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Sunday, 30 June 2013

June update

    Month    Mthly return       NAV


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.


  1. surly you are overbetting your book and risking blow-up if you are up 30%+ in a month?

  2. I don't necessarily agree. I set my stop at 30% of my previous month end NAV. That sounds high, but I see no point copying the standard HF 10% stop-out - it just makes people aim subconsciously for 1% a month returns, which is a fiction anyway, and is only chosen because that's what pension funds want and that's where the asset base is. When you see the knots people have tied themselves in over the past 3 or 4 years it makes me want to avoid the whole 1% a month mentality.
    Having set a very deep stop, I'll obviously lose a lot more than a fund with a 10% stop when I have a bad month. The flip side is that I make a lot more on the way up, so ultimately it comes down to my Sharpe ratio and respecting the stop, which I do.
    Additionally, we've had 4 or 5 once-in-a-decade moves all in the last 6 months (Nikkei up 70%, gold down 25% in 3months, 100bps on 10yr yields in 2 months and a 15% fall in audusd, to pick a few. You can make outsize gains (or losses) in that environment, in a way you couldn't in 2012, say. And if you combine that market environment with a complacent option market you can put these trades on with relatively small downside. Most of the really big months have had at least one option trade that has come right and contributed a good proportion of the gain.
    Obviously though, the down months will hurt when they arrive - you can't hide that fact.

  3. i am totally with you Alastair. I dont like this "stay in the box" mentality to monthly returns and losses. I budget on futures points per week and then add this to a fund NAV % stop loss. If you view it like this, it adds a dimension of "fresh air" to this whole concept.
    ie take a 10mil usd fund. If you allocate 2mil ie 20% of fund to say silver futures for month. On a margin level thats approx 160 contracts but add in another layer of comfort and trade 100 contracts.
    On this one trade to hit 10% loss for fund for month you have to be wrong by 2 points. Now I feel that if that were to eventuate you really shouldnt be doing this as it is quite a "BADLY" timed trade.
    The flip side is with only using 20% of funds, if the trade makes even 2points over month, well thats 10% from one trade.
    I just dont think people take the time to break the numbers down.