Tuesday, November 29, 2016

Bonds Taper Tantrum Part 2

This is getting really bad in the bond market.  It is a bit shocking to see such carnage in fixed income when the economy is this mediocre.  In 2013, during the taper tantrum, you had 10 yr yields go from 1.6% to 2.9% over a span of 4 months, on fears of the Fed reducing QE.  But $85B of monthly QE was still ongoing throughout the year and was only tapering $10B every meeting, starting in 2014.  So you had buying power supporting the Treasuries as the carnage was happening.  But there is no QE now.  And unlike 2013, you didn't have a potential bullish catalyst for Treasuries like you did with ECB going negative and starting QE.  The ECB is already doing their QE and will likely have to taper because of a lack of supply.

With Bunds already near 0%, there is very little lift that it can provide to Treasuries.  The only thing that will help Treasuries now is the economy slowing more than expectations.  That is a higher hurdle than merely riding on the coattails of a big bull move higher in European government bonds.

I underestimated this bond selloff.  It will not be contained at 10 yr 2.40%.  I see at least a move towards 2.5% and probably closer to 2.6% before you can feel safer buying the weakness.  So no, this isn't as great a buying opportunity for bonds like you had in the end of 2013, or even end of 2015.  This selloff will need more time to mature and build, because the equities are not as vulnerable as they were at this time in 2015, and you won't have the boost from European sovereign yields going lower and lower like in 2014.

And the problem is that the Fed hasn't even said anything yet to fan the flames.  And in all likelihood, you will see a hawkish Fed in December, now that the election is over and Yellen fights back against Trump and his hopes for a low Fed funds rate.   Even though Yellen is a dove, the pressure is building for the Fed to start raising rates as equities keep going higher and CPI inflation stays above 2%.  They mentioned in their minutes that they are worried about their credibility.  If they maintain a dovish tone, they will lose their credibility even faster.

That is probably why you are seeing a flattening of the 5-30 yield spread, as money is betting that the Fed will talk tough about rate hikes for 2017.  And this time, I don't think you will get the big equity swoon to hold them off from their plans so easily.  At least not for the next few months.

This feels like the blowoff stage for equities, and the give up stage for bonds.  Looking out over 2 to 3 months, I am a bond bear, equity bull.  But looking out over 2 to 3 years, I am a bond bull, equity bear.   The fund flows in November are finally making distinct big moves.  Lots of money is going into equity mutual funds and ETFs, finally.  It was a long time coming.  It took optimism about Trump of all people to get those skittish investors to jump into the pool.  All the signs for the final top are there.  We just need to let it play out for the next few months and take the other side.  In the meantime, don't waste your bullets playing for singles.  There will be much bigger opportunities in 2017, as the crowd finally embraces this overvalued, aging bull market.

Monday, November 28, 2016

USDCNY 6.91 and climbing

The higher they go, the hard they fall.  There hasn't been such heavy inflows over a two week period since late 2014.  That led to choppy and toppy markets in 2015 which led to moments like lock limit down in S&P 500 futures on Monday, August 24, going from 2100 to 1840 over a span of just one week.  How soon we forget that the reason for that big drop was because of fears of the deflationary effects of a Chinese yuan devaluation and Chinese financial stability.  The USD-CNY exchange rate rose to 6.38 that day.  Today we are at 6.91.   And yet not a peep.  The situation in China has gotten worse, and the Chinese are selling Treasuries to defend the yuan to prevent it from falling even more.  When the yuan is in a controlled descent, it makes it obvious for those with yuan to get the hell out of that currency and convert it into dollars, euros, yen, whatever.  But now there is news of the Chinese government trying to crack down on capital outflows by making it difficult or illegal for Chinese companies to do foreign mergers and acquisitions.  Many of these acquisitions are a way for the Chinese to convert their yuan into dollars.

If the CNY was a free floating currency, it would be at 10 right now.  There has been so much money printing by the PBOC to keep their debt pyramid from collapsing that you now have more M2 money supply in CNY (dollar converted) than in USD.  How can the US with a GDP almost twice that of China and with the world's reserve currency have a smaller M2 than China?  It makes no sense, and it points to a massively overvalued yuan which has kept its value because of capital controls.

The most interesting thing to watch in 2017 is not what Trump will do, but what happens in China.  We are getting really close to that Minsky moment where faith in the Chinese government and the PBOC causes a panic out of the yuan and into foreign currency based assets.  In China, there are very few choices.  The only thing I can think of that the Chinese investor can buy to protect against a yuan devaluation is gold or other hard assets denominated in dollars.  Perhaps they will go back to hoarding copper or oil.  A yuan devaluation would export some deflation into the global economy but I don't see it as trigger for a global financial panic.  But I do see it as a trigger for a panic out of yuan based assets, mainly the one that the Chinese have been hiding out in the most:  Chinese real estate.

The smart ones in China already have transferred most of their yuan assets into USD or other foreign assets to convert their vastly overvalued currency into something more accurately valued.  Even if that means overpaying for luxury condos in Manhattan or London.

This bull market in the S&P is getting very old, and I will be actively looking for signs of a major top in 2017.  The optimism over Trump's tax cuts and infrastructure spending is way overdone, and a disappointment over its economic effects could trigger the downside of the slope.  We are getting close to the peak of the mountain.

I don't see any good trades in the near term, the S&P should continue to grind higher, and I won't actively look to short until we get into 2017 and closer to 2300 level.

Wednesday, November 16, 2016

Blog Break

Market has gotten back to the previous highs.  But the current run looks worse than the post-Brexit run, due to the much higher interest rates and poorer breadth figures.  There aren't as many stocks participating in this rally as we had in July.  If I was a paper napkin chartist, I would say that we just might have a double top on our hands.  I won't go that far and be bearish, but definitely not bullish here.

And the bond market looks like it will have to consolidate this higher range from 2.15-2.35% 10 yr yields.  Lot of unwinding going on.  I disagree with many of the pundits that are calling the end of this bond bull market.  The structural weakness in the economy will not be eliminated with some tax cuts, deregulation, and infrastructure spending.  The financial market needs QE to maintain high valuations.  QE >>>>> Fiscal stimulus.

Will be back after Thanksgiving.

Monday, November 14, 2016

Overreactions to Trump

There is a consensus forming among investors that is more perception than reality.  The perception of deficit spending with tax cuts being inflationary and adding to growth and thus bad for bonds and good for stocks.  But with the assumption that the Fed will be raising rates regularly in 2017 (that is what the bond market is predicting), that is a negative for growth.  When you raise the cost of mortgages, the cost of corporations to issue bonds, and cause a reverse wealth effect on bond holders, those are all negative for the economy.  Real estate will slow down.  So will debt fueled buybacks.  Sure tax cuts will provide stimulus, but without QE, those dollars are immediately sucked out of the economy from bond buyers.  And there will have to be a lot of money set aside to buy bonds because there are huge projected increases in the budget deficit with these unfunded tax cuts and infrastructure spending.

And the bond market is global.  The jump up in Treasury yields is also pushing up yields globally, providing a monetary drag to the economies globally that will not be getting that tax cut or deficit spending.  I believe the net effect is a negative for global financial asset prices which weigh heavily towards fixed income and real estate.

So if the growth expectations aren't met, as I suspect, that could set up a strong counter move in bonds in 2017.

Another perception is that the dollar will be stronger because of higher interest rates.  A lot of that move already happened in 2014/2015 when the euro and the yen were getting crushed on expectations that the Fed would raise and the ECB and BOJ would cut and do QE.  The euro and yen are undervalued already versus the dollar on a PPP basis.  Also, don't forget the dollar was extremely weak under George W. Bush's reign when he had a similar tax cut plan while the Fed raised rates continuously from 2004 to 2006.

With this weakness in the bond market, the stock market should have a difficult time going higher.  But the money flows to the stock market should keep the downside limited.  The 10 year yield is coming towards some major resistance in the 2.30-2.35% zone, which is the top of the zone in yields last winter.

Friday, November 11, 2016

Fast Money

Listened to CNBC Fast Money yesterday.  It is a good indicator of what Wall Street fast money is thinking.  Trump is good for banks, industrials, and defense sector.  Bad for utilities, telecoms, and bond proxies.  The paper napkin 5 minute analysts are having a field day with the potential scenarios of a Trump presidency.  It was clear that there was still some apprehension, because after all, many of them were scared to death last week, so it is impossible for them to turn on a dime and go max bearish to max bullish.  But let's just borrow renowned commodity king Dennis Gartman's phrase: they are pleasantly long.

As long as they are not maximum bullish, there is still fuel for the market to go higher.  But the change in market opinion was much more rapid than I anticipated.  Perhaps it is the proliferation of hedge funds and their herding behavior that leads to such quick moves, and then total stagnation and flat markets once we reach the pre-destined level.  It is unlike what you saw in the 1990s and 2000s.  Since 2009, there have been very few pullbacks when the market is in an uptrend.  Only after you reach a point of stagnation does the market finally pullback.  That also is usually when the intermediate term trend is over.  

I do believe equities will go higher in the coming months, but I will probably play it small or just sit out the rally.  I don't have a lot of conviction when betting on a blowoff move, even if I do think it is likely to happen.

By the way, with the way bonds are trading, I don't think you will get much reward for the risk that you take going long bonds for the rest of the year.  With the huge jump in yields over the last 2 days, it is clear there is a lot of money stuck in a painful spot holding long duration bonds.  The uncertainty of a Trump stimulus package is a huge cloud hanging over the bond market.  The prudent choice is to wait for the liquidators to sell to stronger hands.  After you get a bit more fear in bond investors and higher yields, maybe 2.40% 10 year yields, then it may be time to do some buying for the long term.

Thursday, November 10, 2016

They Love Trump Now

Everyone remembers what happened post-Brexit.  Lots of anxiety over a nothing-burger and those memories are still fresh in the minds of fund managers.  They don't want to be left standing at the bus station.  They are jumping on this post-election bounce with a renewed view of Trump and his policies, forgetting about his tough trade talk, and his wild and unpredictable rants, and awaiting fresh fiscal stimulus in the form of massive tax cuts and infrastructure spending.

The mood has changed from that of apprehension about a post-election selloff and Trump fears to embracing Trump and his economic policies and even praising his victory speech.  That is what happens when everyone waits for the event to be over to deploy their cash.  And yes, that cash is all on the long side.  You have to think about asset managers from a long only perspective.  There are few if any "real" hedge funds anymore, most are masquerading as expensive, lower beta equity index funds.

So when they go to cash, and then deploy their cash, it means they are buying stock.  Not bonds, but stocks.  Bonds are things you hold when you are uncertain, not when you are certain.  And investors are certain that things will be rosy when Trump puts out his economic plan.

Ignored in this rally to the moon is the sharp rise in bond yields, a killer for those low growth high dividend paying stocks.  How soon we forget that corporate America benefited BIGLY from being able to issue loads of bonds at low interest rates, much of them used for stock buybacks.  That game has gotten a bit more expensive now.  Sure you will get some bridges to nowhere built and have some tax cuts, but it is taking from one hand (bondholders) and giving it to another (receivers of tax cuts).  You see, it is no longer a gravy train now because QE is not monetizing deficit spending like it did from 2009 to 2014.  And thus, deficit spending has a price now:  more Treasury supply = higher yields.  When QE was in full force, deficit spending didn't have a price.  The Fed effectively put a ceiling on yields with their POMO.

This is getting closer to how envisioned the final stage of this bull market to be.  A Fed that has stopped QE, felt pressure to raise interest rates as markets go higher under a deficit spending boom, with investors excited about overvalued equities as the potential for higher GDP growth under Trump's fiscal stimulus gets everyone excited.   Trump will try to do what Reagan did in the 80s.  But the big difference is that global demographics are much worse now and the debt ratios much higher.

There are no good short term opportunities in stocks, but I do see an opportunity brewing in the not so distant future in bonds.  But let's wait for these moves to mature, over the coming weeks and months.  A lot of money has still not been deployed and the latecomers will always be there to keep the market on trend until they are satiated with supply.

The next 6 months are going to show you what a top looks like after a long bull market.  I can already envision a blowoff top in the S&P as it heads towards 2300 as the latecomers pile in.  It will be a sight to see.

Wednesday, November 9, 2016

Bond Blood

They are looking for blood in the bond market.  Haven't see a move down like this since the taper tantrum in 2013.  I do NOT think that it will be that bad of a bond rout, because monetary policy is not what is involved here.  The Fed isn't going to change their policy.  I see more of a spring of 2015, where yields went from 1.65% to 2.48%.

It is a new bond market now, it has a HUGE monkey on its back in the form of Donald Trump.  He has a blank check because Congress is Republican controlled, and he will be able to get away with massive corporate tax cuts and infrastructure spending.  A double whammy to the bond market.  Not only will Treasury supply balloon higher as the budget deficit soars, but you will get a marginal boost in economic activity from the infrastructure build and corporations making more post-tax income.

Despite all those things, these fiscal stimulus packages are usually more hype than substance.  But the hype will be in full force for the next few months.  It does not take away from my very long term view that bonds are in a structural bull market due to aging demographics and overleveraged global economies.  However, everyone trades in the short to intermediate term, so it is probably sell first, ask questions later.

Looking to buy bonds soon.  2.10% 10 year is my buy level.  There should be a short term rebound after the 30 year auction tomorrow is out of the way.

Why Trump Won

Very low voter turnout.  Trump's voter base was far more passionate and likely to vote than Clinton's.  I don't think the polls were that wrong, it was that they didn't measure how likely a Trump voter or Clinton voter would go out to vote.  Since both candidates were unpopular, I totally underestimated the low voter turnout factor, which favored Trump.  These polls have a margin of error of 3-4 percent and that margin for error is needed to account for things such as low voter turnout and the "silent majority".  There indeed was a shy Trump supporter thing going on.  The urge for change was too great for Clinton to overcome.

As I stated before Trump would be considered stock negative and bond negative, and that is what we have.  More bond negative than anything else, especially the long bond.  It seems like Trump is scaring bond investors much more than stock investors.  His infrastructure spending talk and his well known desire to cut corporate taxes have a good chance of passing through a Republican controlled Congress.  I wouldn't say that kind of fiscal stimulus is wildly stock positive because it is accompanied by higher interest rates.

Judging by the open, the S&P has only given back part of the Monday-Tuesday rally.  It is clear that there are a lot of people in cash who need to deploy it regardless.  And some of that bond money will go to stocks, because cash these days always burns a hole in an investor's pocket.

I will be selling most of my long today and go back to just observing what goes on.  At these levels, I am slightly bullish so not enough to hold a full position.  I will be waiting for an opportunity to get long bonds if we see a further selloff later this year, perhaps to 2.10% area on 10 year yields.

Tuesday, November 8, 2016

Overestimating Trump's Odds

It is easy to root for one side or the other.  If you are a Democrat, it is easy to be rooting for Clinton and be biased to the long side, expecting a Clinton win.  If you are a Republican, you will probably be rooting for Trump and be biased to the short side hoping for a big immediate payoff, like Brexit.

You have to trade the market as it is, without an irrational bias.  You cannot trade the market that you want and be successful.  If you want a bear market, or are hoping for a big drop, you can't just go in there and buy puts or short stocks in the hole hoping for a big payoff.   Hope is not an investment strategy.  I have been there before, long puts, thinking that the market is due for a correction, and then waiting and waiting, eventually giving up and covering for big losses.

 Objectively, if I didn't have any position on, I would hope for Trump to win.  Not because I like his views, but because he would bring more volatility to the market.  But I am long, and obviously hoping for Clinton to win.  Everything tells me that Trump's odds are inflated even at 20% chance of winning because of the polling data, how much media bashing he has taken, the fact that he is so disliked, the big mistakes that he has made over the course of the campaign.  He has gotten more disciplined lately but the damage was done with the hot mics and sexual harrassment accusations from all over, and rigged election talk, etc.  Trump was never popular to begin with, but he has offended too many people, showed his lack of political skills by going off on various targets, to his detriment.

The biggest, most underrated factor in this election is the extremely anti Trump media bias, which I don't think anyone could overcome.  Even the conservatives don't like him much, as he struggled to get endorsements.  It seems like at least 90% of the articles that I read in various online news sites is an article critical of Trump.  Although I am not a Trump fan, some of those articles seem to nitpick everything, and blow them out of proportion, making him look worse than he really is.  And he already looks pretty bad just by watching his speeches and debate performances.  This election has clearly become a Trump vs. non Trump race.  It is a referendum on Trump, not a race between candidates of two parties.  The media has clearly done their best to make Trump look as toxic as possible.  You cannot underestimate the power of the media to shape the minds of people and create a new subjective reality that affects their actions and opinions.

Anything can happen, but the odds of a Trump win are probably closer to 5% than 20%.  And the market seemed to be pricing in a 50/50 shot for Trump last week when the fear was at its highest and the FBI investigation on Clinton was still going.

I've seen many mentions of Brexit when traders talk about this election, but those Brexit odds were always much closer than Clinton-Trump odds.  In fact, it seemed liked traders were ignoring the polls that did show Brexit leading for a period of time, as if it was a temporary fluke.  That hasn't happened with Trump even when he got that last minute gift from the FBI.

Throw out the Brexit playbook, the trading ahead of the election has clearly brought in more fear than pre-Brexit, just by looking at CNBC and the put/call ratios.  That gives it a much higher likelihood that the market is well hedged for the event and holding too much cash, which they will probably deploy if Clinton wins.

Monday, November 7, 2016

Presidential Election Scenarios

It looks like last week was fear week.  The week to get scared, buy puts at inflated prices, and hedge against a Trump presidency or Clinton getting arrested.  The chicken littles had a field day, but like the last 8 years, their time in the sun looks brief.

You can hate the game, say the rallies are fake, the fundamentals suck, but you have to trade what you know.  And when there is a lot of fear over something that isn't that scary, that presents a buying opportunity.  These dips happen over and over again, and you would think traders would eventually catch on to the fact that they are usually buying opportunities and not a start of some big correction, but 2008 is still seared into the minds of so many investors.  Eventually these dips will keep going down and be the start of a bear market but probably only after we get some real economic weakness.

The market overreacted on the Clinton emails and Trump gaining in the polls.  You are taking a lot of that back today.  Based on what happened in Brexit, I am pretty sure you aren't going to rip too much higher than these levels ahead of the election results.  At the same time, odds are very high that we have reached the apex in fear (as measured by VIX and put/call ratios) for the next few weeks (barring a Trump win, which objectively by most pollsters is about 15% probability).  That is not tiny, but it is small enough to make the risk/reward from buying equities ahead of election results a positive EV bet.

I would roughly guess that a Trump win would drop the S&P about 80 points the next day.  A Clinton win would probably raise the S&P up about 30 points.  Given what I think odds of Trump winning are(about 15%), it is probably a good bet to go long.  However, unlike Brexit, if Trump wins, I don't see a quick dip and then rip because of international money that is scared to death of Trump and will flee US stocks as a result.  That would take several weeks to play out.

I eventually think that would set up a monster long buying opportunity into the trough of that selling, but I don't see such a short correction like Brexit.  A Trump win would be much more of a shock to the system than a Brexit.  Easily by a factor of 100.  It would be more of a dip, dip some more, spend some time lower, scare the foreigners out of US stocks, and then rip for months on end.

Under a Clinton win scenario, you will get a big gap up that can eventually take the market up to 2160-2170 resistance zone over several days, and then we probably fade ahead of ECB and FOMC in December.

As for the Congressional races, I don't think those will matter much, because frankly, the Republicans and Democrats probably can't do anything substantial enough to affect the economy.

The odds favor the bulls.  I remain long S&P.

Friday, November 4, 2016

8 Straight Down

The pundits like to bring out random statistics to state the seriousness or peril that the market is in.  We have been down 8 straight days, the last time since October 2008.  But they don't like to mention that the down days in this streak are microscopic compared to the down days in October 2008.  It is like comparing 8 straight paper cuts to getting hit with eight bullets from an elephant gun.

What has been noticeable is that the VIX has been vastly outperforming the inverse of the S&P.  In other words, option premium has been rising rapidly, more than one would expect from a couple percent down move.  Usually that is bearish short term, but more bullish intermediate term, especially when the rise in that volatility is due to a big event (like a presidential election).

Also, you have seen several days of high equity put/call ratios despite the relatively small down days.  That tells me many of the nervous investors are hedging with puts ahead of the election, which is a positive.

The base case is for the market to bottom before Tuesday's election, and then rally on the results in the intermediate term, whether it be Trump or Clinton.  If Clinton wins, you get rid of the uncertainty and have a predictable cookie cutter politician.   If Trump gets elected, you will have a short term reflexive selloff like after Brexit, but then you will have an equally violent rally when investors realize that Trump is actually more likely than Clinton to enact pro-growth fiscal policies and cut corporate taxes.

I did some buying near the close yesterday in S&P, and will look to add a bit more if we dip today.  Running with the bulls, at least for the next week or two.

Wednesday, November 2, 2016

Election Fears

They tried to hold 2120 and when it broke, we got a little panic yesterday.  You can play the percentages, and have the odds in your favor, and still lose.  I dipped a toe on the long side around 2120 and took some heat.  But the statistics are favorable after yesterday's trade.  We finally got some fear into this market, with the uncertainty over the election finally coming to a boil.

There are going to be less willing buyers ahead of the election, so the only way to get them enticed is to lower the prices.  And that's what happened.  We finally got some higher volume and got rid of a lot of complacency in a hurry.  There is a tendency to dip a week or two ahead of these big events like Brexit and the US election but then rally only a few days ahead of it.  It is as if the market trades on what will happen a week later, not a day later.  So we are getting rid of the nervous short term buyers afraid of a possible Trump presidency, however small the odds are.  They don't want to risk jumping in ahead of a possible plunge.  There is opportunity when others have irrational fears.

I actually think Trump is equity positive and bond negative, while Clinton is more equity negative, bond positive.  But people are thinking Trump equity negative, bond negative, and Clinton equity positive, bond positive.   So you are not seeing much of a bid in bonds despite the S&P weakness.  Trump's economic policy will be to lower taxes and spend more, similar to Reagan.  All else being equal, that is equity positive.  His trade policies scare some people, but it will be impossible to push through any kind of big trade barriers with the Congress bought and paid for by the multinationals.

Thinking an intermediate term S&P bounce from here to the end of next week towards 2160 after the uncertainty of the US election dissipates.