Wednesday, 25 February 2015

RU, a pain in my Bund?

This morning I own up to having pains in my Bund. Piles of it, as Bunds are higher.

 Since I have started building a short Bund position I have been gaining confidence as a) it hasn’t broken higher b) Greece issue is waining rather than waxing c) European stocks are driving higher as faith of a return of growth, or at least no imminent collapse in growth, has returned and there are better yields to be had than in negative rates at the short end of the German curve. I was additionally relieved to see Credit Swiss research calling fo 10yr Bund up around the 1.3% yield by year end.

Against this I have been fighting the oft quoted against me views that QE is coming, which I counter by arguing that that bit of info has been in the price since QE was announced b) European growth is not really going up yet c) The ECB is going to crush deflation through policy stand back d) Europe isn't fixed e)Money needs to be held in Europe and before decisions on allocation are made you hold it somewhere safe , like bunds

I then see this morning that the likes of the Japanese civil service fund is cranking up its holdings of foreign bonds from 2% to 15%, and that makes me quake. Not that one fund is doing an allocation, but that if that thought pattern is repeated throughout Japan then there will be a wave of assets allocated by managers who have no qualms about buying stupidly low yield, having had decades of practice of buying their own stupidly low yields.

Meanwhile in other parts of the 'Who would have thought it' alternative universe,  Irish 10yr is now yielding below 1%, which is making me ask what other oddities there are out there to add to German, Swiss and Danish negative yields, Global MSCI equities hitting a world record high and oil being around $50 bucks. Imagine if in 2011 you had put a trade on that paid off if Irish 10yr was at 1%, Oil at $50 and Global stocks at record highs. You would have been carted off to the funny farm before even being allowed to place it. Once again this highlights why what is consensus today can so swiftly change.

And with that I have just talked myself into staying short bunds.

Greece is on simmer having been on hard boil, so market’s ADHD attention can switch to the next worry. Market worries appear to be similar to PEZ sweet dispensers. Remove the top one and the one underneath pops up to be given as much attention as the previous no. 1, even though it was there all the time.

Yellen and the Fed have filled many column inches with her being read as dovish, or not, or maybe or.. and at this point we see Fed watchers examining the ink density of full stops and the weight of the notepaper it was issued on for upcoming clues. I must be one of the few people who think that micro-tuning Fed timing is one of the biggest wastes of time mankind has ever invented, to the point I should wrap the whole exercise in an App called 'Rate US’ the success of which makes Candy Crush look like Friends Reunited.

For me there are bigger issues out there - and the one that frightens the willies out of me (and could in fact be another reason to buy bunds) is Rrrrrraaaaaaashaaaaa.

- The Ukraine ceasefire didn’t hold.
 - Russia has almost stopped pretending they aren’t there.
 -British forces head for Ukraine as David Cameron issues warning to Vladimir Putin Ok, to train Ukrainians but we know where this leads and this headline has to be the most frightening I’ve seen for a while. Interestingly and perhaps reassuringly Russia hasn’t become a UK election issue. but I just hope Cameron doesn’t think it his political Falklands.
- Cameron is also threatening to switch Russia of the SWIFT payment system.  Russia is already building bypasses around that so doubt they are worried.
- Meanwhile Russia is buzzing European airspace and the US are parading troops 300yds from the Russian border in Estonia.

And yet I feel I am alone with my own childhood terrors of Russian conflicts and nuclear wars. Popular US commentary once again appears to be dismissive and a blind faith prevails that economic sanctions will work (well they effectively did with Reagan’s Star Wars all-in poker bluff in the 80’s) or through military power (all Russia’s equipment is old and rubbish). Everything that Russia has done so far backs up my original belief that threatening Putin makes him stronger. But we are back to a problem we see everywhere. Morals come first these days rather than best outcome. I hate to say this but I agree with the UK Green party in that we need to appease a little. Standing up to a bully is all well and good and works well in US teen movies, but in the real world down a darkened alley having fallen out of a night-club sometimes negotiating to give the mugger a couple of notes rather than kicking off world war three and losing the lot is a sensible option. In the mugger analogy there is an ultimate rule of law over it together with enforcement (someone will later go and track them down and hopefully punish them). With Russia there is no overriding super-authority that can prosecute and punish. It would be great of the US had the power to do something without using Europe as a muddy football pitch again for superpower playouts, but their track record of binary 'with me or against me’ foreign policy has left the world looking like a recently kicked red ant nest. Is there some irony that the EU was originally formed to prevent war yet is now so inwardly focused on petty bickering over who owes who what for the buffet of cheap funding, that they could really screw up over the biggest war threat on their doorstep?

If Dijsselbloem is such a crack EU ‘get what we want’ negotiator I suggest he pops off to Moscow for a chat.

This may sway a bit from markets but it does reflect on what makes people make investment decisions. I find there are those that introspect and those that look wider afield. The introspective appear to be gaining foothold in funds as micro-specialists beaver at individual relative value and quants pour over historic performance and cross correlations but neither of them have time to look up at the non-financial inputs that may hit their asset class  (Russia a good example). This leaves the macro decision to be made by the asset allocator and in most cases that buck is passed back to the client who then turns to a consultant who once again looks back over history. Have you ever heard a consultant pass comment on future global political outcomes rather than drown you in spreadsheets of past performance, diversity and risk measures?

Which leads us back to the beginning. My final hope for my Bund short is that these introspective management views that consultants and real money apply these days has built up a risk in bonds that I can bet against. When the dam breaks real money and the poor pension funds who are matching duration of assets to liabilities are going to get hosed by negative real return. "But hey, we are only following the rules and against benchmark we are.." Yaaawn.

Post script -  I raise exhibit 1 in the case against real money bond logic in a following post here . It is the case made by JPM Asset Management for buying Bunds which I counter point by point.

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