Oct update

		indexed NAV
	adjusted return
		100.00
Nov-12	17.8%	117.77
Dec-12	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
Jun-13	36.9%	729.55
Jul-13	-12.6%	637.46
Aug-13	-1.7%	626.31
Sep-13	-9.6%	566.31
Oct-13	-4.9%	538.62

A very frustrating month here :

Equities               0.0%      Long Nikkei positions cancelling gains from S&P longs
Rates                   -1.8%     Shorts in US fixed income and small losses in Schatz & Bobl calls
Commodities      -1.3%     Stopped out of short gold at 1344, which turned a good trade into bad one
FX                       -1.8%    Stopped out of long USDJPY, short AUDUSD and long GBPCHF

Having sidestepped most of the US political noise I found it very hard to re-establish positions. Having had a large drawdown I'm running with much smaller positions and tighter stops. With hindsight, the positions should have been smaller still and the stops deeper : nearly all the trades I cut subsequently came good, so the lesson for November is to look for smaller positions on higher conviction trades.

Market outlook
US
October's first tier data (ISMs and payrolls) suggest that the real economy never believed the Washington pantomime. Perhaps Main Street is just as cynical as Wall street about the threats of US politicians. Either way, it's hard to see how Nov and Dec payrolls are going to be poor. That and the Fed's latest rhetoric (perpetually low rates should outweigh any taper) make me think that a Jan taper is most likely. I think the market basically "knows" this, but hasn't yet priced it in because we all got so badly hurt by the Fed's U-turn in Sept. Short gold, long the dollar (against AUD and JPY) and a small short in fixed income are all worth re-entering.

Japan
As things stand the impact of yen weakness on CPI will peak soon, but CPI is still a way from the BoJ's 2% target. Either Abe concedes defeat, or he makes another push to revive inflation. Defeat looks like political suicide, so my money is on another round of monetary stimulus. It's hard to buy more JGBs - they're already buying more than the annual net issuance - so the path of least resistance might be to buy more ETFs and equity index trackers. They'll be exploring the options for more easing at the same time that the Fed is talking its way to a Jan or Mar taper, so USDJPY

Sep update

Sep update

		indexed NAV
	monthly return
		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
Jun-13	36.9%	729.55
Jul-13	-12.6%	637.46
Aug-13	-1.7%	626.31
Sep-13	-9.6%	566.31

I feel like calling the US authorities and demanding my money back. I'd have put Summers for Fed chairman and an initial taper both as high probability outcomes, and obviously neither was. Having had a humiliating week in mid Sept, P&L preservation demanded a serious cut, so at least I've been largely on the sidelines during the current political fiasco in Washington.
I don't have a clear idea how to trade this situation - it's completely binary, driven by political egos and everything is correlated (so no good hedges that I can see). It beggars belief that the politicians will consciously drag us over the edge, but the gridlock and the dynamics in Washington are pushing that way. After all, everyone was aware of the risk of war in 1914 and no-one wanted it (well, maybe one did), but it still happened. I have some Schatz and Bobl calls 20-30bp OTM in case the unthinkable happens. The only long term position I'm keeping is long Japanese banks.

Things I'm watching with a view to enter when (if ?) the debt ceiling/shutdown is resolved :

Japan - people are starting to question Abenomics, which seems premature as you wouldn't expect it to be an easy straight line process. Offshore positions are being trimmed while domestic retail and institutional money are preparing for what could be the next leg (NISAs, GPIF asset re-allocation for example). BoJ seems to be talking down the JGB market and attempting to floor yields at 0.50, which sets up an interesting risk return there perhaps. I want to get the all clear from Washington first though.

Aussie - I'm out of the slowdown trade, as the data has bounced and housing seems to be following the NZ route.

UK - the recovery was looking great, until Osborne decided on a huge dose of adrenaline straight into the heart muscle (aka Help To Buy). Cue all 1 bed flats repricing to £600k. It seems unlikely to end happily. Being long GBP against CHF and AUD was a nice trade, but I'm now on the sidelines as explained.

USA - I'm concerned that everyone "knows" a default is unthinkable and that sanity will prevail. Markets are convinced that default is unthinkable, so they're not inclined to panic - but a market panic is the only tried and tested way to break a Washington logjam. So it's Catch 22, the downside being that if something goes wrong in this game of chicken then things fall apart extremely rapidly. Perhaps too rapidly for the authorities to react. The role of Treasuries as collateral seems to me the weakest link.

I'm out of the game till the odds are better.

insurance trade

Generally insurance trades are a waste of money, but the House Republicans seem determined to test that idea to destruction. It's a ninety-something percent probability that the debt ceiling is fixed by mid October, but if it isn't then it's nice to have protection. The best I can see is schatz and bobl calls expiring on Oct25th.

If the politicians screw up, the US could be in selective default soon after Oct 17th. That will raise a question mark against the eligibility of Treasuries as collateral for CSAs etc, and there'll be a mad scramble for every other government bond as banks and hedge funds try to get hold of replacement collateral. That points to Schatz and Bobl calls. Surprisingly the Nov calls (25th Oct expiry) are cheap : 0.01 for the Schatz 110.70 calls and 0.02 for Bobl 126.00 calls. If the unthinkable happens Schatz will trade to negative yields - we were there last year after all, so the precedent has been set - and these calls are in the money. Possible payout ratios could be 50:1 or higher, which seems a lot better than anything available in spx puts.

The real purpose is obviously to provide the backstop to buy equities if/when things are looking really ugly. We're not there yet though.

Aug update

Aug update

		indexed NAV
	adjusted return
		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
Jun-13	36.9%	729.55
Jul-13	-12.6%	637.46
Aug-13	-1.7%	626.31

Another frustrating month, especially in FX where I insisted on selling lows and buying highs again, but things seem to be picking up into September.

Ideas I like at the moment :

1. Long GBPCHF

People are getting used to the the idea that the eurozone isn't going to collapse (yet), but EURCHF is still at historically expensive levels. As CHF will lose more of its safe haven premium it makes it an attractive short against GBP. Obviously there's no net negative carry to speak of, and the chart looks good, as we're breaking out of a 3 or 4 year downtrend. The 1.40 level is good support provided eurozone breakup is off the table :




























It's really a doubly leveraged trade on eurozone recovery, as this is also one of the main reasons for the weakness of the UK economy since 2009. I prefer buying GBP to selling short sterling or gilts as the positioning seems cleaner and I don't want to incur the negative carry in the yield curve.


2. Resumption of the Abenomics trade

Japan still has some of the cheapest equities in the world, especially the megabanks. With very little fuss they offloaded a huge proportion of their JGBs on to the BoJ last quarter (almost half of them in the case of Sumitomo), and they're still on very cheap price/book ratios (0.75 for MUFG) and low p/es around 8-10. Just cheap then. Kuroda's commitment to further easing if the consumption tax slows the economy is important in underwriting the recovery, and USDJPY should be forced higher by rising US yields.


3. Aussie rates

The RBA may be taking a pause or done altogether, but either way the bill curve looks too steep. It's pricing 58bp between Z3 and Z4, and with all the PMIs in recession, retail sales growth stuck at zero and unemployment rising towards its 2009 peak that looks plain wrong. There are plenty of secondary reasons (mining capex cliff kicking in next year, some degree of fiscal restraint from the new govt and poor business confidence, eg the NAB survey). Further cuts next year aren't out of the question, but even without that this is my favourite slowdown trade. It's fighting the US rates headwind, but that's the reason for doing Z3/Z4 flatteners rather than just buying 3yr futures outright. It rolls down from 58bp in Dec to 31bp in Sep.


4. US yields

Last but not least, a Sept taper looks unavoidable now. The interesting question is, what next ? They've stuck so far to Bernanke's timetable (start tapering in Sept, finish by mid-2014), but the domestic data is turning out better than they expected, and the global data is far better. If anything that should bring the mid-2014 end date closer (and please don't suggest that Summers will stick to the schedule because he inherited it).*IF* they start with $10b in Sept, and pause in Oct to see the effects, then they have $75b to remove in at most 5 meetings. Alternatively they could start with $15b or $20b in Sept, or taper again in Oct. Any way you look at it, it's a more aggressive schedule than most people have been discussing, so it seems to me that when the market starts thinking about this on Sept 19th we'll have to sell off some more. Favourite trades here are short EDZ7 (still), covered puts in TYZ3 and FV/WN flatteners, ie 5/30s. And short some gold, just because it's had such a ridiculous squeeze.

July update

July was frustrating : after getting payrolls right and seeing a fresh high water mark, I was too slow to reduce in the face of the Fed's jawboning. As usual, when you start trying to defend P&L I ended up buying highs and selling lows, until I got fed up with my own wrong-headedness and cut properly just after mid month. Net-net, July ended up with a 12.6% loss, split between the following areas :

Equities
   UK               -0.9%
   Japan            -0.6%
   US                -1.2%
Fixed income
   US                -6.8%
   UK               -0.5%
Commodities
   Gold             +0.4%
   Copper          -1.8%
FX                   -1.3%

The driver has been US fixed income, not surprisingly. The data has been extremely strong in my opinion, payrolls notwithstanding. Rates did actually move marginally higher over the month, which makes a loss in this area even more inexcusable. New month resolutions :
- don't spend money on option premium
- run smaller positions
- don't trade reactively
Remaining positions are short AUD against USD and NZD, despite it being a very consensus trade, short EDZ7 and TYU3 and short gold again, all in less than half the size of late June.

All basic stuff. The most frustrating part is that if I'd had the discipline to do absolutely nothing at all I'd have made money in July. Time for a refresher course in trading discipline.

Will Jun payrolls be the straw that breaks the bull market's back ?

We're on the verge of breaking a rather serious trend. This is the 10yr yield since 1980 (the secular bull market in fixed income, older than half the people currently trading it). If 2.50 goes, then watch out. Will Jun payrolls be the straw that breaks the bull market's back  ? 

After good-to-strong recent data (ADP, car sales, durable goods), and a 25bp rally in 10s to flush out the uncommitted shorts, the pieces could be in place for a move to new yield highs. The obvious near-term target is 3%, about the same 150bp selloff that we had in Jun 2003 when the market realised that the last cut had arrived and the next move in rates would be higher. 10y notes have sold off 50bp due to the FOMC (2.16 to 2.66), and retraced 25 to 2.41. A second 50bp selloff from 2.41 would get to 2.91. Presumably that needs a strong payrolls number, which might be what the strength in consumer confidence and spending is saying. *If* we get to 3% then the above chart suggests we're in very scary territory. 

Here's a slightly biased perspective on current data :

5 yr highs                                                                               5 yr lows

Consumer confidence

Michigan, Bloomberg, Gallup, Conference Board

Housing market

NAHB index, permits, new home sales, Case-Shiller,

     S&P Comp-20 YoY change, existing home sales

Labour market

JOLTS job openings 3mma                                                   Jobless claims 4wma, unemployment rate

Gallup job creation index

Misc

Vehicle sales, NFIB optimism

and just for the record :

Fed balance sheet                                                                   Fed Funds rate 

What weakness there is comes from China, the Gulf, perhaps the Eurozone, and lagged effects of the sequester. I'm only really concerned about the first two.

The point is that broad swathes of the US economy, covering housing, consumer confidence & spending intentions, the labour market and business confidence, are recovering strongly, while monetary stimulus remains at full throttle. The Fed have stepped away from the controls and are claiming they won't come back before 2015. Fixed income had a wake up call last month, but 10s at 2.50 aren't cheap : how many investors who were bullish or confidently sitting on carry trades two weeks ago have had time to adjust to a bearish mindset ? Usually the shock of a loss takes longer than a fortnight to heal, so I think the path of least resistance is towards higher yields as people re-position themselves for a tightening Fed.

The "brave" trade here is to maintain a short into payrolls : buy short dated put spreads on TY and US and buy back the lower strikes of any longer dated put spreads in the hope of re-establishing them at much better levels. Actually it's not really that brave - the risk/reward based on the chart above makes the short trade the easy one. The scary trade here is to be long.

June 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
Jun-13	36.9%	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.