Market Insights

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You Read It Here First…

The summer is almost over, and you, Dear Reader, are ready. You know that the market is primed for self-destruction, wound up into an unbalanced frenzy by Perma QE and the passive money momentum machine. And you know that it takes only one match to light the fuse. You know we will see Black Swan price action on White Swan events. So what's the event going to be?

One word, 6 letters, 2 syllables. Sounds like a Latin past participle for the verb "Brexere", meaning rupture with one's closest trading partner.

But just in case you weren . . .

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In Memoriam

Today I learnt of the passing of the man who taught me all about the markets. And a good few things about life too. Forgive me then for a moment to remember him.

Armed with a Classics degree from Cambridge, a dramatic flourish of melancholy from Northern Ireland, and a handy bit of know-how from amateur boxing, Ed had charisma, knowledge and tenacity in spades. We met just after September 11th 2001, at Merrill Lynch. I had just started as a graduate, plunged into the foreign exchange desk in the midst of recession, and the omnipresent Bin-Laden-induced threat of War. Ed had that memory seared upon him more than most, having been on an introductory trip to the ML NYC office and seeing the second plane crash into the towers.

During the mayhem, he revealed his true calling: teaching. He was the only person who sat down with me to give me a structure to this new crazy day that kicked off at 7am. “Write down the opening levels when you walk in”, he urged, “and a few bullet points from the morning meeting… that will get you through the day without looking like an arse”.

Looking like an arse was the usual state of affairs for a graduate trainee. He did his best to help me, not only to understand what was going on, but also to get used to an environment where failure meant money losses or even job losses. That meant no kid gloves, for which I am eternally grateful. You’ve never really experienced humiliation until the dealing desk turns round and looks at you when you take your first phone trade, and instead of “Mine” or “Yours”, you meekly tell the trader “His?”.

No-one laughed more than Ed, who thumped me on the back and told me not to f**k it up next time.

That was Rule No.1 of course: “Don’t F**k it Up”.
Rule no.2 was inevitably, “Never forget rule no.1”.

Fortunately he didn’t let me sink or swim too far on my own in those early days. He would step in if I found myself out of my depth, but never by patronising me. He would encourage me if I did something well, but never by promoting arrogance. A few months in, he called into the desk for a market round-up. I seriously reeled off some information about non-farm payrolls, technical levels and the Euro hitting parity against the Dollar. Silence. He chuckled. One of his excellent cigarette-and-alcohol-stained chuckles. I braced for the inevitable criticism. He simply said, “F**k me, you almost sound like a real salesperson, praise the f**king Lord we are making something of you my girl!”.

Having passed the test, I could join the various client events and drinking sessions in our nearest pub, the Viaduct. (Why they literally built an investment bank on top of a pub, I’ll never know). I was part of the gang. It didn’t matter that I had a cleavage, Ed just cared that I had a brain. For a team of 40 people with only 4 women in it, this was a blessed relief.

He and his Northern Irish buddy, the Ballymena Academy boys, were the only men who didn’t treat me any differently because I was a woman. They watched out for me. They wanted me to succeed.

In latter years Ed would tell me how proud he was of the part he played in my success. He could never, unfortunately, be happy with his own.

He was the cleverest man I ever worked with. The most charismatic with clients. The smartest about trades. The most humble. The most honest. Someone who I believed in as much as he believed in me. If only he could have believed more in himself.

The demons chase us all. If we are lucky, we can escape them or at least shove them where they haunt us least. For the man we called Little Old Edmundo, it proved an ongoing battle that ultimately ended only in the harshest form of peace.

He was no angel. The greatest teachers rarely are. It takes an understanding of both darkness and light to teach someone how to navigate the path ahead. We argued, we cried, we shouted, we hugged, we laughed. We learned. And what could be a greater gift in life than that?

— RIP My Friend —

It’s Always Darkest Before…

We here at BlondeMoney try to neither be optimistic fools nor fatalistic doom-mongers. Either could garner us more headlines but neither is useful in a world of cold-headed investment decisions. You know by now what’s going to cause the next crisis, so how about a dose of good cheer. It’s always darkest before the dawn.

1 Euphoric Equities

The Nasdaq hit a new all-time high and the FANGs are back baby yeah! Here’s the FANG+ index, on which you can trade futures and options, which just about says it all:

The rally was allegedly due to Goldmans upgrading Tech to overweight; we prefer to think of it as Momentum Is The New Safe Haven. So let’s not mistake this euphoria for an all-round “coast is clear” risk-on rally.

2 EM Excited

It will look like that, however, because we are now all so embedded in the game of prices telling us the story. Emerging Markets might just get the buy-the-dip boost they’re looking for, with the astonishing timing that Argentina has been upgraded back into EM status, from mere Frontier, by MSCI. It’s been in the Frontier for almost a decade and despite its recent woes, MSCI still decided to grant it the full-on emerging market accolade. Where it goes from here will be a fascinating test of our hypothesis: inclusion into an index creates a full-on demand for a country’s assets from the passive index-trackers. Will their flows dominate the active discretionary guys who still fear for Argentina’s health?

Even more excitingly for our hypothesis, MSCI have retained the caveat that they can kick Argentina out again:

‘However, in light of the most recent events impacting the country’s foreign exchange situation, MSCI also clarifies that it would review its reclassification decision were the Argentinian authorities to introduce any sort of market accessibility restrictions, such as capital or foreign exchange controls.’

If that were to happen, then the passive outflows would join in with active outflows, creating an automatic increase in selling on assets already under pressure. Just the kind of feedback loop we hypothesize that passive investments embed into the system.

3 ECB Easing

Our favourite Irish farmer-investor, @LorcanRK, flagged up the key points from the ECB officials’ leaked story to Bloomberg yesterday. The ECB “could consider relaxing the rules on buying” for its reinvestments. As they have a 3 month autopilot right now, this means they could pause and build up a warchest of cash before plunging it back into the market. It certainly gives them flexibility to smooth out any wobbles in the market once they pull back from QE proper. And – Draghi must love this – it could be done any time, without a monetary policy meeting. No wonder Mario called this “an important decision… not a marginal one at all“. It’s his get-out-of-jail free card as he goes into his final innings as President. But it also means some permaQE could be a little bit more “perma” than we first thought.

4 Brexit Back In Its Box

These parliamentary votes of the past two weeks were supposed to deliver high drama. Government defeats, battles, bish bash bosh. In the end, neither Brexiteer nor Remainer rebelled, the government persists, and the boil has yet to be lanced. Is it possible now that Theresa, like The Donald, has become an accidental master of three-dimensional political chess? That the UK will end up with the ideal negotiating outcome where nobody is pleased but those displeased are too divided to do anything about it? If so, then market expectations of a muddle through will be the right one.

This chimes in with the general euphoria we have so far described. It’s a funny kind of euphoria; the kind that comes from the absence of dark, rather than the presence of light.

As one of our clients says, it’s always darkest before… it gets really dark.

Elections a-go-go

At the start of the year, the European elections were the big event risk ahead. Fast forward nine months and this weekend’s German election is met with barely a shrug, thanks to the victory of an oedipal ingenue into the Elysee Palace. The threat of Marine Le Pen has receded so much that one of her closest aides has just quit the National Front, and with it, one of the key architects of their Frexit policy. The Eurosceptic knaves have been vanquished. Even a country that has voted to leave, will today see its Prime Minister lay out a policy for its exit that means it won’t exit for 2 years after it’s technically exited. Geddit?

Blondemoney forgives you for EU-fatigue. At some stage, the Brexit shambles negotiations will produce an almighty bout of excitement, but for now it’s just so earth-shatteringly nuanced as to be eminently forgettable. Hand us an instant-result FOMC meeting any day.

At least politics this weekend should provide a binary outcome.

First up it’s the German election. Although no-one really much seems to care about that, with Merkel consistently riding high in the polls, rarely troubled by the opposition’s Martin Schulz. The bookies have her party emerging as the largest at an eye-wateringly certain 1/100. Even as the largest party she likely has to enter a coalition, however, with the following potential scenarios that could emerge:

Given the market is totes not both’d, we might not get much of a reaction to any of those scenarios, but things to watch out for would be:

  • FDP joining a coalition – as they are the most “anti-Euro” of the larger parties
  • AfD gaining any kind of representation – or indeed, if they don’t, despite polling almost twice what they were in the last election, thus suggesting the anti-establishment vote is dying off

Next up it’s the New Zealand election. This had looked to be hanging in the balance with polls showing the charismatic new young (female) leader of the Labour Party driving them into the lead in the polls ahead of the incumbent National party. “Jacindamania” is now ebbing away, however, with the most recent polls giving National a clear lead of 7-10 pts. Again the market doesn’t seem too worried, probably because the New Zealand Dollar is most often used as just a proxy “risk on / yield hunting” currency. But there are potential pitfalls ahead. The Labour Party want to change how the RBNZ works, and introduce a Fed-style dual mandate; while coalition partners could include the anti-immigration party the NZF. Admittedly, the NZF have already been in government, and a new mandate for the RBNZ might not change much in practice.

Either way, we will have a sense of the result by 8am BST Saturday morning when the exit polls come out…
And for Germany, by 6pm BST Sunday evening.

(Although for both, coalition forming could mean the final government isn’t in place for a few weeks yet).

You might wonder why everyone is so relaxed, given how unreliable polls have become recently. Blondemoney would argue that polling accuracy is proportional to the proportionality of the voting system. In other words, if it’s a proportional representation system, then it’s easier for the polls to capture. The more it’s “first past the post”, or an electoral college, then it’s much harder to predict.

Both the German and NZ elections use a fairly proportional system – a mixture of PR and FPTP. For the election geeks amongst you, both countries actually use the relatively unusual ‘Webster/Sainte-Lague‘ method for determining seats from vote share. (And if that’s not your weekend reading sorted, I don’t know what is). So the polls should be decent at predicting the result. (Famous last words??)

Either way, from this point on, Merkel in charge of Germany means she can get on with taking the EU forward. That may be marginally Euro positive. For New Zealand, its currency can get on with being the favourite of those who like to trade EM without being able to invest in EM!

 

 

Will the Fed end the Truman Show?

We have talked before about how the market is sailing with unsurpassed ease towards the inevitable brick wall at the end of the Truman Show. At some stage, we will wake up from the low volatility, lowflation, low rates environment. The tricky part, as ever, is picking the tipping point. So let’s just consider these charts:

1. The last real bout of volatility came at the start of last year, when China was blamed for market turmoil that ended up with a rout about CoCos. Since then, global equities have had a very lovely time thanks, up 40% in almost a straight line (h/t @HayekandKeynes):

2. And as we know volatility has concomitantly collapsed. Here’s another take on that with a look at the 1 month volatility on the Russell 2000, which is in single digits for the first time (h/t @DriehausCapital):

And just a reminder of how mad this is, historically speaking, with @charliebilello flagging up that the last 5 days have been ‘the most peaceful in the history’ of the S&P:

I flagged up before to keep an eye on the AUD, and if it can stay above 0.8000 then that’s a good indicator of euphoria continuing to trend. It’s managing it, but Blondemoney is now concerned about that perennial canary in the coalmine, the South African Rand. That’s fallen almost 5% against the US Dollar in the past two weeks. Now, some of that really is because of issues specific to South Africa (with President Zuma still under a corruption cloud). But we know that when there’s a mad dash for yield, those pesky political issues are pushed aside. The euphoria cannot be all pervasive if the Rand is weakening.

So, it’s over to the Fed. Tonight they have the platform to provide quite a signal of their intentions. It’s Janet’s penultimate FOMC meeting to include a press conference. If her term isn’t renewed, that means it’s her second-to-last chance to make her legacy stick. She was handed the poisoned chalice of removing policy accommodation into a weak and uncertain economy, and she will want to make sure she is considered to have gotten the job done. Equally, she wouldn’t want to leave a trail that could implicate her in whatever the next crisis may be. So, she needs to stick to her guns. They’ve hiked, but not in such a way as to destabilise the markets. Have they done enough to prevent another financial bubble emerging? Or have they done too much, and squeezed out inflation before it got any momentum?

That’s the line she has to walk tonight. USD/JPY overnight straddles are priced around 95 pips, suggesting a big figure move could be on the cards. But with most markets comfortable with no volatility at all, yet a divergence occurring between the high yielders, there is the possibility for a much bigger move. Look out for a higher USD from here.