The time has come, the walrus said, to emigrate to Substack

 

This blog is moving.

After some thought, I am shifting future writing over to Substack, which you can find here:
https://polemicpaine.substack.com it continues to be free. If I took payment I'd have to up the quality, uphold a responsibility and would start sounding like a self promoter. 

There is nothing dramatic in the decision. Platforms change. Habits change. Substack has simply become where readers and writers now seem to gather, and it feels like the right place to continue.

When I first started blogging back in 2010, Blogger was the obvious choice. It was simple, open, and perfectly suited to the way people wrote then. Over the years, this space accumulated its own small archive of thoughts, arguments, detours, and obsessions. That mattered, and still does.

All of those posts have now been migrated to Substack, so the full record of Polemic's Pains lives on there as well, intact and in one place.

After a long pause, I have started writing again and doing so on a platform built for that purpose feels oddly energising. Less fiddling, more writing. More conversation. 

This blog will remain here as a record of those earlier years. New posts, though, will live on Substack.

If you have followed my writing before, I hope you will join me there. And if you are new, then this is the right moment to arrive.

Thank you 

The Fed-Watching Club

Market commentary has always organised itself into clubs. Not formally, of course, but socially and reputationally, with all the signalling that comes from deciding which conversations are worth being seen to have. At any given time there is a fashionable place to be, a subject that confers seriousness and relevance and the reassuring sense that one is close to where things are happening.

These clubs change. Trade data was once the most exclusive room in town, full of people talking knowingly about containers, ports and mysterious lags that only insiders understood. Then came the Non-Farm Payroll club, which enjoyed a long run as the place where real macro people gathered, eyes fixed on a single Friday morning print that briefly mattered more than anything else. CPI had its moment too, as did the Philly Fed survey, which for a while allowed people to sound granular and regional without actually leaving New York. The Beige Book club has always bumbled along, attended mostly by people who insist it contains insights if read carefully enough, which it sometimes does.

Above them all sits the grandest and longest-running club of the lot, the Fed-watching club.

For a long time this was the place to be. It felt exclusive, serious and central. Knowing how to parse a statement, how to read a Chair’s tone or how to anticipate the market’s reaction to a particular phrasing marked one out as someone who understood how markets really worked. Membership conferred status. It was the Groucho Club of macro commentary, selective, expensive in terms of time and effort and faintly smug about it.

The problem is that it still behaves as though nothing has changed.

The Fed-watching club is now more Soho House. There are branches in every city, online versions in every timezone and an endless stream of people desperate to be seen inside, nursing the same drinks and having the same conversations. It costs more than it used to, in time and attention and it impresses rather less. Everyone wants to belong because belonging still signals seriousness, even as the substance has thinned.

Inside, the conversation has become oddly repetitive, as if chemically encouraged rather than argued through. Endless debates over quarter-point moves, over commas in statements and over the emotional timbre of press conferences fill the room, all of it delivered with great confidence and very little reference to whether prices are actually moving for those reasons. It feels industrious, authoritative and reassuringly legible, which is precisely why it remains so crowded.

By design, the Federal Reserve sets the overnight price of money. It anchors the very short end of the curve and only under conditions that assume orderly markets, available balance sheets and cooperative plumbing. Beyond that narrow strip of maturity, rates are not set but discovered. They reflect supply, demand, issuance, collateral availability, hedging costs and the willingness of private actors to intermediate. Long rates do not follow guidance, they follow gravity, and gravity has never applied for club membership.

This began to matter enormously once central banks stopped merely setting prices and started trading bonds, a moment that should have been an embarrassment for the Fed-watching club. QE was not a subtle extension of rate policy but a large buyer entering the market and removing duration by force, compressing term premia and pushing private capital elsewhere. When that process later reversed under QT, it became equally clear that balance sheets were constrained, intermediaries selective and capital far less eager to absorb what had previously been warehoused. Prices moved in both directions for the same reason, quantities changed, not because guidance improved, which should have settled the matter. Instead, Fed watching doubled down, debating phrasing while the furniture was being moved back into the room.

Fed-watching culture prefers not to dwell on this because it is difficult to dramatise. Rate decisions come with meetings, forecasts and microphones. Balance-sheet operations arrive via footnotes and operational notices, which are inconveniently where prices tend to move. One flatters commentators and fills airtime, the other interferes with tidy narratives.

At the same time, enormous fiscal issuance is treated like an embarrassing relative who has turned up unannounced and is best not discussed. Governments issue at scale, duration floods the market and the assumption seems to be that someone else will absorb it, yet commentary prefers to debate rate cuts as though they were the main event rather than a sideshow running alongside a much larger supply story.

There is also the small matter of the global dollar system, which operates far beyond the Fed’s domestic jurisdiction. Offshore dollar funding, FX hedging costs and cross-currency dynamics routinely drive price action, none of which responds particularly well to domestic narrative management. The Fed sets a price in one place, the dollar system clears everywhere else and the club conversation barely notices.

The persistence of the Fed-watching club has less to do with effectiveness than with convenience. It offers an alibi. If trades go wrong, the Fed surprised us. It offers safety. Being wrong in a crowd is cheaper than being right alone. It offers performance. Talking about rates sounds serious and travels well. Talking about balance-sheet capacity, collateral velocity or fiscal dominance does not.

Markets, however, remain stubbornly uninterested in club membership. They move when marginal buyers change, when balance sheets fill up, when issuance overwhelms demand or when intermediaries step back. These are not side effects of policy, they are how policy becomes price. Rate cuts often soothe nerves rather than alter arithmetic, a comforting drink rather than a structural repair.

None of this is to argue that the Federal Reserve does not matter. It is to argue that the club built around watching it has become fusty, over-subscribed and oddly resistant to the idea that the scene has moved on. Like Soho House, it still trades on reputation long after exclusivity has vanished.

Fed watching endures not because it offers a good return on intellectual effort, but because it offers a reliable social one. Very clever people spend vast amounts of time interrogating marginal policy signals that explain less and less, largely because doing so looks serious, travels well and carries little professional risk. The misallocation is striking. The same intelligence applied elsewhere would be far more productive, which is precisely why this fixation should fade as returns continue to disappoint.

The doors remain crowded, the conversations earnest but the signal, as usual, is elsewhere.

Preparing for War, Trading for Peace

 

This weekend's headlines announce that the UK government is preparing the country for war, which is the sort of sentence that once would have belonged to the archival past tense but has now returned to the present with a straight face and a briefing note, accompanied by earnest talk of resilience, mobilisation and national readiness, as if modern conflict were something you could prepare for with a laminated checklist and a stern reminder to pull together.

The tone is serious enough, yet one cannot help noticing that when Britain speaks of preparedness it often does so with an institutional memory that drifts unhelpfully toward Dad’s Army, a world of improvised courage, borrowed kit and the comforting assumption that enthusiasm will substitute for industrial depth. This is charming on television and catastrophic in reality, especially when the conflicts being gestured at are defined less by moustaches and morale than by munitions throughput, energy intensity and semiconductor supply chains.

This is where the market’s recent behaviour becomes faintly absurd. European armaments stocks have pulled back on the back of peace headlines and diplomatic choreography, as if the mere suggestion of talks were sufficient to reverse a decade long repricing of European vulnerability, even though the political language has hardened, the spending commitments have broadened and the industrial machinery is only just being rebuilt after years of strategic neglect disguised as efficiency.

This is temporal dissonance again, the same old habit of compressing short term political theatre into long term economic conclusions, a reflex that flatters the trader’s sense of agility while quietly ignoring the stubborn physical reality that shells, explosives, missiles and air defence systems do not appear because sentiment improves and do not disappear because a framework is floated over coffee.

If Europe and the UK are serious about readiness, then the awkward truth is that the hardest parts of rearmament are not rhetorical but industrial and they collide directly with other fashionable policy commitments that markets have not yet reconciled. Explosives and propellants are energy intensive to manufacture, which would be an unremarkable observation were it not for the fact that net zero policies have pushed European energy costs to levels that make domestic production structurally expensive before a single safety audit or planning inquiry is even completed. You cannot will cheap munitions into existence while simultaneously pricing energy as though heavy industry were an optional vice rather than the foundation of sovereignty.

Then there is the small matter of inputs. Europe lacks meaningful domestic production of many of the metals and specialist materials that modern weapons systems depend on, from rare earths for guidance and sensors to high grade alloys for propulsion and armour, while the technology stack that binds it all together, semiconductors, optics, electronics, remains globally fragmented and strategically exposed. Preparing for war while importing the ingredients from jurisdictions you do not fully control is less a strategy than a hope dressed up in uniform.

This is why the market’s recent pullback in defence stocks is more interesting than alarming. It does not reflect a collapse in demand or a reversal of policy but rather the familiar urge to find narrative closure, to treat peace talk as policy unwind and to take profits without admitting that valuation and crowding had become uncomfortable. Markets enjoy endings, preferably moral ones, and they enjoy them even more when those endings justify doing nothing further.

The error is to imagine that investing in armaments is a bet on endless conflict. It is not. It is a bet on governments having crossed a threshold where the cost of being under prepared now exceeds the political discomfort of spending too much later, a threshold that once crossed is rarely receded from because no minister enjoys explaining why savings were prioritised over readiness.

If today’s preparation risks resembling Dad’s Army, the lesson is not that the threat is imaginary but that the gap between rhetoric and capacity remains wide and closing that gap requires precisely the sort of long dated industrial investment that markets habitually undervalue when distracted by short term headlines.

Peace may come, pauses may occur and negotiations may multiply, yet none of that removes the fact that Europe has repriced its own fragility and discovered that it outsourced too much, stocked too little and assumed too much about continuity. When defence stocks fall because the market pretends that lesson can be unlearned quickly, the humour is dry, the irony is thick and the opportunity is structural.

The Bezzle and Temporal Dissonance

 

Markets have always possessed a peculiar talent for flattery, though the form of that flattery evolves with each cycle and the present era has refined it into something unusually elegant. We are encouraged to believe not merely that we are correct but that we are early, patient and principled all at once, which is an astonishingly generous self-assessment for any system built on leverage, expectation and borrowed confidence.

There are two distinct mechanisms by which this illusion is sustained. One is old enough to have been properly named, examined and absorbed into the intellectual furniture of market thought. The other is newer, faster and more psychological and is still widely mistaken for sophistication rather than recognised for what it is, which is a failure of temporal discipline masquerading as foresight.

Galbraith gave us the first in the form of the bezzle, a term he introduced most clearly in The Great Crash of 1929, where he described it as the interval during which perceived wealth exceeds real wealth without producing discomfort because nothing has yet forced recognition of loss (https://creditwritedowns.com/2009/01/quote-of-the-day-john-kenneth-galbraith-the-bezzle.html).

The bezzle is not simply about prices being excessive, which is a phrase that explains very little, but about a collective misapprehension of wealth that persists precisely because it feels stable, respectable and deserved. During such periods balance sheets appear sound, refinancing proceeds without friction, narratives align neatly and dissent is treated less as analysis than as a lack of imagination. A concise modern definition captures this well by describing the bezzle as perceived wealth that exists only because fraud mispricing or misunderstanding has not yet been revealed (https://www.forbes.com/sites/eriksherman/2019/10/25/galbraiths-bezzle-is-the-machine-that-props-up-income-and-wealth-inequality/).

Wealth during a bezzle feels real because it behaves as though it were and behaviour is far more persuasive than arithmetic. People act richer, institutions lend more freely and risks appear smaller simply because they have not yet been realised. The danger is not optimism itself but the absence of resistance, which delays the point at which illusion and reality are required to reconcile. As several modern commentators have noted, the bezzle expands most easily in environments where rising asset prices are treated as confirmation rather than signal (https://blogs.cfainstitute.org/investor/2019/09/12/the-bezzle-and-the-central-banks/).

Temporal dissonance operates differently and far more intimately. It is not a distortion of value but a distortion of time. It emerges when markets price outcomes that may indeed occur eventually as though they are imminent, while investors justify their exposure using the language of long-term inevitability despite holding instruments, structures and liquidity promises that are inherently short-term.

You hear temporal dissonance most clearly in how positions are defended. This is a ten-year story, we are told, by people who will not tolerate a two-quarter disappointment. Near-term earnings are dismissed as irrelevant by funds that publish daily performance. Volatility is celebrated as the price of conviction right up until it demands behaviour inconsistent with self-image and stated horizon.

When the bezzle and temporal dissonance overlap markets become particularly fragile because strong narratives are capable of sustaining perceived wealth far longer than fundamentals alone would permit, while temporal dissonance keeps investors exposed well beyond the point at which prudence would normally intervene. Narrative strength matters not because it alters cash flows but because it alters tolerance for discomfort and it is discomfort rather than valuation that ultimately forces exits. This interaction has been observed repeatedly in modern asset cycles where belief systems outlast balance-sheet reality (https://carnegieendowment.org/china-financial-markets/2021/08/why-the-bezzle-matters-to-the-economy).

Artificial intelligence equities sit squarely within this overlap. There is plainly a genuine technological shift underway and denying that is merely performative scepticism, but the speed with which distant, uncertain and highly competitive future revenues have been capitalised into present valuations speaks less to sober analysis than to narrative momentum. The bezzle reveals itself in assumptions about margins, scale and market dominance that leave little room for competition or commoditisation. Temporal dissonance appears in the insistence that these are long-term holdings even as price action, sentiment and positioning remain acutely sensitive to quarterly guidance and incremental news.

Crypto assets represent a purer bezzle and a more chaotic expression of temporal dissonance. Here perceived wealth often lacks any anchor in cash flow and is sustained instead by reflexivity, scarcity narratives and a permanently deferred promise of future utility. The language is resolutely long-term while the behaviour is unmistakably speculative. When the narrative weakens perceived wealth contracts sharply, only to be reconstructed later under a revised ideological wrapper and pricing once again advances ahead of adoption. Commentators have repeatedly warned that such cycles are textbook bezzle dynamics rather than novel financial evolution (https://www.steadyhand.com/national_post/2019/12/02/beware_the_bezzle/)

Private technology markets conceal bezzles more effectively because they suppress price discovery. Infrequent marks, internal models and funding rounds that validate prior assumptions allow perceived wealth to persist without meaningful challenge. Temporal dissonance emerges when so-called patient capital depends on continuous refinancing and when disruption narratives collide with the very real liquidity constraints embedded in fund structures. The story remains intact but increasingly defensive rather than expansive.

Uranium equities provide a particularly instructive case because they sit uncomfortably between genuine structural change and aggressively front-loaded pricing. There is a credible long-term case for nuclear energy, driven by baseload requirements, decarbonisation constraints and geopolitical reshoring of fuel cycles, but the bezzle risk emerges where scarcity narratives extrapolate constrained supply into permanent pricing power without sufficient regard for demand elasticity, reactor build timelines, financing bottlenecks and political reversibility. Temporal dissonance is evident in the way decade-long nuclear investment cycles are traded through highly volatile equities expected to deliver near-term returns while being justified as strategic holdings. The result is a market that speaks fluently about the inevitability of nuclear’s resurgence yet reacts sharply to short-term inventory data, policy headlines or fund flows, revealing a mismatch between the time horizon required for the thesis to mature and the patience actually available to its holders.

Green transition assets introduce a further complication because the narrative carries moral reinforcement. Subsidies, mandates and policy commitments extend the life of perceived value even when underlying economics disappoint. Temporal dissonance is acute because urgency is priced aggressively while infrastructure, commodity supply chains and consumer behaviour evolve slowly, unevenly and at times reluctantly. The transition may well occur but the timetable embedded in prices reflects politics rather than economics.

Even sovereign debt in the developed world exhibits a subtler version of these dynamics. Here the bezzle lies in the assumption that safety itself is immutable and that duration can remain benign despite fiscal dominance, demographic pressure and political constraint. Temporal dissonance appears in the belief that sustainability concerns belong to the distant future even as refinancing cycles shorten and tolerance for adjustment weakens.

The persistent error is to treat long-term correctness as a substitute for short-term resilience. The future does not arrive on schedule and cash flows do not materialise on narrative demand. Perceived wealth has a habit of evaporating precisely when it is most widely agreed upon, most confidently defended and least questioned.

This is not cynicism. It is simply memory.

Markets change their language, their technology and their aesthetics but they remain remarkably consistent in their ability to confuse value with timing and conviction with durability. The bezzle flatters us by telling us we are richer than we are. Temporal dissonance flatters us by telling us we are more patient than our behaviour suggests.

Both are abundant today and neither should be mistaken for wisdom.

Biases in feedback lead to CBA

I am fast adopting a bunker mentality. I know that listening to the opinions of others builds a sample set on which to base one's own opinions but the behavioural biases of social platforms make it all too much like hard work.

The only way my opinions can benefit me is through the actions I take based upon them. Yet in expressing them I am suffering from what follows. Demands to justify them or to defend them against evidence to the contrary. It is particularly interesting how people do expect an answer in response to their demands. Where did this expectation that anyone ever needs to respond to a demand come from? It's probably as a spin-off of the journalistic use of the term ‘demand’. We demand answers! Well, I’m not going to give them to you so whatcha going to do about it, do some more demanding? I have no incentive to invest time in persuading others that my views are correct. I will ultimately be judged by the future, not by those challenging me.

Looking at this through a bias filter, anyone who disagrees with an opinion will cite the views of others to support their case, affecting an arms race of ’someone more famous/respected/right agrees with what I say' citations. People appear to have stopped thinking for themselves, instead needing to select one of the thousands of academic papers on any subject to do their thinking for them. Academic papers are two a penny. There is always one that will support any view making their employment in discussion less and less effective yet they are used to attack either the evidence supporting the opinion or the opinion itself.

Yet anyone who agrees with the opinion will tend to stay quiet. I assume because there is a belief that an opinion doesn't need support if the author is already on board with it. So we have a bias. Lots of negativity versus little support. If I were to respond to the critics by adapting my actions to represent the balance of response I would ALWAYS have to change my mind as the ‘disagree’ pile of evidence always outweighs the ‘agree’. This is reminiscent of the famous Monty Hall problem where it's always best to change your choice. I assume that if I announced I'd followed popular feedback and reversed my position, the bias of feedback would swing to the other side supporting my original view. I could, at that point, step back leaving a barroom brawl between all participants as I sneak out of the saloon.

Or is all this disagreement supplied to me for altruistic reasons? Do people realy care whether I am right or not, just for my benefit? Naaahhhhh.

They care about whether THEY are right or not. If they have based decisions and actions on views that oppose those expressed and those expressed are right then they are wrong, resulting in a loss that includes the loss of the security of a narrative framework that they have hung their decisions upon. Rebuilding a broken narrative framework takes time, thought and effort and an admission of failure, which comes with its own psychological problems. Hence there is a preference to avoid this cost until its absolute necessity, which usually occurs as a phase change rather than a smooth transition. We hang on to beliefs because humans like certainty and hate uncertainty. We go through our lives craving certainty as certainty removes risk, to the point of preferring to believe in the models we employ to run our lives well past their sell-by dates. There is also pride. But being able to admit when you are wrong is essential to succeed in life and certainly if you are trading in the markets. If we never adapted our models for, say, crossing the road as cars evolved from 5mph to 60mph, we would be splats in the road.

Yet there is value in the volume of criticism of my financial market opinions. It's related to the fact that financial prices reflect the aggregate of the expectations of all participants (note it's expectations that drive prices, not the maths or data of the ‘now’). Prices change due to changes in those expectations. If I am deluged in criticism then I can take that as a good sign that no matter how logical their argument, the next move will be a reversal of expectation and a reversal in price.

This is particularly important in these times of virus as I believe the most important input into determining price direction is the watching of others, rather than studying deep reasoned analysis. Why? Because the complexity and detail of current analysis are camouflaging the error function of the primary input, which in these times is usually a big fat assumption, let's even call that a guess. The errors around this primary assumption are so huge they make further analysis worthless. Effectively polishing a turd with detail.

This type of analysis is over-relied upon. Normally as a crutch to support priors. It was only two years go when the last decimal point of forecasts of UK GDP out to 2030 was being quoted as gospel to support or decry Brexit, yet here we are deep in an ‘unforeseen’ that has made all of them worthless.

So what is it that drives the criticism. The desire to be perceived as right? Why? Does being right or the respect of others pay the bills? Not unless you are selling snake oil. I don't care about making an idiot of myself - no one pays me for my views, I have never had an offer of employment based on my publicly expressed opinions, nor am I a journalist needing a profile nor a following to ensure my continued employment.

It doesn't matter if anyone thinks I'm a moron, but as far as publishing financial market trades goes, I’m switching from 'transmit' to 'receive'.

BTP time bombs.

My last post was on Turkey and oil. Oil, only briefly to say it was turning and Turkey in a great long verbose way to say it was turning.

Last week every eye was upon the Turkish lira. But market attention is drawn not by absolute badness but by relative baldness, so the complete explosion in Italian politics over the last five days has drawn the macro tourists away from Turkey, leaving it free to pick itself up, dust itself down and become one of the world's best performing assets this week, knocking the socks off even the USA. Oil has also continued its downwards track leaving the long Turkey short oil trade looking like a podium winner. But there is no one even watching the champagne spraying ceremony because they have all dashed off to Italy.

Italy is really big stuff compared to the shakedown of a Turkish market that has already been seriously shaken down. If you think Turkey is a source of contagion in EM, you just have to watch what Italy can do to the DMs.

Italy is where risk and reward have been forced together between the huge clamps of ECB policy. Applying billions of Euros of force to the BTP market the ECB has managed to hold things for long enough to convince the market that Italian risk was not far off German risk and that Italian yields could be lower than US yields. And the money poured in on the implicit promise that the ECB would always be there and the explicit promise that they ‘would do whatever it takes'. Which is all fine as long as Italy doesn't decide to tear up its agreement with Europe and hence the ECB.

Unlike Turkey, Italy has a LOT of money parked in its debt markets. First, because it has a lot of debt and second because it pays more than the rest of core European. Finally, it will only lose you money if it defaults.

Losing money in bonds is a game of peek-a-boo. If you don't look at it won’t have cost you anything because any bond with a positive yield will, on full repayment at maturity, have made you money on an absolute basis. However, on a relative basis, things can be very different. Bond markets are about chasing the best yield and that implies relativity. Bond performances are barely ever measured against absolute return, instead choosing to be measured against a benchmark. So relative performance is absolutely key for measuring success. As soon as we have the relative performance we have to keep a track on how things are going and though we know we will get our money back in the end, if the value of bonds fall relative to the benchmark we are 'losing money’.

One obvious way not to be losing money, if we know we’ll always make in the end, is not to look at the price of the bond whilst holding it. 'No looky' no lossy'. Or no mark to market. This is what the ECB does with its holdings and that applies to the current 250bio it has on its books through QE. If it has no intention of selling them before maturity then there is theoretically no reason to mark them to market.

Funds are a different kettle of fish as investors constantly want to know what the worth of their assets are for value and for risk management sakes and that involves measuring them against current market prices. Kaboom.

Italy has always been a dirty little secret in real money portfolios. The long-term traditional real money accounts have huge amounts of higher (well, it was) grade Italian debt on their books under the title of European bonds. Desperation for yield and performance has forced many to wade into the 'Draghi guaranteed' higher yielder. There was little chance of being criticised by senior management for being long Italy, as to doubt Draghi was to doubt the existence of the Euro and therefore the existence of your own large European financial institution. If you know the event that blows up your fund also blows up the whole company then there is no relative disadvantage to holding them, if it blows up you lose your job either way.

When Europe started to recover and the Eurozone lift-off story started propagating 18 months ago, the chance of Italian default through local credit pressures was seen to fade and the demand from private hands to buy the previously considered toxic NPLs and sub-grade debt that was polluting Italian banks’ balance sheets was huge. The banks eagerly offloaded swathes of it and were starting to be classed as clean again. So banks were bought again too.

The purchasing of Italian based debt by private hands has been huge. Real money, hedge funds and SWFs own it and swathes of it have been built into all sorts of illiquid high-yielding structured products. The Italian banks are still holding enough of it together with government debt, to have some serious problems. Everyone is up to their necks in it.

The question is who has the longest mark-to-market interval. If you don’t have to look at the relative value then you might be able to ride this out as long as there is no default or restructuring into NuevoLira. But trying to keep a lid on exposures is going to become harder as time goes on. We are going to see fissures open up in places we probably haven’t yet imagined. Try picturing financial Europe as a Hawaii Big Island lava map. Even Herr Oettinger may find the soles of his feet warming up through German institutions' Italian debt holdings.

BTPs erupt in Portfolios

So in summary. I am a fader of peak 'tabloid' noise. Tabloid noise is indeed at a fever pitch. But in the case of Italy, we are not quite there yet. Mrs Watanabe has not yet sung and, though trying their best not to make any noise, those with Italian debt embedded in ‘safe' funds are going to be crying for their mamas before we see this over. Of course, that is unless Mr Draghi and the Eurocrats bow to quiet pressure to ‘just sort it out’.

I had wondered whether Italy might issue 250 billion of a 1000yr zero coupon BTP. They could exchange this with the ECB for all the shorter-dated stuff they hold and as ECB isn't mark-to-market, they would have effectively written off Italy’s debt. Just an idea.

Finally, its time to resurrect a post from 2014 which is once again very apt. Though my interpretation this time is that there is a lot more to worry about.

Monty Python's Four Italians sketch
https://polemics-pains.blogspot.com/2014/10/the-four-italians-sketch.html

Tabloid Turkey.

My Tabloid-o-meter shot into the red this week on two matters - Oil and Turkey. I have had very successful runs in both over the last two years but with the amount of noise surrounding them, I have reversed my positions as both are likely to correct. However, I am going to leave oil for now and concentrate on the Turkish noise.

Watching the crowds form around the Turkish sell-off is like watching a fight break out in the school playground.

Two kids start shoving each other, a crowd gathers, others see the crowd and ask what’s going on, more join as the playground’s attention starts to get sucked in by the gravity of the situation. They are told by those who didn't know what was going on what is going on, but Chinese whispers are propagating the further out the crowd is from the epicentre. Teachers are called and kids start Facebooking the action. The media notice and a reporter arrives, then the TV crews (let’s stay this is a Beverly Hills school) and suddenly a 'school-fight expert' is on the screens. To fill time and tighten the tension he even suggests that the fight might spread to neighbouring schools as gang culture is rife. Watching this on TV, parents pull their kids out from all the local school. Why? they don’t really need the reason, just the fact that their darlings have the smallest chance of being hurt is enough. Meanwhile, an enterprising guy opens a book on the fight, offering odds. People who have no clue about the antagonists are betting on the outcome. Seeing there is money to be made, big online betting sites get involved. Adverts appear extolling how much money can be made betting on the fight and an old man with ‘The End is Nigh' on a placard is spotted wailing outside the school. He's interviewed on TV as an expert on the upcoming global destruction. Finally ‘Phyghtchain' is ICO’d. The crypto coin backed by the physics of fight. Ten minutes after it launches someone in the centre of the scrum notices that the two scrapping kids have vanished, having been called home for their tea.

Well, that’s what it feels like, and pretty much encapsulates the anatomy of the past few EM crises. If you had faded the noise you would have made a lot of money.

Turkey has been firmly at the centre of my geopolitical radar for years, but the failed coup and the onset of the Putinisation of Erdogan had me shorting Turkey faster than a butcher on Boxing Day (26th Dec, for my non-UK readers).

The concerns being that Turkey was going to be a massive problem in the overlap of every sector of global politics. Add this to the price of coffee in Bodrum cafes and it looked like an obvious short. Yes, I do use a bit of coffee PPP as an indicator for when a country moves from EM to DM, usually through UM (Upstart Market, where they think they can charge alpine prices for emerging levels of service) and Turkey went UM very quickly in the early naughties.

The problem with starting the ball rolling on shorting Turkey was the yield. Yield is like a hill in the road. To get over it you need enough momentum in underlying price to overcome the drag of yield gravity. if you are paying 10+% of your returns away hoping for a move that is greater than that to pay you off, in a world where if you manage to make 5% as a fund money manager you are a hero, you need a really strong belief that you are going to get a big move your way. And this is where momentum comes in. If you travel fast enough up that hill of price then you will make it successfully to the other side in profit. While things grind along slowly it may not be worth the risk.

Until the day comes when something triggers the tipping point and the yield is no longer enough to pay for the risk in price moves. This is what happened with Erdogan's policy announcement that high interest rates were bad and weren’t going to be used to defend the currency. Boom. Momentum meant that prices were moving far faster than the yield could compensate for. Who cares about 16% p/a interest costs when you are getting 5% moves in a day? As momentum explodes the relative return of carry is diminished.

Those long of the carry trade were underwater and the risk-reward was seriously changed. Japanese yield hunters were finally triggered out of their positions (normally the last out) and the resulting sharp moves were what sucked in media attention and anyone thinking there was a buck to be made. Why has everyone piled in? Well… Well, a good question to ask is why are you selling TRY now rather than selling it a year ago at much better levels? The answers I hear back are that ‘this time is different’. Deficits, Balance of Payments, screwed up policy, political isolation and a rising US dollar and global rates.

So which bits of that are new?

Deficits and BoP are cited every time there is an EM sell-off, but we know from experience that investors are tarts enough to be bought off by high yield once things stabilise.

The screwed up policy and political isolation - these are based on Erdogan and I concur it is a long-term mess, but the balance of monetary policy position has shifted with the 300bp rate hike on Wednesday. The political situation is a very good reason to be concerned in the long-term but it isn't anything new to us.

Rising US rate and a strong dollar - This generic EM wasp spray is brought out every time there is an EM crisis. As seen in 2014 and 2016 it never ends up killing EM. It is also important when reading articles on the amount of dollar debt out there, to consider who owns it. EM dependency on US-based lending is waning. If EM issue USD debt and buy USD debt then as rates rise, yes, the borrowers suffer but the lenders gain. Often it is the same countries or companies who are both long and short - most of it is intra-China. So whilst I agree that higher US rates and a stronger dollar don't help matters it certainly isn't responsible for the chaos.

QE unwind? Money was cheap and it was easy to park it in high yield. But the reduction in liquidity is reflected in rates and a move in rates is yield differential and though US rates may be 2% higher than last time, Turkish rates are higher still. It’s a great back-fit story but it isn't the trigger or the ‘now’.

So, as with an old wedding cake being recycled for the first christening, we have the old baked reasons to sell Turkey re-iced with some new ones.

Turkey is still a tinderbox and Erdogan’s positioning in the world will have to be resolved before we can see any long-term improvement but I do not see this event as THE blow-up. EM blow ups are more like dud fireworks. They explode in your face when you go back to wonder why they hadn’t gone off. Early 2014 may be a good case in point to follow. We had maximum noise before Turkey ended up as the best performing EM of the year.

I do not see Turkey acting as a catalyst for a contagious event. It is an easy sensationalist game to play and Ambrose Evans Pritchard is at it already, quoting the head of the IIFF  but the world is now smart enough not to clump all ‘EM’ into the one fund-box it used to.

With noise at such levels and every macro tourist flocking to Turkey, I have turned my shorts into Turkish longs looking for momentum to fade and the weight of the carry costs tied to the ankles of TRY shorts to drag them, spluttering, underwater.

Is the EU protectionist?

In response to the Tony Barber piece in the FT "The EU is no protectionist racket"



- The EU’s FTAs are quite narrow and include Rules Of Origin constraints on manufactured goods.

- These are primarily goods trade deals which suit France and Germany but would not suit the UK. They also seek to impose EU product standards (more on this later).

- Public procurement is an area of French and German strength. It is why public procurement is one of the very few services that has been included in recent trade deals the EU have signed. However public procurement falls under State-Owned Enterprises (SOEs) or is classified as national security concerns. So though on the face of it it looks like the EU isn’t being protectionist via the trade agreement when it comes to actually awarding the contracts practice, these concessions are never awarded to foreigners. They impose local regulatory standards or clauses to make sure this is the case. The inclusion of the public procurement clause is a concession that will never result in anything for the counterpart.

- The US is not an innocent party, but it does have a legitimate argument that China, Korea and Germany have taken unfair advantage on trade by following mercantilist policies that restrict domestic market access via regulatory measures. The US is seeking to use its leverage to adjust this relationship.

- The US has already stated it would like to have a trade deal with the UK. There would be cheaper food in the UK as a result. the argument over such things as chlorinated chicken can be defused by clearly labelling produce and letting the consumer choose (c.f. free range eggs).

- Of course, the UK should depart from EU regulatory alignment where it is in the national interest. That is the point of taking back control. A significant trade deal that opens up markets in services and food is eminently in our better interests.

- The Irish border issue is not legally solvable. A fudge is required and will be found. The UK will not police it even if the EU wants to. The EU is being overly legalistic on this front, and technology will ultimately provide the solution. Lawyers have too static a view of a dynamic world, especially in this respect. The tendency for Eurocrats to regulate for the now, or the past, rather than the future is also why the EU is not going to end up with thousands of City bankers. Banking functions, including trading, are going to be dominated by AI and we should expect to see the supra-national FANG model become the norm in banking. The computer may sit where the regulator tells it to sit but those programming it won’t.

- They are protectionist by insisting other standards that might not conform to Rules of Origin requirements (in themselves protectionist). Erecting blanket trade barriers with the UK, even with products that do match their standards, because the UK won't enforce all of their standards domestically is pretty close to the definition of punishment beatings and protectionism.

- Setting EU standards is a form and force of protectionism that tries to export the cost of European social models on the non-EU supplier countries. It requires these countries to completely change the way they produce goods etc and instantly puts them at a disadvantage with French/German firms. This is why Dyson moved his production to Malaysia: they stitched the rules up to the UK's disadvantage. As a result, he pays the EU external tariff to export Dysons to the UK.

- The most liberal of FTAs is the Australia /New Zealand agreement, which involves Mutual Recognition Agreements. These accept that both countries' regulators are competent enough to be accepted by the other without the need for harmonisation. Harmony in this sense, though sounding peaceful, is the forced infliction upon other countries by the EU of the EU’s way of doing things (do it the way we want you to do it, not the way you do it) to their protectionist advantage. If you don't submit to being 'harmonised' with EU standards then you cannot have market access. A more sensible view would be that developed countries, by and large, have high enough product standards and service regulation that they should have Mutual Recognition Agreements instead of harmonisation.

-THIS IS NOT ABOUT TARIFFS, it's about Non-Tariff Barriers - which the EU excels at imposing. It's a French national pastime - remember the Battle of Poitiers with VHS recorders coming in from Japan? Why do they want to stop the UK from keeping the City? Because they want the business. True free-traders would allow it to continue with regulatory cooperation and Mutual Recognition. The BoE/FCA/PRA are amongst the best financial regulators in the world from a financial stability standpoint. The ECB et al, in appealing to financial stability risks as a reason for on-shoring, are applying the same logic as warning that building a bridge across the Thames will decimate the boat building business. It's protectionist.

- If the EU have always been such a liberal free trade loving union then why has it taken them decades to come up with these FTAs? Could it be that they feel threatened by the UK leaving? The UK had been pushing for such agreements years ago to no avail. If they had progressed with these earlier it may have defused some of the arguments for Brexit.

- Finally, let’s not forget that the EU’s very existence is based on a bilateral protectionist agreement to protect French agriculture and German steel and coal.

Behavioural gamma and fractal attractions - I blame the Russians.

I am fast wondering if someone has perfected the ultimate 'hunt and destroy’ algo trading weapon. The development of programs that can sniff out other’s stop levels and micturate all over them before running off maniacally laughing with their positions has been around for years, but the precision with which market moves have sliced and diced the flesh from many a portfolio this month has me wondering if the Russians have developed the killer algo of all killers.

I don’t really wonder if it’s the Russians, I more expect someone else to wonder if it's the Russians because if anything that involves a computer and cannot be easily explained, or rather can be easily explained by ‘yeah ok, I was dumb not to see that coming’ but we don’t want to say that - it's blamed on the Russians. I use it all the time now. My wife popped out of the room during ‘Call the Midwife’ on Sunday night and when she returned the TV was tuned to ‘Dragons Den’. I told her it must have been the Russians as I didn't know where the remote was. She couldn’t find it either to turn the channel back, thus proving my point. We also found that the Russians had turned the thermostat down in our house from 24C to 20C, which I can cope with but the Russians, as my dear wife pointed out, have also cut the power to all the wires and chargers by my bed, emptied the fridge of high-fat foods and hidden my favourite clothes. Damn cunning, these Ruskies.

Markets have turned ‘difficult trading’ into a form of waterboarding. I don’t need to talk you through the details of various asset swings over the last few weeks but if you have a position and your stop loss is in the range zero to infinity,  there is a good chance you have been stopped out. Unless you are an investor, in which case you have waved your hand in a marginally dismissive way whilst tilting your head slightly back to peer down your nose and languidly intone, “No my dear chap, I'm an investor, not a speculator, my investments are to provide me with long-term returns”. Which actually translates to - “ I haven’t got a clue what is going on with the markets as I had a chap come round to the house who sold me this marvellous long-term investment fund, no I don't know what the fees are actually, that I don’t have to look at as he assures me that it will pay me handsomely when I retire. Mr Woodford’s something or other”.

I was taken out today. Out of gold longs, stock shorts, and lunch. Only one was pleasurable.  Mourning the loss of my gold position, I bought a new one as I applied my trading maxim - 'the best time to enter a position is just after you have been stopped out of it’. Sad, but unfortunately true recently.

If you had your screens off for the last 36hrs you could well ask "what Fed minutes?"

This sort of thing hurts when you are suffering from  'fractal attraction’ and  'behavioural gamma'. When you don’t know what is going on you have some choices.

1- Carry on, pretending you do know what is going on - you may get lucky
2- Walk away - Clever, clever, clever.
3- Get angry that you don't know what is going on and make it a mission to know what is going on in an ever more dangerous search down the old mine of broken dreams - Danger danger danger Will Robinson.

Or perhaps Lassie - “What's that Lassie? You saw Polemic trying to dissect every price move down to a 3minute chart looking for patterns in order to look for breakouts that would define the next big move? And you think he needs rescuing? Nah.. he’ll already be dead"

The 'fractal attraction' is the drilling in on tighter and tighter time frame charts in the search for a pattern. Each zoom showing pretty much the same pattern, or lack of one, as the previous. Fractal-like. The 'behavioural gamma' is the chasing of any move that looks as though it is setting the next direction, as you really don't want to miss out, only for you to be caught out on a reversal and have to chase it the other way. Behavioural gamma increases dramatically when there isn’t a fitting narrative. It isn’t options gamma, as it is linked to behaviour not a mathemantically derived hedging demand, but I suppose you could imply a link between behavioural gamma and options gamma stemming from the same source of uncertainty.

One could even go so far as to cogitate if one drives the other or that the total sum of behavioural and options gamma is constant. But my mind is wandering too far.

I guess the point of this ramble is to say. Don't get sucked in. When you don't know what’s going on, walk away, as curiosity may well be terminal feline flu.

Just blame the Russians.

GRReat - the Global Risk Repricing

First a recap -

10 days ago -

My best case is that no narrative can be ignored and all have their strengths.  But instead of them each being a separate diagnosis of different potential diseases they are all symptoms of a single greater one. They are all building into a great big superstorm of grief encapsulated in a super-narrative

Inflation, corrections, a spike in volatility (really an increased cost of insurance), problems in leverage, US bonds, problems in risk parity, China sell-offs, Junk bonds sell off, aren’t all separate but are all part of the same single story - the new super-narrative of ‘The great global risk repricing'

A sudden spasm of awakening to true risks may now be underway.  For years we have been saying that credit is too cheap and that junk bonds are way too expensive and that leverage has been practically free. I hate to hark back to QE, as we know that it has spawned a rash of ridiculous pricing, but this, folks, could be the big one with regards to waking up and smelling the coffee. Free money does not mean any risk.

This reassessment of risk perceptions can also include US Treasuries. If there is a chance that they are no longer the ultimate safe haven then the schism would have dire consequences for the stability of current investment theory. No, I am not saying that US Treasuries aren’t safe as houses, I am saying that all you have to have is people questioning them for problems to kick off as soon as Monday.

And that is why waiting for bonds to go up to know if this is over is all the more important, If they don’t then it is really bad news.

Currencies have worn this move fairly well. Yes, they have moved with the classics like AUDJPY doing the risk off thing, but considering the size of the equity moves they are hanging on in there. Most notably,  the popular position of short USD hasn't really seen much of an unwind but it should be considered as part of the short UST trade. This is not about rate differentials anymore, as we have seen the divergence of rate differentials vs FX widen for the past few months, but about underlying trust in the US to manage its affairs. It's part of the risk adjustment as the US and USD have moved a notch right along the scale between Switzerland and Zimbabwe.

So what do we do? the trader in me wanted to buy on Friday, so I did, but the pragmatist thinks this is far from over.


And then 7 days ago - Shorting the CPI and being stopped out. 

I have to say that today was a hero to zero day for me in equity land. I played the CPI figure perfectly as stocks decided that the inflation story really. really is a concern. Until it isn't. And that ‘until it isn’t’ occurred about 15 seconds after maximum 'it is a really, really big concern'. That was when perfection vanished in a puff of humility and the ‘natural bounce up off the lows'  spent the rest of the day grinding higher up to new highs.

I am not too shy to own up to the stock shorts costing me money. I hate grinds, they are worse than sharp moves mostly because sharp moves engulf your emotions in one hit, whilst grinds tie you naked to a chair and beat your bits with a knotted rope until you are finally put out of your misery by the pistol to the head of a stop loss.

But I JUST KNOW that  US stocks will now tank. But if I don't understand why equities are going up then I must get out. Understand? That where your narrative fits whatever it is you want it to fit, but unless someone takes a 3ft pipe bending machine to the current narrative of ‘it’s inflayshun innit’ to make it fit with today’s moves then I am afraid this narrative is broken

We are getting through narratives faster than plates in a Greek restaurant.

Since then.

I licked my wounds until Monday when I started shorting things again. I couldn’t bear to think about missing the big dump. Why Monday?

Momentum was fading and we had just had a new narrative on the block - Double deficit. The double-deficit was the next big thing. But double deficits are like herpes to many countries. Many have them but are mostly unnoticed. They are a pain and you don't want to give them to anyone but the worst they normally do is sting and everyone points, rings bells and shouts ‘unclean!’.  But when something else comes along they fade away into the background to reside in the ganglion of government statistics. A double deficit? How quaint.

We can have double deficits narrative and we can have inflation narrative and we can combine them in a theory of the US crowding out, but to combine them requires something to happen - risk assets have to reprice lower and the overall discount rate applied to US assets has to go up to compensate for future USD depreciation. Meanwhile, a bit of risk premium creeps into apparently risk free assets.

Now the inflation narrative is only supportive of stocks and commodities and emerging markets if it’s cost-push inflation. In this scenario, short end rates rally a touch as Fed lags as it is cost driven. But if the inflation is demand-pull inflation we have a different position as the Fed will tighten faster, real yields will go up, bear flattening the curve and stocks will fall as the market starts to worry about a potential recession from a potential Fed over tightening.

So we have both inflation and double deficit - stocks down
Cost-push inflation - stocks up
Demand-pull inflation - stocks down

Two out of three are down for stocks.

Today the Fed showed their hand and stocks fell.

And now?

I am hoping that the narrative will now find some clarity, but I am still very aware that this narrative is US-centric, yet major panicky moves are always contagious. So I am constantly watching everything else.

Europe - It’s a bit sad we have had the Brexit vote in the UK, not because of the result but because of the shading, it has put on the reporting of Europe. In the salons of London, it is considered terribly bad form to point to concerns in Europe because having declared an avid will to remain in the EU casting criticism on anything European is seen as handing sharp object s to the leavers.

The AfD is rising in popularity in Germany (I read something that they are now the 2nd most popular party).  Italian elections are on the way and have all the hallmarks of doing a Brexit/Trump in providing a ’shocking' result as the concerns of the basic voter are dismissed as socially incorrect and troubles shuffled under the official carpet.  Greece has just failed to get its latest round of bailout money, Ok, they will but it is a reminder that the new glass tower of the European economy is built upon the limestone caverns of past debt mismanagement and a sinkhole could open up at any moment.

Back in 2016, I think it was for my ‘thoughts for 2017', I suggested that Europe problems could be obscured as long as economic growth kept everyone happy. This is what we have seen. The concept of default risk has evaporated and even Italian banks have been able to offload what was previously considered as toxic waste under a new wrapper of 'high yield' to private hands. Let's also not forget what Portuguese government debt is yielding. Less than US treasuries the last time I looked - now there IS a changed narrative.

But I can’t forget what is out there and how every thread of favourably reassessed credit risk leads to the door of the ECB.

The concentration of credit risk that has flown into the ECB is stupendous. Of course, it isn’t default risk because the ECB can QE until its heart content. But how content will that heart continue to be when Draghi is replaced by Darth Weidmann, commander of the Bundeathstar. I saw comments that the SPD approved of his appointment. That’s not a story. The story would be if Syriza approved of his appointment. He is a very clever man to move onto that throne under the cover of a benign economy, but even today the PMIs of Europe began to disappoint.

We tend to look at whatever is the current issue with respect to the world rather than in balance with the rest of the world. When the EU has a crisis, it’s just an EU problem and the US is just fine. When Britain has a Brexit wobble then it's Britain's wobble and the EU is just fine. Rarely are the comparative strengths and weaknesses observed and considered. One part of the equation is anchored whilst the other is considered the variable.

But maybe it isn’t. We think this a US-centric issue in the markets but we must watch out and be impartial in our judgments. Though we have global growth masking other problems, once the problems arise, global growth can collapse.

I am still playing the macro short on risk but am desperate for low-risk yield. I just think that all risk is priced too low as we enter the Great 'Global Risk Repricing’ which I hereby copyright as the GRR. Grrrrrrr indeed.

When it occurs the central banks are going to have a knife edge to walk between loosening, to counter the restrictive function of higher risk premia and tightening, to counter the inflationary effects we are already seeing. As they say with great comedy. "the secret is in the t t t timing",

If they get it right, they won't have to do anything as tightening of risk premier does their job for them. GRReat.

But the risk rolls on.

The diary of a messed up market day.

Well. Well Well. Or ‘three holes in the ground”, as my uncle used to say. That was a day.

The last two weeks have so far seen

Meltdown Monday
Turnaround Tuesday
We'll be OK Wednesday
Thumped Thursday
Found a base Friday
Make up your mind Monday
Trying Hard Tuesday

and today?
WTF Wednesday

I have to say that today was a hero to zero day for me in equity land. I played the CPI figure perfectly as stocks decided that the inflation story really. really is a concern. Until it isn't. And that ‘until it isn’t’ occurred about 15 seconds after maximum 'it is a really, really big concern'. That was when perfection vanished in a puff of humility and the ‘natural bounce up off the lows'  spent the rest of the day grinding higher up to new highs.

I am not too shy to own up to the stock shorts costing me money. I hate grinds, they are worse than sharp moves mostly because sharp moves engulf your emotions in one hit, whilst grinds tie you naked to a chair and beat your bits with a knotted rope until you are finally put out of your misery by the pistol to the head of a stop loss.

I think I might have been watching too much McMafia. Actually, that James Bond and Le Chiffre reference stemmed from a picture I saw of Macron in a Bloomberg article this morning and it just struck me how much Macron looked like Le Chiffre from Bond’s latest Casino Royale.

But I JUST KNOW that  US stocks will now tank. But if I don't understand why equities are going up then I must get out. Understand? That where your narrative fits whatever it is you want it to fit, but unless someone takes a 3ft pipe bending machine to the current narrative of ‘it’s inflayshun innit’ to make it fit with today’s moves then I am afraid this narrative is broken

We are getting through narratives faster than plates at a Greek restaurant.

I fell for that inflation one I really did. I even thought about what would do well in an inflationary world and thought.. hmm stocks could do well in an inflationary world because they hold tangible assets that are inflating so the value of them must go up against a deflating USD. Unless they own large amounts of debt and the cost of funding that goes up faster than the inflating asset values. I then thought this is getting complicated as I'll need to know the debt levels of the companies and if they are fixed or floating against which benchmarks and which currencies and where their manufacturing vs sales is and and ...  and then I stopped. It was all too much.

I'd wandered into this because my favourite dodgy high beta oil stocks that went to cash like everything else on the 12th Jan, might be worth buying again as I think we might be near the end of the oil dump. Have you noticed how correlated it is to SPX price moves?

But the problem with my dodgy oil stocks is that they have large loads of debt and funding that, relative to where rates were a month ago, would mean that oil will have to be a lot higher than its last recent peak. So I haven't bought them. I just bought oil instead. It’s always worth remembering that if you think something is going to go up or down, instead of getting clever with correlated stuff, just buy or sell the thing you think will go up or down. For example, with oil, don’t mess around with NOK/JPY FX thinking you are being clever, just buy oil.

The only consolation was a ‘that doesn't look right' enlarging of my long gold positions in the low 1320s and I did buy gold mining stocks, including some very dodgy ones. I even bought an ETF of gold miners (an ETF? In this environment? Are you mad?). It would be great if someone could inform all the goldbug loons of yesteryear, who took their evangelistic crusade to crypto-land, to come back because their one true Messiah is risen again. I never thought I'd miss them but we should point out that burying your gold coins in the backyard of your log cabin leaves your assets a little more accessible than down a phone wire that those pesky government agents, who you are sure you saw spying on you in the woods, could cut.

So that's been my day. I have ended it by kicking myself for not standing true to my initial beliefs that led me to eject all my positions in mid-January ahead of Martin Luther Turn Day. as defined in my post 4 days ago. 

1- Markets take off in January en masse in the direction set by all those ‘2018 trades of the year’. This sets consensus.
2- The week after Martin Luther King day, or Martin Luther Turn Day as I prefer to call it, together with the first expires, can often trigger a turnaround.
3- The start of February sees a peak crisis in something - EM, Bank Balance sheets, whatever.
4- This causes first round damage in the assets associated with the assumed crisis.
5- This causes losses which need countering by selling other assets that are in profit
6- This sees a cascade unwind in anything that is leveraged and heavily positioned.
7- Narratives chase price moves but are usually later proven to be incorrect.
8- These February washouts of the consensus trades of the year slowly settle down and reverse, leaving March as the time to really put on your trades of the year.

Good luck out there, I've had as much adrenaline as I can take for a fortnight. It made the skiing holiday look tame.

What happens next? The great global risk repricing.

Following swiftly on from the last post's synopsis of the changing narratives of last week, in the famous words of a UK TV sports quiz show, it's time for "What happen's next"? When a clip is shown and the contestants have to guess the, normally unlikely, outcome.

The clip shows US equities falling over, bashing heir head and looking dead only to spasm as we freeze the frame. So .. what happens next?

Friday felt like fear but the rally into the close makes this all the harder to call as both camps have ammunition.

For the bounce -

Nothing has really changed, the US economy is doing well, indeed it’s very success is what has triggered this fall.

Company earnings are booming and are not going to fall. In fact dividend yield on stocks has just gone up 10% due to the price drop. Thank you.

We needed a healthy correction. That was it. The weak holders are now out and will no doubt be sucked in slowly as prices rise again pushing them up further. Effectively we have more marginal buyers wanting to get back on the bus now they have been thrown off.

It isn't that bad, we are only back to last Noveber prices.

Why should overseas investors in overseas stocks be concerned about domestic US inflation? European investors in European stocks, where the ECB is still slow to drain liquidity, should see more reason to buy.

The size of that fall and the way it worked over the last two days saw the market move from 'unconcerned' to 'doubtful' to 'fear', only to see everything rebound into the close on Friday. We are done.

It was indeed just a volatility blow out, the ripples are settling.

It was a typical February positional wash out across all asset classes, hanging on an excuse of the labour data that tripped some ridiculous leverage in silly products. Over positioning of the year favorites has been rationalised and we can get on with it all again.


And for the trouble ahead -

It ain’t over until the fat cow squeals. the fat cow being the sacred cow position of short US treasuries.

If USTreasuies because what I saw as fear on Friday isn’t anywhere near fear yet and we are still in a complacent mode. this complacency can be reflected in headlines I saw on Friday saying we had ‘entered a corrective phase’ #. Entered a corrective phase? we entered a corrective phase two weeks ago! The sign should say; “Thank you for visiting corrective phase, only 2 days to meltdown, drive safely!"

Volatility lingers - from my last post on the last two week's action

One of the consequences of measures of volatility moving is that it affects how much leverage you can have in your portfolio. The lower the volatility in an asset the lower the assumption of risk in holding it. Value at Risk, or VaR models, dominate bank, traditional fund and, most importantly, algorithmic funds. When the number you use as a volatility input increase you have to reduce your holdings even if you still consider your base argument for holding them valid. It depends on the time frame of allocations, these can be instant in high-frequency models, to monthly for old-fashioned real money to really slow with retail. Value and volatility shocks linger in the darkest crevasses of portfolio management for ages. It's like oil on beaches after tanker spills.

That US Stocks are only back to where they were in November, meaning that losses for many are only lost profits not losses versus original investment, can be read as suggesting that many are still long.  I know this is nitpicking for mark to market, especially with a year-end real in between, but for retail it’s a psychological 'get out of jail' card. You can bet that every IFA out here is telling their clients not to worry. Probably because they haven’t yet worked out the reason to sell. This is a tell that there are many trapped longs out there praying for buyers to come back in.

But who? Real money funds have not liquidated on this and are probably as caught as retail. yet they have been sitting off record loads of cash so what are they going to spend to buy with. the wall of retail certainty will have dried up too. Of course, we will have the ‘just a dip’ buyers return but that doesn't mean it’s over. As we saw last Tuesday, buying dips and seeing a run-up doesn't mean you are right.

If this really is a US inflation story then why indeed are global stocks melting? The case for buying says that if this is US Centric that we need not fear in rest of the world. But the corollary is that as everyone else assets are dumping then this is not US-centric and the narrative is wrong.

The inflation story may just be the next narrative that will be questioned and thrown away as greater fear of unknown emerges.

This has become a global risk sell-off for equities and has started to become a general risk sell-off, but rather than looking at my usual ‘February, favourite trade squeeze’ what if this is something else?

What I am suggesting -

My best case is that no narrative can be ignored and all have their strengths.  But instead of them each being a separate diagnosis of different potential diseases they are all symptoms of a single greater one. They are all building into a great big superstorm of grief encapsulated in a super-narrative

Inflation, corrections, aspike in volatility (really an increased cost of insurance), problems in leverage, US bonds, problems in risk parity, China sell-offs, Junk bonds sell off, aren’t all separate but are all part of the same single story - the new super-narrative of ‘The great global risk repricing'

A sudden spasm of awakening to true risks may now be underway.  For years we have been saying that credit is too cheap and that junk bonds are way too expensive and that leverage has been practically free. I hate to hark back to QE, as we know that it has spawned a rash of ridiculous pricing, but this, folks, could be the big one with regards to waking up and smelling the coffee. Free money does not mean any risk.

This reassessment of risk perceptions can also include US Treasuries. If there is a chance that they are no longer the ultimate safe haven then the schism would have dire consequences for the stability of current investment theory. No, I am not saying that US Treasuries aren’t safe as houses, I am saying that all you have to have is people questioning them for problems to kick off as soon as Monday.

And that is why waiting for bonds to go up to know if this is over is all the more important, If they don’t then it is really bad news.

Currencies have worn this move fairly well. Yes, they have moved with the classics like AUDJPY doing the risk off thing, but considering the size of the equity moves they are hanging on in there. Most notably,  the popular position of short USD hasn't really seen much of an unwind but it should be consdiered as part of the short UST trade. This is not about rate differentials anymore, as we have seen the divergence of rate difererentials vs FX widen for the pat few months, but about underlying trust in the US to manage its affairs. It's part of the risk adjustment as the US and US has moved a notch right along the scale between Switzerland and Zimbabwe.

So what do we do? the trader in me wanted to buy on Friday, so i did, but the pragmatist thinks this is far from over.

I will run my long with a trailing stop ready for part 2 as so far that may have only been part 1.i and 1.ii.

I can't help but think that gold is looking exceedingly attractive.

The changing narratives of a market dump.

It’s February and I have been using Twitter more than the blog as, in effect, most of my thoughts are pretty simple and don’t need expounding but it is probably worth pulling everything together for the record and to evaluate the 'what happens next'

As regular readers know I have a regular concern about the way markets start new years, which can effectively be summarised

1- Markets take off in January en masse in the direction set by all those ‘2018 trades of the year’. This sets consensus.
2- The week after Martin Luther King day, or Martin Luther Turn Day as I prefer to call it, together with the first expires, can often trigger a turnaround.
3- The start of February sees a peak crisis in something - EM, Bank Balance sheets, whatever.
4- This causes first round damage in the assets associated with the assumed crisis.
5- This causes losses which need countering by selling other assets that are in profit
6- This sees a cascade unwind in anything that is leveraged and heavily positioned.
7- Narratives chase price moves but are usually later proven to be incorrect.
8- These February washouts of the consensus trades of the year slowly settle down and reverse, leaving March as the time to really put on your trades of the year.

With this in mind, I approached the third week of January with huge caution, switching holdings to cash, but Martin Luther Turn Day came and annoyingly it didn’t produce the falls, which was FOMO painful. However, month-end was looming and it wasn’t hard to calculate that, with bonds having fallen and equities have risen so much, rebalancing of assets in funds was going to see some very large selling of equities and buying of bonds.

The large size of equity selling occurred in the days running up to the end of the month but there didn’t appear to be the bond buying. However, the narrative of ‘just month end’ still accommodated the equity move leaving those long excused from their positions.

But the 'end of month’ narrative had an expiry date - the end of the month - and though this had passed we saw no bounce in stocks and the amplitude of intraday swings in equity prices was picking up (normally a turn signal).

Friday morning had me scratching my head as to why traded volatility wasn’t rising

We didn’t have to wait long. The US data showed a growth in wages. This flickered like a force 4 tremor on the seismometers along the San Andreas fault of inflation concerns. Bonds sold off again and stocks fell heavily, with inflation concerns triggering ‘just stop losses’ as the inflation story had been a back-burner narrative for a while. However, we know that ‘just stop losses’ is on a par with quoting Fibonacci levels in the league of ignorance of real reason.

With both bonds and equities lower, attention turned to the 'risk parity' sector with it now being blamed for the stop loss action. Risk parity funds switch between bonds and equities as historically when one falls the other rises, hence keeping risk levels constant, but now we had bonds and equities falling sharply. So, it was assumed, it must have been them. Even volatility was polite enough to move with VIX a whole point and a half up from 13.5 to 15.

Now a quick brief here to anyone reading this who is scratching their heads over what this volatility product thing is. Experts, please jump this.

Volatility is a mathematical measure of how fast and far a price moves. It is a historic measure as you need to know how far and fast something has moved to work out how far and fast it has moved.

But volatility is also the key ingredient to pricing an insurance policy. If you know how far and fast something has moved in the past you make ASSUMPTIONS as to how far and fast it will move in the future. This assumed future volatility, though psychologically referenced through price anchoring to past volatility is basically an informed guess.
The maths used to calculate insurance policies or options as we like to call them in finance, the Black-Scholes model, can pin down every variable (Exercise price, forward prices, interest rates, discount rates, time, etc) but there is always an unknown variable (otherwise we are saying the future is certain) and this unknown variable all boils down to one number called 'implied volatility’. And this is what is traded in options markets. 

The word ‘implied' should be the clue to the danger here because as this is the only effective unknown the equation, should the price of the option change, even though basic demand (say a corporate wants to hedge a large overseas future payment) then the implied volatility changes too. This does not mean that actual price volatility of the underlying asset will change even though the implied volatility has. Nor does it mean that, as volatility is so closely linked to implied probability in the equations, that any actual probabilities have changed. 

Basically, it may IMPLY that probabilities have changed but it doesn't mean they actually have. It is worth comparing this to CDS pricing where the same calculations are made as it too is an insurance product, where many confuse CDS prices with the actual probability of default.

So with this in mind we look at the next derivative of implied volatility - which we have already decided is a derivative of the maths of guessing where prices will be in the future - the VIX. This is an index of lots of specific implied volatilities from lots of different assets in different time frames. If you think it is simple then just look here to correct that view. Yet this index is bet upon in its pure form through a futures market and as soon as something can be bet upon as a future it is assumed to be clean and pure. As this future can be bought and sold and held in a portfolio the dangerous next step is to consider it as an asset rather than the complex hypothetical maths derivate of the future unknown that it actually is.

As this comfort grows funds are structured to hold these futures in ETFs and ETNs. and if the movement in these ends seems pretty small they are geared up by leverage to multiple factors in specialist ETFs. Finally, a product is offered a product that goes up when implied the VIX goes down - the XIV (as in VIX reversed, not the French king Louis XIV, though they both suffered excruciatingly painful deaths). 

As stock prices had been rising strongly for a year demand for hedges against them falling had dropped. And so implied volatility fell too. (I won't get on to the asymmetric behaviour of volatility but it is worth bearing in mind that historic volatility can be as high on strong up moves as it can be on down, but the way people associate implied volatility is that it goes up on price falls). 

This created a trend which was observed as an trend in a true asset and was sold as such. As soon as past performance can be cited as a reason to buy then a dangerous feedback loop evolves (see Bitcoin). Money poured into the trend with very little idea of what was actually being bought, indeed funds themselves started to sell volatility to increase there own performance having missed out on the stock moves. 

We even saw people study these products with technical analysis like an asset, adding trend lines, oversold/overbought lines and Fibonacci levels (see above) to it. The distance they had stretched from the reality of what drove these things had reached parsec levels. But it had already established itself as a legitimate hedging tool and had become embedded in countless financial products and bank and fund positions.   

So what happened?

Monday saw the dormant VIX crack as leveraged trades in toxic products cascaded down the tree of hedges into ‘have to sell stocks’ which just pushed up volatility making it all worse.Volatility skyrocketed, both implied and actual. I am not going to quote a number it hit because different time frames have different values and I could just pick, as the press does, the most impressive. They were already performing statistical crimes by reporting that volatility had gone up 100% when it had gone up from 14% to 28% (that's up 14%).

Even with this massive 10% move in stocks the narrative of explanation was still not concerned that this was anything to worry about in the longer term. It had moved from 'just month end', through 'just stops on wage data' to 'just an explosion in mad dog leveraged lunatic esoteric products'.

Which is somewhat ironic as on this basis it would be clear that the crash had been caused by everything that posts 2008 enforced regulations and been put in place to rid us of - ridiculous leverage in products that are toxic, bought by punters who have no clue and sold by spivs who point at past performance to sell them. It was textbook.

Tuesday saw the ‘volocaust’ settle down as volatility products were now the assumed culprit and this wasn’t a reason to sell global risk. But even though VIX, which was by now as keenly watched for direction as stocks themselves (another example of the tail wagging the dog). A rally in stocks was assumed to be great news that everything was settling down and the 'volocaust' was passing, but massive moves up in the underlying asset can be as representative of chaos in a volatility market as much as down, as delta hedges in the underlying get more desperate. A rapid up move did not mean volatility was falling even if implied volatility was.

Global assets were now wobbling. If this was indeed just an esoteric product wobble then why on Tuesday night / Wednesday morning did Chinese and Japanese stocks put in such a battering? Moves like that in China, without anything else to look at, would normally of themselves because for a mini global rout (2015) but these were being studiously ignored.

Wednesday saw rallies, which made my China theory look iffy and reinforced the 'it's just vol' story - until the close, which was dreadful. Stocks were being dumped again.

One of the consequences of measures of volatility moving is that it affects how much leverage you can have in your portfolio. The lower the volatility in an asset the lower the assumption of risk in holding it. Value at Risk, or VaR models, dominate bank, traditional fund and, most importantly, algorithmic funds. When the number you use as a volatility input increase you have to reduce your holdings even if you still consider your base argument for holding them valid. It depends on the time frame of allocations, these can be instant in high-frequency models, to monthly for old-fashioned real money to really slow with retail. Value and volatility shocks linger in the darkest crevasses of portfolio management for ages. It's like oil on beaches after tanker spills.

Thursday saw another leg downwards as things were now starting to look global. China was still steadily falling, FTSE was now down 10% off the highs, the DAX was in serious trouble (the darling of the ‘euro-uber-alles' trade) and it was all starting to look as though we had a big mismatch between action and explanation. When that occurs things get really messy. Not understanding why something unpleasant is happening is the gasoline on the fire of fear.

Friday was interesting. What appeared to be fear emerged properly with even the 'just a healthy correction’ crowd looking a bit like the Monty Python Black Knight, yet the markets bounced into the close. There was no new news. Price is news (PIN).

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Stepping back from all of the micro of the week, we could fit all of the above into the classic layout of the original 8 steps of a February wash out. It starts as a US concern, has accelerated and is now hitting global risk appetite with apparently dissociated assets in far off places being sold.

‘Inflation' may now be sprawled in colour on the billboard outside the cinema but inside the show is a classic black and white blow out of consensus trades.

The big what 'happens next? ' I'll ponder over in the next post "What happens next? The great global risk repricing." (Now posted here) but I am far from sure that this is over.

But before I go I’m going to be a bit unkind. But it does need to be said. There a lot of people out there who pride themselves on analysing the minutia of finance, looking for clues as to the next nuance of price moves or the odd basis point arb between trades, or clever sector switches, or curve trades. So it is with an evil gloat I see their detailed embroidery get burnt up in the house fire caused by the gallon of gasoline left in the oven that they failed to spot. At the end of the financial day, you are judged on PnL not PhD

Cash is oversold.

If I was selling a trade idea I would be now composing lots of arguments as to why I am getting really nervous about the markets. But I can’t. Call it a trader's instinct or some unexplainable subconscious human pattern recognition, but I am nervous about the markets. To the point that I have started shutting down long-term positions, even my long-term favourites in commodities, emerging markets, and dividend yields.

The clues are like flitting shadows in my periphery vision but ones I can more clearly identify are -

Metals - A nicely bubbling speculative play on growth rarely sees metals sell off and copper and iron are really off.

North Korea - news stories work like investments and have their own cycle of overland under response. More attention is paid to the speed of change than the underlying slow grind. The easiest things to miss are the quiet unobtrusive trends which don’t have a 'Wow - look at that 10% move’ bringing them to general attention. North Korea is a slow-burning fuse on a potential powder keg.

Fed - A few years back I stopped getting excited about Fed meetings as the hot air to true impact ratio has always been too high. This latest one has left the market a bit confused apparently with excuses being attached to ‘unexpected’ market responses. I’d rather read this as a confused market that is grasping at straws. An indication that any new feature or price drive can easily pick up a new herding.

EU - Growth is wallpapering over the cracks in the EU allowing Juncker to assume the role of Caesar with his federalist plans. The European markets are buoyant, the spreads of periphery against core are getting to the point where they appear to be discounting convergence with no chance of independent default. All are discounted as well with EU, so how much more good news can there be?

One of the greatest trends of the past years has been the issuance of debt rather than the issuance of equity. To the point of frustration as nearly all the fruity projects I’d like to invest in are, quite rightly, held in-house. Why issue stock when you can issue debt to a closed group without all the aggravation of coping with a slew of irritating nonparticipating shareholders. The only time you ‘ll get a slice of the pie is once the idea has been maxed out for the early investors.

But if there is going to be an end to the underwriting of debt by central banks then the risks change. I think we are at the start of the great reversal here all that debt that has been issued to buy back stock gets reversed.

Do I want to hold bonds? No. Do I want to hold equities? No. Do I want to hold a guaranteed return paying above inflation? Yes. But the number of government renewable energy schemes that guarantee that is reducing fast and it’s unfortunate that the surest way to receive an inflation-busting sure fire yield is through an arbitrage of misplaced government subsidies.

So what do I hold? There is one chart that I have never seen but would love someone to produce. It is effectively the inverse of an index of every investment there is. It would be the price of fiat cash. Not having seen such a chart, but imagining it and imagining the work technical analysts could have with it, I would not be surprised for them all to be saying that cash is in dangerously oversold territory. With the accompanying ‘we haven’t seen cash this cheap since xxxx” commentaries.

Who does hold fiat cash these days? Everything is invested in a scheme. Or a new version of cash which isn’t cash. The fallout from the 2008 meltdown was a complete distrust of banks which has spawned the growth of pseudo banks that have much higher risk than traditional banks but are perceived not to as they are not banks. Cash is not king at the moment, apart from places that have been devastated by natural disasters leaving them without the power needed to make electronic payments. The dependency of the monetary system on power infrastructure is often overlooked.

But I am going into cash. It is very oversold. There are probably clever ways I can play hedges but the best hedge is to exit your position. Or buy one in a garden center.