing power on Wednesday
  • Tax overhaul update: President Donald Trump is scheduled to head to the House, rallying Republican members before vote on tax bill
  • German Chancellor Angela Merkel meets heads of her Christian Democratic-led bloc, Free Democrats and Green party to kick coalition talks into gear
  • Cisco Sees First Revenue Growth in Eight Quarters; Shares Up
  • Koch Brothers Are Said to Back Meredith Bid to Buy Time Inc.
  • Health Care for Millions at Risk as Tax Writers Look for Revenue
  • Cerberus’s Feinberg Switches Strategy to Shake Up German Banking
  • Mattel Drops on Report That It Rebuffed Approach From Hasbro
  • New SUVs at Peugeot, Ford Offset U.K. Drag on Europe Car Sales
  • Google Sued for Using ‘Bait and Switch’ to Hook Minority Hires
  • Santos Seen Luring More Bids After Rejecting $7.2 Billion Offer
  • AT&T’s Clash With America Movil Slows Nafta Telecom Talks
  • Mobileye’s $15 Billion Deal Masks Drop in Israel Tech M&A
  • Mugabe’s Refusal to Resign Is Said to Stall Zimbabwe Transition

In Asian markets, a modest uptick in US stock index futures helped the Nikkei 225 stem some of its recent losses, with financials and retailers leading the way; as a result, he Japanese blue-chip index closed up 1.5%. The ASX (+0.2%) also managed to shake off its early losses, last closing up, with the energy sector outperforming (although this was on the back of confirmation of a rebuffed Santos takeover offer) as consumer staples and utilities weighed. Chinese stocks edged lower, while the Hang Seng moved higher Treasuries operated in a narrow range throughout the APac session, while JGBs were relatively listless, with a solid 20-year auction the highlight of the session. Aussie bond yields moved to session highs in the wake of the aforementioned labour market release, where they consolidated.

In European markets, equities kicked off the session on the front-foot in a continuation of some of the sentiment seen overnight during Asia-Pac trade (Nikkei 225 +1.5%). Some slight underperformance has been observed in the FTSE 100 with gains capped by a slew of ex-dividends which have trimmed 14.56 points off the index. Notable ex-dividends include both of Royal Dutch Shell’s listings, with the oil-heavyweight subsequently hampering the energy sector as WTI and Brent crude have failed to make any meaningful recovery from Thursday’s losses. Elsewhere, the likes of Fiat Chrysler (+2.5%) and Volkswagen (+2.4%) have been giving a help hand by the latest EU new car registration data. In fixed income, a limited reaction to better than forecast UK consumption data, and clear reservations about retail activity over the key Xmas and New Year period based on bleaker signals from anecdotal surveys and non-ONS data. Hence, Gilts dipped to 124.72 (-15 ticks vs +8 ticks at best), while the Short Sterling strip reversed pre-data gains to stand flat to only 1 ticks adrift before stabilising again. In truth, core bonds were already on the retreat from early highs (ie Bunds down to 162.43 vs 162.71 at best) in what appears to be a broad  retracement within recent ranges rather than anything more meaningful.

 

In FX, GBP has once again been a key source of focus with GBP/USD hit early doors amid reports in Politico that the EU are leaning towards rejecting the UK’s request for a bespoke trade deal. However, sentiment saw a mild recovery after reports in the Sun suggested that PM May could be on the cusp of upping her Brexit settlement offer in an attempt to kick-start trade talks. The main data release of the session thus far came in the form of UK retail sales which painted a less dreary picture of the UK economy than some had feared, although gains were short-lived as Brexit remains the focus. Marginal sterling buying was seen in EUR/GBP, trading around session lows, helped by a stop hunt through yesterday’s lows. Cable too saw a bid later in the session, benefiting from the weaker USD. Elsewhere, EUR/USD is back below 1.1800 vs the USD after topping out just ahead of October’s 1.1880 high, and now in a fresh albeit higher range flanked by big option expiries between 1.1795-1.1800 (913mln) and 1.1815-25 (4.8bln). Another roller-coaster ride for the Antipodeans, with AUD choppy on mixed labour data (headline count miss, but jobless rate and full employment upbeat) and pivoting the 0.7600 handle vs the USD.

In the commodities complex, as mentioned above, WTI and Brent crude futures have failed to make any noteworthy recovery from the sell-off seen on Tuesday with energy newsflow particularly light during today’s session thus far with markets looking ahead to the November 30th OPEC meeting which is set to give nations the instruction to extend oil production cuts. In metals markets, gold prices have traded in a relatively similar manner with prices unable to be granted any reprieve from their latest tumble. Elsewhere, Nickel and Copper have been weighed on, sending prices to multi-week lows as concerns around Chinese growth prospects continue to linger.

Looking at the day ahead, weekly initial jobless claims, Philly Fed PMI for November, import price index for October, industrial production for October and NAHB housing market index for November will be released. The BoE Carney’s, Broadbent and Haldane will all participate at a public plenary session while the ECB’s Villeroy de Galhau and Constancio are due to speak, along with the Fed’s Williams, Mester and Kaplan.

US Event Calendar

  • 8:30am: U.S. Initial Jobless Claims, Nov. 11, est. 235k (prior 239k); Continuing Claims, Nov. 4, est. 1900k (prior 1901k)
  • 8:30am: U.S. Philadelphia Fed Business Outl, Nov., est. 24.6 (prior 27.9)
  • 8:30am: U.S. Import Price Index MoM, Oct., est. 0.4% (prior 0.7%); U.S. Export Price Index MoM, Oct., est. 0.4% (prior 0.8%);
  • 9:15am: U.S. Industrial Production MoM, Oct., est. 0.5% (prior 0.3%); Capacity Utilization, Oct., est. 76.3% (prior 76.0%)
  • 9:15am: U.S. Bloomberg Consumer Comfort, Nov. 12, no est. (prior 51.5); Economic Expectations, Nov., no est. (prior 47.5)

Central Bank speakers:

  • 9:10am: Fed’s Mester delivers keynote address at Cato Conference
  • 1:10pm: Fed’s Kaplan speaks to CFA society in Houston
  • 3:00pm: ECB’s Constancio speaks in Ottawa
  • 3:45pm: Fed’s Brainard delivers keynote at OFR FinTech Conference
  • 4:45pm: Fed’s Williams speaks at Asia Economic Policy Conference

DB's Jim Reid concludes the overnight wrap

There has been a lot of noise around the HY market in the past week or so as a combination of macro factors along with some notable earnings misses have weighed on the market. iTraxx Crossover and CDX HY have widened by around 25bps and 30bps respectively from their most recent tights, while the price level of the largest USD HY ETF (HYG US) is basically back to the same level as where it started the year, however this overstates the move in the US cash market and even more so in Europe. Looking in more detail at the cash market US HY has widened by around 60bps and EUR HY is 46bps wider from the  recent cycle tights only a few weeks back but both are still around 25bps and 100bps tighter on the year respectively.

In a broad historic context the recent moves hardly register but in the context of a year that has been headlined by extremely low levels of volatility they are certainly significant. For EUR HY there were two other periods where we saw some sort of correction this year. In March/April (ahead of the French elections) the index widened 27bps in 42 days and then in August/September (after the North Korean escalation) we saw a 29bps widening over 30 days. So the current 46bps of widening in just 12 days has been somewhat more aggressive than anything else we’ve seen this year.

Looking at similar data for the US we have also seen two previous corrections. In March spreads widened 61bps in 20 days and then in July/August we saw 45bps of widening in 15 days. So the current c.60bps widening over 22 days is actually of a similar magnitude to this year’s previous corrections. The moves look even more stark when we focus on single-Bs though. EUR single-Bs have widened by more than 100bps from the most recent tights, more than halving the YTD tightening we had seen. For USD single-Bs the recent widening (65bps) has actually reversed more than 80% of the YTD spread tightening we had seen to the recent tights.

The question from here is whether this recent back-up in spreads is simply going to lead to a fresh buying opportunity or whether it will lead to something more significant. Despite some of the recent profit warnings we think that it is more likely to be the former at the moment. But at the very least the pace of this turn around highlights how quickly market sentiment can change, especially when spreads are so tight. HY was looking very very stretched relative to IG in Europe and this corrects some of that. Overall it certainly provides us with some food for thought as we look to publish our 2018 outlook in the next 10 days.

Even though US HY has been one of the weaker markets of late there’s no doubt that the recent global equity sell off has struggled to gather momentum as the US session has progressed over the last week. Following through on this, Asia has been weak since the Nikkei sudden sell-off last week and Europe has followed with yesterday seeing the 7th successive daily fall in the Stoxx 600 (-0.49%) – the longest losing streak since October/November 2016. Meanwhile yesterday the US (S&P 500 -0.55%) again closed off the early session lows showing that this equity sell-off isn't really being US led. For the record since last Wednesday's close the S&P 500, Stoxx 600 and Nikkei are down -1.15%, -3.17% and -3.86% respectively which helps illustrate this.

Volatility has been on the way up though even in the US over this period. The VIX spiked to 14.51 intraday which was the highest since August 18th. It closed at 13.13 (+13%) which is still the highest since the same period. Meanwhile the VSTOXX index was up +2.25% and is now at the highest level since early September.

This morning in Asia, markets have stemmed losses and are trading higher. The Nikkei (+1.24%), Kospi (+0.52%), Hang Seng (+0.53%) and ASX 200 (+0.30%) are all up as we type. WTI oil is trading marginally higher and after the bell in the US, Cisco was up c6% after guiding to its first revenue gain in eight quarters.

On now to the big data of the yesterday and possibly the month. US Core CPI inflation surprised modestly to the upside in October, rising 0.225% in month-on-month terms (a firmer 0.2% print than DB expected). This raised the year-overyear rate to 1.8% (1.7% expected). The data provide additional evidence that the core inflation trend is firming after a string of very weak prints earlier this year. According to our economists, the three-month annualised change in core CPI inflation is now at 2.4%, the strongest since February 2017. We think inflation is turning a corner and regular consistent misses vs expectations will not be a feature of markets in 2018.

Staying in the US, the House’s version of the tax plan is reportedly on track for a vote on Thursday (local time). In terms of the Senate’s version, rhetoric appears to be heating up as the mark up process continues. The Democrats were reportedly not impressed with the last minute change to add in the repeal of the Obamacare individual mandate, to which Republican Senator Collins partly agrees on, noting that it “gravely complicated our efforts to combine tax reform and changes”, although she has not decided whether to vote against the bill or not. Elsewhere, Republican Senator Johnson has publicly confirmed that he is opposed to the revised GOP plan as it stands, in part as it does not do enough to help partnerships relative to the larger tax cuts for corporates.

Quickly recapping other markets performance from yesterday. Bond markets were firmer with core bond yields down 2-5bp (UST 10y -5bp; Bunds -2.1bp; Gilts -3.5bp) while peripherals underperformed with Portugal bonds leading the softness (+2.5bp). Key currencies were little changed, with US dollar index marginally higher, while Euro dipped -0.06% but Sterling rose 0.05%. In commodities, WTI oil fell another -0.70% (-3.2% for the week), in part following reports that Russia believes it’s too early to announce a potential extension of production cuts at OPEC’s meeting at end of the month. Notably, WTI is still up c18% from late August. Elsewhere, precious metals softened a little (Gold -0.16%; Silver -0.14%) and other base industrial metals were little changed (Copper -0.45%; Zinc -0.54%; Aluminium +0.36%).

Away from the markets, there were a deluge of Fed and ECB central bankers commentaries yesterday but overall contained minimal market moving information. In the details, the Fed’s Evans noted he was open-minded regarding policy action at the December FOMC ahead of discussions with fellow colleagues and sounded dovish on inflation, noting “I feel we are facing below target inflations” while reiterating the US labour market is “vibrant” and unemployment rate “could go below 4%”.

In Europe, the ECB’s Hansson was upbeat on the demand side of the economy and “feel more confident that inflation will eventually reach the levels consistent with our aim”. Elsewhere, the ECB’s Praet pointed to the importance of interest rates post QE, noting that “policy rates will eventually regain their status as the main instrument of policy, and our forward guidance will revert to a singular approach”. Finally, the ECB’s Coeure noted that it’s important for the ECB “to ensure that our own measures do not adversely affect the intermediation capacity of repo markets”.

Over in China yesterday, there were more signs that the government may tolerate slower economic growth in 2018. The Economic Daily reported that the deputy head of the Research Office of the State Council Ms Han has flagged that GDP growth at 6.3% in 2018-2020 would be sufficient to achieve the Party's 2020 growth target. As a reminder, our Chinese economists expect GDP growth to slow to 6.3% yoy by 1Q.

Finally, over in Zimbabwe, President Mugabe’s c40 years of power may be coming to an end with Bloomberg reporting the 93 year old was confined to his home, with military forces taking control of state owned  media outlets and sealing offthe parliament and central bank’s offices.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the core retail sales for October (ex-auto & gas) was in line at 0.3% mom, but with the prior reading upwardly revised by 0.1ppt. Elsewhere, the September business inventories was flat and in line for the month. Finally, the November empire manufacturing index fell from a c3 year high of 30.2 to a still solid reading of 19.4. After the recent economic data, the Atlanta Fed’s GDPNow estimate of 4Q GDP growth has edged 0.1pp lower to 3.2% saar.

In the UK, the September unemployment rate was in line and steady at 4.3% – still at a 42 year low, while the average weekly earnings remains low but was slightly above expectations at 2.2% yoy (vs. 2.1% expected). Elsewhere, jobless claims (1.1k vs. 1.7k previous) and claimant count rate (2.3% vs. same as previous) were broadly similar to prior readings. The Eurozone’s September trade surplus widened to EUR$25bln (vs. EUR$21bln expected), while the final reading for France’s October CPI was unrevised at 0.1% mom and 1.2% yoy.

Looking at the day ahead, the final October CPI report for the Euro area will be out. UK retail sales data for October and Q3 employment data for France will also be released. In the US weekly initial jobless claims, Philly Fed PMI for November, import price index for October, industrial production for October and NAHB housing market index for November will be released. The BoE Carney’s, Broadbent and Haldane will all participate at a public plenary session while the ECB’s Villeroy de Galhau and Constancio are due to speak, along with the Fed’s Williams, Mester and Kaplan.

http://WarMachines.com

Why Pound Volatility Is Here To Stay

By Vassilis Karamanis, an FX and rates strategist who writes for Bloomberg.

Brexit Ructions May Mean Sustained Pound Volatility: Macro View

This week’s spike in the volatility of the British pound could prove longer-lasting than the bouts of instability seen so far in 2017.

One-month implied volatility for GBP/USD is on course for the biggest weekly gain since January after Conservative Party lawmakers were seen willing to challenge May’s leadership and talk of a 60 billion-euro Brexit bill resurfaced.

On Wednesday, demand for low-delta options hit a three-month high. EU officials were said to be bracing for failure as both sides seek a breakthrough in negotiations before a crunch meeting next month.

The jump in pound swings is nothing new, though previous episodes were neither prolonged nor sustained. Traders tend to respond in a late fashion to political risks, and adverse market outcomes have been avoided in the end. Volatility has actually been in a steady downtrend since January, as forward guidance by the central bank made sure investors faced as few surprises as possible.

This time, however, BOE Governor Carney has stressed the importance of the divorce talks to monetary policy. And the turmoil in Westminster means the current impasse in negotiations may continue into 2018, making sure sterling remains very sensitive to Brexit headlines.

Investors may need to keep rolling over their long-volatility positions to stay hedged if a no-deal outcome is back in the cards.

http://WarMachines.com

The “Other” Side of Asymmetry You Never Hear About

By Chris at www.CapitalistExploits.at

Everyone’s heard of “The Big Short”. We’ve Hollywood to thank for that, and thank them I will. After all, who didn’t love Margot Robbie explaining how it all worked? Even Mrs. Chris liked her.

Of course, our heroes correctly bet against these mortgage backed securities smoking piles of isht and now they all drive Porsches and eat lobsters in their bathrobes.

Likewise, everyone’s heard of Jesse Livermore’s famous shorting of the 1907 and 1929 markets where he made a fortune — over a billion green ones in todays money, actually.

Then there’s the legendary stories such as Paul Tudor Jones shorting into what was to become known as Black Monday in 1987, tripling his money.

Now, if you were to ask what defined these trades and made them different from any other, more often than not you’d be told that a lot of money was made in a very short period of time, which in itself is unusual.

True, but that doesn’t tell the whole story.

Dig further and ask what made it so, and you’d likely hear that the upside in the trades was high as opposed to say buying the Dow, taking a strong sedative, and waking up in 20 years.

All of these things are correct, but if you ask me this misses what is probably THE most important point that actually acts as a potential (note: I said potential, nothing is guaranteed) “tell” in any market. Bugger all downside risk. And this happens for very obvious reasons.

It actually comes back to what makes any market become over or undervalued in the extreme. In psychology it’s known as the Dunning-Kruger effect or the cognitive bias in which individuals with low ability perceive themselves as having high ability. It is, in essence, overconfidence.

It was overconfidence that led Joe Sixpack to continue to buy real estate at prices which had become completely disconnected with the incomes that must support those prices, leading to the GFC.

It was overconfidence that led the pointy-shoed suits on Wall Street to package subprime mortgages up, believing that a pile of isht when added to other piles of isht through the magic of diversification turns isht into non isht. Many actually believed that. Overconfidence.

In a past life, I saw this at the big banks who construct ridiculously complex models to assess risk. I spoke about this in “VAR shocks” where I marvelled at how they keep getting it wrong. A fair amount of blame must rest on the shoulders of overconfidence.

In fact, the most epic financial screw-ups in history have all been accompanied by overconfidence.

Remember LTCM?

Granted, I’ve never received a Nobel prize but if I ever did, I’d probably feel overconfident, strut my stuff, and do something monumentally stupid.

Like becoming so confident bond spreads couldn’t widen beyond a certain point for a certain period of time that I’d throw all sensible position sizing out of the window and go all in. I’d probably do that just before a major crisis like the rubble collapse. It’s why, if I ever make it onto the cover of Forbes or Time magazine, you should probably immediately unsubscribe or at least do the opposite of whatever it is I’m doing.

Over the weekend, I was thinking about where investors are confident today or indeed where they’ve completely lost confidence. So I set my skinny fingers to work and looked back at what’s transpired in the last couple of decades to see if I could find a market where investors got completely hosed for getting it wrong.

And you know what smacked me like a pan on the face?

The standout winner: Shorting the JGB market.

It’s not called the widow maker for nothing. This is one trade that has been just ideal for folks who like to be tied up and beaten for thrills.

Understandably there’s not many of these guys left. If you want to hear a deafening silence, try this. Yell into a room full of hedgies, “who’s short JGBs?”

Here’s the 10-year Japan government bond yield curve:

We all know the math here. Heck every macro hedgie worth his salt has looked at and had a crack at this bad boy, including yours truly. Ouch!

Maybe the BOJ keeps buying the bond market until they own the whole damn thing. Maybe nobody cares. Maybe the yen doesn’t even move after the bond market is completely owned by the BOJ. Maybe deflation is like stupidity: Here forever, no matter what.

Then again, maybe Harvey Weinstein’s a loving husband and a nice guy.

What is unique about Japan is that the BOJ is targeting yield and holding the 10-year at zero. Not sub zero – just zero. This is important because as we now know yields can go negative, meaning shorting a bond that’s trading at say 100 no longer means it can’t trade at 109.

To illustrate my point just take a look at bunds.

At present, they’re are as crazy as Heinz after you’ve nicked his beer and taken off with his daughter. We can see that the yield is negative all the way out to the 8-year.

And this is what makes JGBs kinda unique.

Theoretically, the floor is zero. Granted, this could change, but let’s go with it for the minute. If your central bank tells you explicitly where the bond is going to trade at, then what the hell’s the point in trading it?

To answer this, let me return to the beginning of this missive. What is it that most people miss when talking about massive payoff trades?

The answer is very, very low risk should the trade not pan out.

Sure, we all want big payoff trades, but the other side of asymmetry is our cost of entry and our risk if we screw it up. Well, let’s return now to our sake drinking friends.

Due in no small part to the BOJ holding the 10-year yield at zero, volatility has lost all the bones in its body and collapsed. Nobody’s playing anymore. Take a look: Implied volatility of 1.2%. That’s basically free.

Which presents an interesting situation. The cost to short JGBs now is about as close to zero as we’ve ever gotten.

What I ask myself is this: Have the laws of economics been suspended indefinitely?

Because if we do the simple math (as so many fund managers have done for the last 20 years), we still realise that even more than ever with a debt to GDP of over 250% it’s become so very important to ensure that nothing, and I mean nothing, moves rates on the BOJ.

Because if it did. Well…

Right now, everyone has given up on this trade, except the two guys with balls in their mouth. The world is fragmenting politically, and the BOJ has pegged the bond market. And if there’s one thing history teaches us, it is that all pegs break at some point.

Right now, there are multiple indicators showing both stress in bond markets and rising inflation.

What happens if the tiniest bit of inflation creeps in and the BOJ attempts foolishly to keep the peg?

Well, it’ll mean a godawful amount of yen printing to keep the short end of the curve under control. But the printing of yen can quickly lead to an inflationary feedback loop, especially given that all maturities would come under pressure and this would mean the BOJ would be firefighting across maturities. More printing of yen, more feedback loop. Kaboom!

Hmmm….

Something to think about. And it’s close to free.

– Chris

“All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope. That is why the numerical formations and patterns recur on a constant basis.” — Jesse Livermore

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Liked this article? Then you’ll probably like my other missives on

this topic as well. Go here to access them (free, of course).

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http://WarMachines.com

The Unbearable Slowness Of Fourth Turnings, Part 2

Authored by Jim Quinn via The Burning Platform blog,

In Part 1 of this article I provided the background regarding the phases of Fourth Turnings and where we stand nine years into this period of crisis. I will now ponder what could happen during the remainder of this Fourth Turning.

“History offers no guarantees. Obviously, things could go horribly wrong – the possibilities ranging from a nuclear exchange to incurable plagues, from terrorist anarchy to high-tech dictatorship. We should not assume that Providence will always exempt our nation from the irreversible tragedies that have overtaken so many others: not just temporary hardship, but debasement and total ruin. Losing in the next Fourth Turning could mean something incomparably worse. It could mean a lasting defeat from which our national innocence – perhaps even our nation – might never recover.” – Strauss & Howe – The Fourth Turning

The most important point to comprehend is the death of the existing social order always occurs during the course of a Fourth Turning. Thus far, those constituting the Deep State hierarchy have fended off their demise. They are utilizing every tool at their disposal to retain their wealth, power and control. As their mass media propaganda machine falters, they have redoubled their rigging of financial markets to promote a narrative of economic recovery, while further enriching themselves and their cronies.

It is clear they have reached the peak of financial manipulation, money printing, and artificial interest rate suppression. The narrative is faltering. Their last and final option to retain power is war. As their “everything bubble” (stocks, bonds, real estate) inevitably implodes, civil and/or global military conflict will be utilized to distract the populace from their Deep State domestic disasters.

The time for compromise is long past. There are no moderates left in the political spectrum. The mood of the country is clearly trending towards conflict. Trump, as the grey champion of this Fourth Turning, has proven to be a lightning rod of hate. He infuriates his political opponents, the left wing media, many in his own party, foreign leaders, billionaires and most worrisome to his well-being – the shadowy surveillance state intel operatives.

His own FBI and CIA have been subverting his presidency and attempting to initiate his impeachment or as a last resort – coup. After running a campaign championing a reduction in foreign military intervention in the Middle East, reducing commitments to NATO and increasing cooperation with Russia, it appears Trump has been taken into a room and told the military industrial complex calls the shots. Trump has clearly made a self-preservation decision to avoid being JFK’d.

The possibility of global catastrophe is not taken seriously by the vast majority of Americans. It’s been over seventy years since the last global conflict and most of the people who experienced the horror are dead. We’ve forgotten the past and are condemned to relive it, just as we do every eighty or so years. The lack of volatility in financial markets portends drastic levels of volatility as the perception markets can’t fall has lured Wall Street 30 something MBAs and the investor class into a sense of invincibility.

Geopolitical tensions have been rising dramatically over the last few years, with religious extremism, oil, petro-dollar, historical rivalries and nationalism driving the world towards conflict. These extreme economic and geopolitical stresses are coinciding along the same timeline and will erupt simultaneously, catalyzing the climactic half of this Fourth Turning.

“The risk of catastrophe will be very high. The nation could erupt into insurrection or civil violence, crack up geographically, or succumb to authoritarian rule. If there is a war, it is likely to be one of maximum risk and effort – in other words, a total war. Every Fourth Turning has registered an upward ratchet in the technology of destruction, and in mankind’s willingness to use it.” – Strauss & Howe – The Fourth Turning

With the House of Saud descending into madness as religious zealots, kings, princes, and foreign infiltrators vie for control of their depleting oil riches, and tens of billions in high tech weaponry provided by American arms dealers, a Middle East conflagration is a certainty. Iran has been winning the proxy wars in Syria, Iraq, and Yemen. Saudi Arabia and Israel are determined to stop Iran’s expansion at any cost.

Mixing religious extremism, oil riches, gas pipelines, opium, egotistical dictators, nuclear bombs, hatred and territorial ambitions into the deepening militaristic global mood change is destined to spark a chain reaction of unintended consequences and unyielding responses. The next Middle East war will not be a proxy war. It will be a fight to the death.

You need a scorecard to figure out the alliances, opponents and wildcards.

Iran appears to be aligned with Iraq, Qatar, Syria, Hezbollah, Yemen, and Russia.

 

Saudi Arabia appears to be aligned with Israel, UAE, and the United States.

 

Various factions, who include Turkey, ISIS, Al Qaeda, and the Kurds, are fighting one or more of these parties.

 

In many cases the enemy of my enemy is my friend applies.

Peace and compromise are out of the question at this point.

It’s just a matter of who pulls the trigger to kick off the fireworks. It looks like Saudi Arabia is willing to gamble everything on a final showdown with Iran. Once the shooting starts and the U.S. and Russia are sucked in, all bets are off on what happens next. Diplomacy will not be an option.

This scenario presumes a Korean conflict doesn’t happen first. With reckless actions on the part of Kim Jung Un and reckless rhetoric from both sides, the odds of a Korean conflict are the highest since the 1950s. With three carrier groups sitting off the Korean coastline, just one provocative act or mistake could unleash a fusillade from both sides, killing hundreds of thousands in a matter of days. Global treaties, alliances and economic realities are pushing global powers in unforeseen directions, just as this Fourth Turning enters its most dangerous phase. Human failings are the constant throughout history. But, human failings resulted in 50,000 deaths during the American Revolution Crisis. They could result in hundreds of millions of deaths during this Crisis.

The U.S. and Europe’s provocative actions with NATO forces surrounding Russia, the ongoing Ukraine civil war, the Syrian civil war, and false accusations of rigging the U.S. presidential election have pushed Russia into a closer alliance with China. Saudi Arabia has also strengthened ties with China, as the debt financed shale oil boom has lessened U.S. purchases of OPEC oil.

The EU is falling apart, as debt creation has failed to revive economies, governments are bankrupt, Muslim hordes destroy their social fabric, and a revolutionary spirit is in the air. Germany, France, Sweden and most of Europe have signed their own death warrant by allowing their countries to be invaded by millions of young Muslim men intent on destroying their way of life. Global disorder is expanding exponentially and is surely leading towards war.

War will either be the trigger for the forthcoming financial crash or a direct result of the forthcoming financial crash.

The core elements of this Fourth Turning (debt, civic decay, global disorder) are going to juxtapose and connect, accelerating into a chain reaction of chaos, civil uprising, global war, mass casualties, the fall of empires, and ultimately the destruction of the existing social order (aka Deep State).

When Americans see their wealth vaporized for the 3rd time in less than two decades by the same criminal bankers and corrupt politicians, they will not forgive, forget and bail them out again. They will seek out the guilty and make them pay through street justice. The fraudulent Deep State controlled scheme is beyond redemption and must be destroyed in order for a Constitution based free market system to be reintroduced. The result could also be dictatorship or worse. The outcomes will be determined by the actions we take as citizens.

With a debt inundated global economy already slowing; panicked central bankers beginning to take their foot off the accelerator; massively overvalued stock, bond and real estate markets; consumers in debt up to their eyeballs; stagnant wages; rising inflation; currency and trade wars heating up; deficits rising again; and gridlocked legislative bodies, the onset of war in the Middle East would cause oil prices to skyrocket and trigger the stock market collapse 3.0.

At this point, even the slightest hint of wage inflation causing interest rates to rise even modestly would prompt a market meltdown. The perfect storm is headed our way. The triple threats of debt, civic decay and global disorder cannot be avoided. We can’t defy the chaos set in motion by the cyclical nature of history. The seasons cannot be reversed, so we must brace ourselves for the oncoming storms.

“The future’s uncertain and the end is always near.”Jim Morrison

“No one here gets out alive.”Jim Morrison

There are no guarantees or certainties regarding what happens over the remaining decade or so of this Fourth Turning. Don’t believe God will exempt our empire from the tragedies that have befallen past empires. Debasement and total ruin are not inconsequential possibilities. Hubris, arrogance, decadence, and debt have devastated previous global empires and are present today in copious quantities as the American Empire enters its critical threshold of national survival. There are a myriad of internal and external competing forces which threaten both the status quo and very existence of our nation.

There will be moments of extreme danger and severe threats in the coming years. I do not consider the Russian people or the Chinese people my enemies, but my government will attempt to convince us to go to war against them, in order to maintain their empire. Human nature has not changed over the course of history, but the technological advancements in warfare have placed the ability to obliterate the planet into the hands of weak minded malevolent men, whose egotism and thirst for power know no bounds. Human flaws and frailties could endanger the world and its inhabitants. Do you trust the leadership of your country to do what’s in your best interest?

I do not trust my government. I do not trust the puppet politician front men for the Deep State. I do not trust the mega-corporations who dominate our economy. I do not trust central bankers and their Wall Street owners. I do not trust the fake news corporate media. I do not trust the military industrial complex. I do not trust the leaders of organized religion.

I trust my own instincts, reasoning ability, and critical thinking skills. I trust my immediate family members. I trust some of my neighbors. I trust more of people I’ve met through my blog than I’ve met face to face. I trust normal people living normal lives across this once great country. I trust the people who distrust the people and things I distrust. As events spiral out of control, we will need to pick and choose our friends carefully.

If or when the government attempts to force my three sons into a war on behalf of the vested interests to retain their wealth and power, I will resist with every ounce of strength in my aging body. They will not become cannon fodder for the Deep State. We don’t know the events and path which will drive the remainder of this crisis, but we do know our choices will matter.

This is no time for apathy and complacency. For those who grasp generational theory and the cycles of history, the seemingly unbearable slowness of this Fourth Turning is actually a blessing. The slowness allows more time to prepare. If you haven’t prepared for the coming saecular winter, time is growing short. The skies are darkening. Our rendezvous with destiny awaits.

 “Reflect on what happens when a terrible winter blizzard strikes. You hear the weather warning but probably fail to act on it. The sky darkens. Then the storm hits with full fury, and the air is a howling whiteness. One by one, your links to the machine age break down. Electricity flickers out, cutting off the TV. Batteries fade, cutting off the radio. Phones go dead. Roads become impossible, and cars get stuck. Food supplies dwindle.

Day to day vestiges of modern civilization – bank machines, mutual funds, mass retailers, computers, satellites, airplanes, governments – all recede into irrelevance. Picture yourself and your loved ones in the midst of a howling blizzard that lasts several years. Think about what you would need, who could help you, and why your fate might matter to anybody other than yourself. That is how to plan for a saecular winter.

Don’t think you can escape the Fourth Turning. History warns that a Crisis will reshape the basic social and economic environment that you now take for granted.” – Strauss & Howe The Fourth Turning

 

http://WarMachines.com

Yield Curve Collapses; High Yield Credit Gets Mauled: Banks Rally

Content originally published at iBankCoin.com

What?

We’re not supposed to see BAC higher on a day when spreads are collapsing, but we are nonetheless.

Financials are strong on an otherwise weak day, in spite of high yield getting killed once again. More on that in a minute.

JNK and all of PIMCOs high yield bond funds are getting crushed, some down more than 5% over the past 2 weeks.

Juxtapose that against treasuries and you can clearly see not all bonds are created equal. TLT is rising and hasn’t been hit like JNK.

I know this is all very data-dumpish, but bear with me as I attempt to scare you. Volatility is busting loose.

The only thing missing from the puzzle is the sharp rise in the Yen to officially spark worries of a carry trade unwind. What do you think, yen about to break higher or not?

Personally, I’d like to see a rout in NVDA, which is pretty much the poster boy of high valuation tech now, in order to confirm a true break in the market. The fact that banks are strong today suggests there is a bid in this tape, which might lead to a late date rally. Nevertheless, there are still numerous factors to be worried about, especially the breakdown in high yield credit and oil.

The only position I’d consider buying today is long Yen, but I think it’s rather redundant for me, considering my other bearish positions.

Top picks: short NVDA, RUSS, DRIP, UVXY for the laughs.

http://WarMachines.com