february 10, 2016 - amazon s3 · february 10, 2016 greetings, albert einstein once called compound...
TRANSCRIPT
February10,2016
Greetings,
AlbertEinsteinoncecalledcompoundinteresttheeighthwonderoftheworld,adding,“Hewho
understandsit,earnsit...hewhodoesn’t…paysit.”It’soneofthemostbasictenetsoffinance,andthe
principleonwhichmodernbankingsystemsoperate.Unfortunately,inEuropeandJapan,theworld’s
largestandfourthlargesteconomyrespectively,evenifyouunderstandcompoundinterest,you’restill
payingit.Americansreallyneedtostartdoingtheirhomeworkbecausenegativepolicyratesprobably
won’tbeanoveltyoverthenextfiveyears,andcouldbecommonplace.
BeforeeachofthepastsevenUSrecessions,long-terminterestratesfellbelowshort-termrates,
producingwhateconomistscallaninvertedyieldcurve.However,the(potential)upcomingrecession
wouldalmostcertainlybuckthistrend,becauseshort-termratesarealreadyzero.Asperverseasthis
environmentis,itseemsunreasonabletoexpectaninvertedcurveoutto10yearswiththeshort-endat
orbelowzero.Nevertheless,theNewYorkFed’syield-curvebasedmodelimpliesalessthan5%chance
ofrecessionin12months.TheClevelandFedputsthechancesslightlyhigher,at6.19%.Arecessionis
certainlyavoidable,buttheoddsaremuchhigherthanthat.
Investorsarestunnedtosee10YUSTreasury’syieldinglessthan1.75%,butthat’sstilla
whopping150bpsmorethana10YGermanBund.In2008-2009,theFedreactedfasterandstrongerthan
theECBinalmosteveryrespect,whichdroveuplonger-termyields–atleastrelativetoEurope.You’ll
recalltheECBactuallyraisedbenchmarkratesin2008,albeitbeforetheLehmanbankruptcy.Europe,
weigheddownbyGreeceandacommoncurrency,hasbeenstuckinthedeflationarymudeversince.But
itappearsthosedeflationarywindshavenowentangledtheUS,andit’sentirelypossiblethespread
betweenTreasury’sandBundswillcrosssomewherebelow0.50%.
ItseemsasthoughtheUSisfollowingthepathofEurope,butEuropeansarereallyjustfollowing
Japan’slead,where10YJGByieldswentnegativethisweek.Excessdebtisthecommondenominatorin
alloftheseeconomies,andyettheleveragejustkeepsbuilding.TheUSisstillalongwaysfromJapan,but
Chinaisthelastdomino.TheChinesepreventedaglobaldepressionin2008,andit’sunclearwhether
they’llbeableorgenerousenoughtocomeupwithanencore.
Havingsaidallthatit’simportantforinvestorstorealizethatthisisn’tadeathsentenceforyour
portfolio.Thereareassetsthatdowellincrisesanddeflation.Bondsshouldbefine,especiallythosewith
longermaturities.The30YUSTreasuryoffers2.6%yieldversus0.9%inGermany.Theknockongoldhas
alwaysbeenthatitdoesn’tofferayield,butthatopportunitycostisnowgone.Itmayseemlikeyou’re
chasingtherallyingoldhere,butthat’sashortsightedview.We’reonlyafewweeksawayfromthe
secondhighestlevelofCFTCgoldshortsinhistory.Bearishsentimentlikethatdoesn’tjustgoaway
overnight.Themostimportantthingtorememberisthatbearmarketsaretricky,andalwaysinclude
dead-catbounces.Doyourhomework,haveaviewandstickwithit.
TheCup&HandleFundisuparound+3.0%YTD,and+12.0%Y/Y.We’veheldsteadythroughall
ofthisvolatility,andtheportfolio’sconstructionisholdingupprettywell.We’vestillgotadecentchunk
ofcashavailablefordeployment.ObviouslyIwouldlikesomeofourwinning,highconvictionpositionsto
belargerbutsuchisthenatureofmanagingaportfolio.SincelaunchinginAugust2014theC&HFundis
+24%versusa-5%declineintheS&P500.Someofourmonthlypicksaredown,butothershavewon
huge.Intheendit’stheaggregatethatmatters.Ifyou’dliketostartreceivingtheselettersclickhere.
Asalways,ifyouhaveanyquestionsorcommentsorjustwanttovent,pleasesendmeanemailat
Untilnexttime,treadlightlyoutthere,
MichaelLingenheldManagingEditor–Cup&HandleMacro
CanYouHeartheMarket,Janet?
InJuly2008,theECBstucktotheinstructionmanual.UnliketheFederalReserve,theECBdoesn’t
havetotakeemploymentintoconsideration,onlypricestability.TheECBin2008wasn’tthecentralbank
weknowtoday;backthenmonetarypolicywasdictatedbyGermanyandmuchmorehawkish.And,at
thetime,theECBwasextremelynervousaboutinflationbecausecrudeoilhadmorethandoubledover
thepastyear.Sotheywentaheadandhikedrates25bpseventhoughtheFedwasintheprocessof
cuttingratesfrom5.25%toQE3.
Wenowknowthattheoilbubblewasthestrawthatbrokethecamel’sback,andsparkedthe
FinancialCrisis.ButtheECB’sdecisiontoignoreilliquidcreditmarketsandteeteringbankswasthe
greenlightforinvestorstokeepselling.Itsignaledthatpolicymakersdidn’tunderstandwhathas
happeningbecausetheyweren’tlisteningtothemarket.
JanetYellenisheadingtoCapitalHilltoday,andhopefullyshe’slearnedfromtheECB’smistake.
Ostensiblyshehasareasontosoundhawkishinhertestimony.LastFriday,itwasrevealedthatthe
unemploymentratefellbelow5%andwagessurprisinglyjumped+2.5%Y/YinJanuary.Inflation
breakevens,whichtheoreticallymatteragreatdealtowardstheFed’smandateofpricestability,are
collapsing,butthatdidn’tstoptheFOMCfromhikinginDecember.They’vebeenbeatingthe“oil’simpact
istransitory”drumformonths,andcrudeisnowwelloffthelows.ButsurelyYellenmustrealizethatthe
bankingsector,especiallyinEurope,lookslikeit’sabouttocollapse.Right?
Yellenunderstandablydoesn’twanttofeedthe“FedPut”narrative,wherethecentralbankcomes
totherescueeverytimestocksdecline,butsafehavenassetsarerallyinginabnormalfashion.Japanand
Switzerlandbothnowhavenegativeinterestrates,yettheircurrencieshaveralliedquiteabitthisweek.
TheYenrallyinparticulariscauseforconcern.
TheBoJisstillbuyingahugepercentageofthecountry’sdebtissuance,ratesarenegative,andyet
capitalkeepspouringintothecountry.SomeofthatisrelatedtoinvestorsassumingYellenwillwalkback
the“fourhikesin2016”narrative,whichthemarketneverbelievedinthefirsttheplace.Exceptthat
muchofthisweek’sturbulencecouldhavebeenavoidediftheJanuaryFOMCstatementwasevenslightly
dovish.Instead,we’relefttowonderwhetherornotthemarket’smessageisgettingthrough.Ifit’snot,
investorsneedtobuckleupagain.CarnageinCaracas
Inaworldwherewe’reconstantlyremindedofthedeflationarywindssweepingacrossdeveloped
economies,it’salmostrefreshingtoseesomegoodoldfashionedrunawayinflation.TheVenezuelan
Bolivar(VEF)haslostsomuchvaluethegovernmentisimportingplanesfullofnewcurrencynotes,
totalingmorethan5billionoverthesecondhalfof2015.Theofficialexchangeratesis6.32VEFtothe
dollar,butit’smorelike1,000VEFperdollarontheblackmarket.
Thegovernment’sofficialinflationrateis142%Y/Y,buttheIMFbelievesit’scloserto720%-
highestintheworld.Venezuelahasthemostoilreservesintheworld,sothatsectionoftheeconomyhas
reallyputthesqueezetothegovernment’sfinances.Butthemonetarymismanagementhassentthe
moneysupplysoaring,up+130%overthepast12months.
It’sexampleslikethisthatreallyprovethevalueofgold,ofwhichVenezuela’sgovernmentstillhas
adecentchunk.Italsoseemstoprovethatifdeflationistherootproblem,wehaveananswer:print
moremoney.PaulVolckerprovedthatyoucouldstampoutinflationwithhigherratesandVenezuela,
liketheWeimarRepublicandZimbabwebeforeit,isshowingthatenoughcurrencydebasementwill
eventuallycreatehigherprices.Itmightnotbepopularandcoulddestroytheeconomyintheprocess,
butifdeflationispublicenemy#1,weknowhowtofightit.
GreatestofAll-Time
Thereareblowhardycommentsfromcentralbankersallthetime,butrarelydoweseea
performanceonparwithHarukhikoKuroda’sfromlastweek.InthecourseofonespeechtheBoJ
Governormanagedtospitoutthesebeauties:- “Theconstraintofthe‘zerolowerbound’onanominalinterestrate,whichwasbelieved
tobeimpossibletoconquer,hasbeenalmostovercomebythewisdomandpracticeof
centralbanks,includingthoseoftheBankofJapan”
- “Itisnoexaggerationthat[ours]isthemostpowerfulmonetarypolicyframeworkinthe
historyofmoderncentralbanking.”
- “Thisisauniquepolicyframeworkofnegativeinterestratesthatfitswellintothe
Japanesesystem.”
Idon’tspeakJapanese,somaybetheyweretakenoutofcontext,buthesoundsalmostself-
congratulatory.Thesepolicymakersaren’tinventingnewformsofstimulusandresortingtothem
becausepreviousmeasuresfailed.
Again,Idon’tliketodumponcentralbankerstoomuchbecauseoftentimestheyaremerelytryingto
offsetdamageorinactionfromthegovernment.Butthey’renotdoingasgreatajobastheythink.Draghi
misleadinvestorsinDecember,deliveringlessthanmarketsanticipated,causingEURtorally.And
Kurodaseeminglywentoutofhiswaytodisguisethenegativeratesannouncement.Morethananything
marketsdon’tlikesurprises,andifthesecentralbanksaresoconfidentintheirabilitytomanipulate
assetsprices,itwilleventuallybackfire–evenworsethantheJPYmovelastweek.ChartoftheWeek
Despitethecollapseinriskassets,palladiumisholdingupfairlywell.Eventhoughpriceshave
fallen-45%sincethe2014highs,palladiumcontinuestooperateatasupply/demanddeficit.Morethan
80%ofproductionscomesfromRussiaandSouthAfrica,wherethelocalcurrencieshavebeendestroyed,
meaningtherehasbeenlittleincentivetoslowproduction.PalladiumpricedinSouthAfricanRandis
downamere-14%fromthepeak.Someoftheresilienceisrelatedtotheoutperformanceingold,asafe
havenasset,butsentimentissonegativethatit’sreasonabletowonderwhetherpalladiumwillgeta
decentpopifandwhenstocksbounce.
Netpositioninginthefuturesmarketisasbearishasit’sbeeninnearlyadecade.Chineseauto
sales,whilenotgrowingasquickly,stillgrew+7.3%lastyear.There’snotmuchofarecyclingprogramin
China,somostoftheconsumptionisfromnewmineproduction.TheoutlookforUSautosalesmightnot
begreat,butsetarecordin2015aslowgasolinepricesencouragedthepurchaseofbigger,gasguzzling
cars.Andemissionstandardswon’tbegettingmorelaxanytimesoon,soifyou’relookingtogetexposure
toPGM’s,nowmightbethetime.
**Editor’snote:We’regoingtotrysomethingnewthisyear.Iloveinteractingwithreadersandrespondingto
questions,butthevastmajorityaren’tfitforpublicconsumption–i.e.oftenregardingpositionsorstrategieswithin
somebody’sportfolio.Instead,I’mgoingtolinkatimely,macro-related,long-formarticleeveryweek.Tobeclear,
keepthequestionscoming,[email protected]’llgetbacktoyouinshortorder!**
The Secretive Hedge Fund That’s Generating Huge Profits for Yale–BloombergComment:Grantedthisisn’texactlyahard-hittingprofile,butit’stellingthatthesefundsareportrayed
assuccessfulwhilespittingout2%gainsin2015.Notacriticism,$10.5billionisalotofAUMandit’s
hardertogeneratereturnsonlargeassets.Itjustgoestoshowyouthathedgefundsarestillstayingfar
awayfromrisk,despiteclaimstothecontrary.Therealquestionis:howsecretivecanthisfundbeifit’s
beingprofiledinBloomberg?
That’s all. See you next week! Foranyquestionsorcomments,pleaseemailusat:[email protected]:@cuphandlemacro
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