It’s a busy week, with Fed, BOE and BOJ meetings, not to mention latest payroll and ISM data from the US. Throw in the PMIs and flash Eurozone CPI data, and usually we would be getting overexcited about how to pick through the minutiae of all of these signals. Central bank rate paths would be mapped out; business cycles would be plotted; probability paths would be compared with positioning and market pricing would adjust. Oh but now we are going to have to learn something new. All of this could be wiped out in a heartbeat with the swipe of a pen. The new leader of the free world has just realised how powerful he is. Not only can he move 100s of thousands of people around the globe as if he’s playing with a real life Risk board, but he can generate headlines that dominate the ENTIRE WORLD as he does so. And all this with the stroke of a pen. The only amazing thing about all of this is that anyone is amazed. Firstly, he’s carrying out campaign promises; secondly, he’s currently at his most powerful; thirdly, he’s always been a deal maker who will use whatever tools he can to shake up the chessboard; and finally, he loves it. All of it. He’s Living The Dream. He is ripping up the rulebook, and so should you. You can worry about payrolls if you like, but more important this week will be his choice for the Supreme Court plus any new executive orders that relate to trade. The weekend’s activities mean that he is going to be deliberately disruptive. He is going to put America First. He will be testing the Separation of Powers to their limit, because that’s what he was elected to do. Why else did the voters not only elect him but also give the Republicans a clean sweep?
Blondemoney pauses here because we are now going to enter a reflective moment for Uncomfortable Truths. With this kind of disruption, we are going to see the world order scrambled and recreated in a way that we have not seen for a generation. Some of it may be good, some of it may be bad, and your particular choice of which it is will no doubt depend on your political compass. But this blog is not here for judgement. It’s here to explain how markets could react.
And the big point right now is that the market hasn’t ripped up its rulebook. It’s also in danger of getting drawn into the emotion. There seems to be a sense that stocks “can’t” keep going up, because all this stuff is bad. The rational argument then follows that Trump is destroying growth with his plans. Maybe. Maybe foreign investors will dump US Tsys in retaliation; maybe investment will stay away due to uncertainty. But maybe Paul Ryan will get Congress to enact significant tax reform; and maybe the rally in business optimism will revive animal spirits. Maybe then we’ll get massive inflation and maybe then Trump will staff the Fed full of doves. This, like Risk, is a multi-stage, multi-player game. Compared to the relatively straightforward task this week of decoding the Bank of England’s inflation report (Clue: There’s going to be lots of inflation), there’s no wonder we don’t know how to trade it yet.
The up-ending of the normal logic is flagged in a BBRG article today about bears vanishing from the S&P 500. They point out that short interest is at its lowest in 3 years, and that a desire to get long stocks in a cheap way is leading to proliferation of call buying. This means that the put/call ratio is at levels not seen since the Dot-com bust and the global financial crisis:
Regular readers know that #FOMO has ruled supreme for the past few years. All of the central bank QE mandated the risk rally: buy the dip. Even in the past couple of years, as volatility has risen, it’s only in the sense of flash crashes. These were cracks in the ice. We got a bigger crack in the first couple months of last year, but even that was pushed away as “lower-for-longer” turned into “lower forever” and lowflation remained the name of the game. It was always about the soothing power of cheap money. But at the end of last year we reached the end of the road. Cheap money is no more. Inflation is back. And now throw in the kind of political risk that we haven’t seen since before we declared Communism dead and Capitalism the winner. It will turn out that the Great Moderation was about more than just a virtuous cycle of increasing growth; it was a Great Moderation of politics, where all the big questions had been answered, all politicians were the same, and the End of History. But that was the anomaly.
So should we continue to fly headlong into the risk rally now that this is all changing?
Well if people are trying to buy something expensive through a mechanism that they think is cheap, like call options, then the reality tends to be that they still bought it very expensively. What could be the trigger for this reassessment? A few more strokes of the President’s pen