Sunday 30 June 2013

June update


    Month    Mthly return       NAV

15Nov12100.00
Nov-1217.8%117.77
Dec-1337.4%161.78
Jan-1338.1%223.40
Feb-13-3.3%215.92
Mar-1312.4%242.62
Apr-1330.2%315.81
May-1368.8%533.08
Jun-1336.9%729.55


Overall view
The Fed is sticking to its party line : no hikes till 2015, but tapering in September, data permitting. After Stein's speech that sounds disingenuous. They're going to base the tapering "decision" on the accumulated data since QE3 started, and they're de-emphasizing individual payroll releases. That suggests that the decision has already been made, well before they went public a few weeks ago (hardly surprising given the stakes involved). It raises the question of whether Bernanke has lost the backing of the FOMC for QE3. Perhaps the leadership is still in favour, but the troops are rebelling. Lame duck or not, it's a Treasury bear market, and with more tapers in the pipeline and QE3 ending next year, the long end is a sell on rallies at least until Sept. Foreign central banks have got the message and are already selling in size. We've had a huge move though, so probably it gets harder to trade from here.

An interesting question is this : how different is this recovery from "normal" ? Usually rate sensitive sectors like housing and auto sales lead the recovery (tick), followed by increasing corporate investment (tentative tick), and a precautionary buildup in inventories, then falling unemployment (another tick) before finally consumption picks up the baton. The Fed would start hiking a year or so after the recovery started, once falling unemployment was well-entrenched. Aren't we there already ? If so, then 2015 is a wildly optimistic estimate for the first hike. 18 months from today. Really ? Ok, so GDP growth rates are well below normal, but you wouldn't know it if you looked at the unemployment chart. Anyway, GDP stats are notoriously prone to revision. 
Even worse is the Fed's inability to restrain the credit cycle. Normally commercial banks don't hold meaningful excess reserves at the Fed, so the Fed can easily curb excess credit growth, either by hiking rates or raising reserve requirements. To do that now, they need first to reverse much of the cumulative QE (all 3 rounds of it), as until then the banks will have excess reserves which they can lend freely if the demand is there. Or they could raise IOER out of the blue (the 1994 scenario). The Fed have checkmated themselves, just as the economy starts getting traction. They might turn out to be well behind the curve by the end of this year. Of course Bernanke won't be around to deal with the problem. In their shoes I'd be quietly praying for a Chinese hard landing to get me off the hook. The risk premium in the 2016-2018 part of the ED curve could go through the roof in this scenario.

The short trade in treasuries works if US real rates keep rising. The threats come mainly from China, which I've covered by shorting AUDUSD and copper. If the Fed miraculously turn dovish for some other reason then equities should explode higher, and I think that's best covered by a Nikkei long (which is now purged of excess positions I think, and which should work even in a treasury bear market provided usdjpy resumes its climb). My favourite equity market is Japan as explained, and I have a small short in SPX. Nothing in FTSE for now, though I'd buy it rather than selling it here.

Specific trades.
Gold : I've closed my remaining gold short on this collapse, and will wait for a rally to re-establish. I could envisage a stand-up fight between bulls and bears somewhere between 1000 and 750, where we decide who's right. In essence, should gold be at 200 or 2000 ? Until then the primary direction is lower, but we're well oversold so I'm on the sidelines for now. Gold made up 20% of June's performance.

Japan : I can't see usdjpy going down and staying there, with the Fed tightening and the BoJ easing. Now that spec positions have been purged (did they clear the decks for half year end ?), the path back through 100 seems open, and the Nikkei is a buy. This is probably my favourite reflation trade in the current environment. Japanese retail have few other options as inflation rises, and the quasi-govt institutions are being herded into equities by the bureaucracy.

Treasuries : Still a bear market in the long end, although the short end will be supported by Fed rhetoric (until it isn't !). After the FOMC I covered some of my outright short by buying covered calls in EDZ4, selling short Dec 99.375 calls for 10ish bps versus futures, against bearish positions in TY and US. Half of this month's return was US fixed income, so I've taken some profit on EDU4/U5 too. 

Copper : short, looking for a break of 3.00 in HG1. This is another expression of the short AUD trade, but without negative carry and more focussed on china. Flat this month.

Australia : still short, and just trading around the core position by buying a little back on really bad days. A third of June's return was Aussie.


If the easy moves are over, then having a plan and staying disciplined is going to be even more important than usual. Easy to say, not so easy to do.

Friday 21 June 2013

Dammit Jon, those Dec14 euros are 20bps too low, I tell you. Talk them up, there's a good chap !

The selloff in treasuries is on the brink of becoming self-propelled - classic VaR shock stuff. The Fed is trying to micro-manage the short end with these Hilsenrath articles. Volcker and even Greenspan must be quietly seething as they watch this farce, but the attempt to stop rate hikes being priced in only underlines the message that tapering is on the way. Steepeners are the path of least resistance : I like EDZ4/Z7 more than U4/U5 at these levels, but it does suggest selling 10s and bonds against red EDs. Pimco etc are long and wrong here, and clearly aren't out yet, so rallies in the long end are to be sold. 2.5% for 10y yields is too good a risk/reward balance to be sustainable (should be about 20bp higher I'd say). Everything will presumably rally out of sight on Monday after Hilsenrath's pronouncements, so maybe next week will be the window of opportunity to sell the long end before payrolls the week after. The real threat to tapering comes from an equity collapse, so I'm short SPX now.

Copper is increasingly interesting. LME stockpiles are at a 10 year high, and supply - expected demand is projected to triple this year from last. That can only get worse if China's landing turns out to be as hard as it's looking. Why would the new regime back off now ? They have one opportunity only to squeeze some excess from the system and blame it on their predecessors, and that isn't a 2 week process. There'll be false glimmers of optimism along the way, but it seems to me we're into a multi-month tightening in China. With high inventories, prices sitting on a multi-month support level and a hawkish Fed, copper should be set for a break lower. Short now, with a view to selling more if we drop through 3.00.

I've pulled out of Japan entirely (took profit on usdjpy longs and a small long in nikkei), but on reflection maybe usdjpy is still worthwhile, with the two central banks heading in opposite directions. I'll avoid the Nikkei as I don't think this is an equity friendly backdrop.  I'm flat in GBP and the eurozone, but keeping the short audusd trade, and reducing my gold short. It's dangerous to have too many moving parts when it's this volatile.

Thursday 20 June 2013

copper

First thing to admit is that I know nothing about copper per se...

However, the Chinese shibor squeeze seems to be serious, and apart from selling audusd, which I already have on, copper seems the perfect trade. Add a hawkish Fed, and a chart that reminds me of gold in the way that it's been more-or-less supported at 300 for a few years (like the 1530 level in gold) and the risk return looks promising. It's not as clear as gold, where there were massive retail positions and inflation was falling rather than rising, but the degree of consensus about Chinese growth is not dissimilar to the way people spoke about gold a few months ago. It doesn't seem a crowded trade (no-one's mentioned it to me at any rate), so I think it can have a clearout here. Target 2.50 perhaps ?

A bit more homework is needed before making it a "proper" position, but I'm shorting a little bit here. Sell HGU3.

Friday 7 June 2013

Back to the Old Normal ?


A very ugly close, for a payrolls number which shouldn't have been that bad for fixed income. Look at the rolling 6th vs 10th contract (ie EDU4/U5) back to early 2009 :



Where we are now - about 50bp - was the floor until mid-2011, since when it has been the ceiling. (Incidentally you get the same picture, with the same dates, if you look at 10y yields or 30y yields - we're talking about the entire treasury market here, not just one obscure spread). I think that until mid-2011 most people believed we were still operating in the Old Normal, and the US would get a standard recovery (remember all that U/V/L debate ?). If you suggested that the US was in a Japanese style slump (L-shaped), people laughed at you. After mid-2011, with the extended period commitment for zero rates, Op Twist and open-ended QE3, L-shaped has become conventional wisdom, and the world has invested accordingly.

So *if* the labour market, retail sales and private capex hold up in the face of the sequester etc, then it seems that we're crossing from the New Normal (L) back into the Old Normal (U or even V). In that case this spread ought to head towards 100bps - which funnily enough is where the front calendar spread traded in Japan as they exited ZIRP in 2006. Hilsenrath's article today suggests that the Fed is going to taper in Sep or Dec, and the market will extrapolate that into rate hikes a year later.

We're basically at the cusp between two entirely different views of the world, and so vol will go through the roof. A couple more decent US numbers and they'll be throwing in the towels thick and fast.

Saturday 1 June 2013

May update




      Month    Mthly return       NAV

15Nov12 100.00
Nov-12 17.8% 117.77
Dec-13 37.4% 161.78
Jan-13 38.1% 223.40
Feb-13 -3.3% 215.92
Mar-13 12.4% 242.62
Apr-13 30.2% 315.81
May-13 68.8% 533.08

May was obviously one of those months when just about everything goes right, unlike Feb. I left the Nikkei party at 14000 (a bit early, but not complaining) and switched from long usdjpy into short audusd around 1.02. Bernanke fired the starting gun for a fixed income bear market which could have much further to run, and gold turned down as hoped from its rebound near 1475. About the only thing that didn't work was being long cable, but that stopped out at zero cost, so could have been much worse.

Looking forward, the trades with momentum are audusd (lower) and US fixed income (rates higher), which overlap on the US side. The Chinese steel inventory liquidation is getting serious, so iron ore and coking coal seem to have further to fall. Gold looks precarious, but crude and copper are treading water, so it's -3 on a scale of (-5,+5) for Aussie's terms of trades. The miners are thinning and stretching out their capex pipeline - the term is spaghettification -  so the 1% GDP tailwind is turning into a similarly sized headwind. How will they finance the c/a deficit as the capex inflows fall off ? In addition,  how many investors without an EM mandate are long audusd as a surrogate for China exposure ? It's hard to find bullish factors for aussie at the moment.

(A wildcard is the Sept general election : Labour look set to lose, having screwed up the fiscal position, so it might be politically expedient for the Liberals to run on a fiscal responsibility platform. In that case Australia could be getting a dose of austerity just as the capex cliff kicks in, which would only mean one thing for the RBA and audusd.)

US fixed income is all about May and Jun payrolls. If the labour market holds up (which is what the strength in consumer sentiment might be suggesting), then the Fed's rhetoric about tapering will continue, possibly aiming for a taper in the Sept meeting. They've been notably quiet about the recent selloff - tacit approval, perhaps ? Is this the dog that didn't bark ? I think so. My favourite trade here is a u4/u5 steepener, with a target above 60 (this could be the front calendar spread as rate hikes come on to the agenda, and since we're starting from zero I think we could see 100 or higher as the market starts to consider how far the Fed has to travel). Also short EDZ7 and long some low delta green Jun and blue Jun puts, just in case there's a blowout payrolls and the bond market goes into liquidation mode. It'll happen one day.

Japan will be interesting again soon. Right now, it's almost un-tradeable, with 500-1000 point swings in the Nikkei every other day. At least some of the selloff must be a month end effect - we were up 16% at one point this month, so there's some reallocation to be done. And there's the inevitable shakeout after a 70-80% 6 month rally. However the LDP doesn't want to go into elections with the Nikkei having a fit, and they seem to be strong-arming GPIF, Yucho, Kampo and the more docile private sector investors to support equities and take the pressure off JGBs. Fairly soon the storm should blow itself out, and there's a trendline coming in from the start of this rally at about 13000, so I've tentatively sold some July 13000 puts as a first step towards buying the dip. In 3 months' time this *could* look like nothing more than a "healthy"correction : a market that rallies 75% in 6 months is going to have 20% corrections instead of 5% ones, but that doesn't make it a bear market. Incidentally, there's a lot of confused thinking about JGBs. If JGBs collapse, how can the currency rally (they're collapsing because of fiscal sustainability concerns, not because of an imminent cycle of hikes after all). And if the yen falls, the exporters are in even better shape. Obviously the banks will have 'issues' (although they've shortened duration hugely after 2010), but ultimately they'll be bailed out by the Govt if necessary. Too big to fail. A 20 year JGB bull market was hardly wonderful news for equities, so perhaps a JGB bear market will be ok.

Elsewhere, I'm completely out of FTSE and SPX, but still sitting with AAPL, which seems to have quietly put in its first higher low in a year. When they eventually release a new product, perhaps the market will look at the chart and the p/e and feel uncomfortably underweight. People will always need iphones, after all !