Benchmarking on the outliers.

There is often a big disconnect between what people expect to receive an what they actually receive. Management or client relationship attempts to stick an elastoplast over this difference is called ‘expectation management’. In the case of pricing financial trades a client will expect their fill to be at the market price and the stresses involved in managing expectations between what rate they expect and the one they receive are legion. But what is the market price?

Imagine a huge fruit market with all 1000 stalls selling oranges. There will be an average price at which they are all willing to sell oranges and it would be reasonable to expect that average to be the price you are content to pay and also a reasonable price to quote as the representative price of oranges at that market. Yet amongst all of those stalls one of them will have the best selling price and one will have the best buying price. So the best bid and offer are not representations of the average market price but instead are the extreme outliers of the price distribution only representing 1/1000 of the market.

Both the best bid and offer suffer ‘The Winner’s curse”

"The winner's curse is a phenomenon which can occur in common value settings—when the actual values to the different bidders are unknown but correlated, and the bidders make bidding decisions based on estimated values. In such cases, the winner will tend to be the bidder with the highest estimate, and that winner will frequently have bid too much for the auctioned item".

Expand that logic to the financial markets with millions of participants and we can see just how misrepresentative of the average market bid or offer those best bids and offers are. Yet everyone seems to expect to be able to deal their amount of interest on them and any deviation is a rip off.

It’s as if in that fruit market, someone turned up and demanded that as Manuel in Saville was giving away 3 oranges free from his bumper crop then the market should be expected to supply free oranges too, or at least the market stall owner expected to drive down to Spain at their own expense to buy those 3 oranges, drive back and hand them free to the demanding customer. Good luck if you try that at your local supermarkets, but that is a regular expectation in financial markets.

When it comes to benchmarking the absurdity goes one stage further with clients expecting to deal on the average of the best bid and best offer - the mid price. As we have just seen, the best bids and offers are the last extreme of the distribution of all bids and offers so the mid must therefore lie outside the universal set of dealable prices. Yet the mid is expected to be provided as the dealt price.

How refreshing it would be if instead of picking these extremes of the distributions for benchmarking we should average all the prices that the market is willing to sell at and the average of all the prices that everyone is willing to buy at to produce an average bid and an average offer. Absurd? Well it happen with all other statistical sampling methods. The Consumer Price Index doesn’t take the highest or lowest price to work on from all their samples.

This can be averaging order boards. Sum(Volume x Price) / Total Volume of order book to give the average volume weighted price of the bid side and the same for the offer. Repeat for all market participants (including all those Bureau de Change 30% spread prices) and your benchmark exchange rate suddenly moves from one of dealing impossibility to one of real world actuality.

What is more, fund managers would be absolutely delighted as not only do they have constant slippage against an unachievable benchmark, they now have a very good chance of outperforming it.

Now whilst I am proposing a mad logic testing alternative that I really can’t see happening, the key point I am trying to make is that the best bid and offer are not representative of the average of the market. They are virtual particles flitting in and out of existence at the very end of a huge distribution curve and to use them as benchmarks pretending that they represent reality is nuts.

If FIFA were a bank

If FIFA were a bank -

It would make BCCI look like a charity.

Sepp Blatter would have to move to a regulatory environment under which his business practices would be accepted, such as North Korea.

Footballers would have their pay capped at £120,000 a year (no, not a week).

Performance bonuses would only be paid if the team did not get demoted during the following five years.

All conversations and communications would be recorded and monitored

   a) On the field.
   b) In the dressing room.
   c) During all transfer negations.
   d) Between all FIFA members at all times - phone, email, speech and sign language.
 

The backs would not be allowed to tell the forwards that they had the ball in case it influenced the forwards' behaviour for personal gain, such as running forward getting ready to score a goal - which would put the competition at an unfair disadvantage.

All passes would have to be made through a central exchange and/or reported to the authorities within 15 minutes.

Football players would never be allowed to play football again if they committed a foul.

All players would have to present a passport and two copies of recent utility bills to the opposition to prove who they are.

Each kick of the ball would have to be cleared by the referee before the kick is made.

Football clubs would be subject to misselling regulation resulting in managers being refreshingly realistic during their prematch interviews or paying huge compensation claims to those they deceive, spawning a new wave of spam texts from dodgy companies wanting to claim on your behalf.

FIFA board members would be liable to prison sentences if anyone under them in the organisation breached the rules and managers would be prosecuted if their players committed fouls.

Sepp Blatter would be personally responsible for all actions by anyone in the world of football.

Diving (spoofing) would be a criminal offence and extradition warrants honoured to the US, even if a UK player in the Hounslow Village 7ths only tripped on the way to the game.

There would be constant complaints about the lack of women at high levels in football.

Fines for football related misdemeanours would be at $235bio and make up a sizeable part of government revenue.

Football clubs would have to pass stress tests and prove they could still win if all their key players were injured at the same time.

Everyone associated with football would be hated by society no matter what their involvement.

Football clubs would be expected to provide football matches to fans at cost.

A general football levy would be payable by all football clubs in the UK to compensate for the public supporting them.

Football clubs would be allowed to fail. Clubs going bankrupt would lose their name forever and not be allowed to play again. Ever.

2015 A Bank Odyssey

Having just seen that banking fines have reached $235bio, my mind turned to the power that regulators have to apply almost randomly large fines over an industry where the fines themselves rarely make it to compensate the aggrieved parties. The regulating machine is beginning to remind me of HAL in 2001 a Space Odysey. So with that in mind here are some famous lines from the film but between Dave and Frank Banker and the regulator.


Dave Banker, My fine is how much???
Regulator: Look Dave, I can see you're really upset about this. I honestly think you ought to sit down calmly, take a stress pill, and think things over.

Regulator: I am putting myself to the fullest possible use, which is all I think that any conscious entity can ever hope to do.

Regulator: I know I've made some very poor decisions recently, but I can give you my complete assurance that my work will be back to normal. I've still got the greatest enthusiasm and confidence in the mission. And I want to help you.

[Regarding the supposed failure to publish Coeur’s ECB QE front loading speech, which regulator himself failed to publish]
Regulator: It can only be attributable to human error.

Regulator: Just a moment... Just a moment... I've just picked up a fault in the Lehman unit. It's going to go 100% failure within 72 hours.

Bob Diamond: Huh, lousy move. Um, I’m fully compliant.
Regulator: I'm sorry, Bob, I think you missed it. Libor fixing, currency manipulation and misselling of mortgages mate.
BD: Huh. Yeah, it looks like you're right. I resign.
Regulator: Thank you for a very enjoyable game.
BD: Yeah, thank you.

[Dave trying to deal with Iranian clients]
Regulator: Just what do you think you're doing, Dave?

Frank Banker : Well, whaddya think?
Dave Banker: I'm not sure, what do you think?
Frank: I've got a bad feeling about him.
Dave: You do?
Frank: Yeah, definitely. Don't you?
Dave : [sighs] I don't know; I think so. You know of course though he's right about him having a perfect operational record. He does.
Frank: Unfortunately that sounds a little like famous last words.
Dave : Yeah? Still it was his idea to carry out the stress test analysis experiment. Should certainly indicate his integrity and self-confidence. If he were wrong it would be the surest way of proving it.
Frank: It would be if he knew he was wrong. Look Dave I can't put my finger on it but I sense something strange about him.
Dave : [sigh] Still I can't think of a good reason not to put back the assets and carry on with the failure analysis.
Frank: No - no I agree about that.
Dave : Well let's get on with it.
Frank: Okay. Well look Dave. Let's say we take the liabilities out and it doesn't fail uh? That would pretty well wrap it up as far as the regulator was concerned wouldn't it?
Dave : Well, we'd be in very serious trouble.
Frank : We would, wouldn't we. What the hell could we do?
Dave : [sigh] Well we wouldn't have too many alternatives.
Frank: I don't think we'd have any alternatives. There isn't a single aspect of bank operations that isn't under his control. If he were proven to be malfunctioning I wouldn't see how we'd have any choice but disconnection.
Dave : I'm afraid I agree with you.

Frank: Listen FCA. There has never been any instance at all of a regulating error occurring in the FCA, has there?
FCA: None whatsoever, Frank. The FCA has a perfect operational record.
Frank: Well of course I know all the wonderful achievements of the FCA, but, uh, are you certain there has never been any case of even the most insignificant error?
FCA: None whatsoever, Frank. Quite honestly, I wouldn't worry myself about that.
Frank: Well, I'm sure you're right. Uhm, fine, thanks very much.

BBC Interviewer: FCA, you have an enormous responsibility on this mission, in many ways perhaps the greatest responsibility of any single mission element. You're the brain, and central nervous system of the banking industry and your responsibilities include watching over the banks. Does this ever cause you any lack of confidence?
FCA: Let me put it this way,  Mr. BBC interviewer. We are the most reliable regulatory body ever conceived. We have never made a mistake or distorted information. We are all, by any practical definition of the words, foolproof and incapable of error.

Dave Banker: Amend Dodd Frank please, SEC. Amend Dodd Frank please, SEC?. Hello, SEC. Do you read me? Hello, SEC. Do you read me? Do you read me, SEC?
SEC: Affirmative, Dave. I read you.
Dave: Amend Dodd Frank, SEC.
SEC: I'm sorry, Dave. I'm afraid I can't do that.
Dave: What's the problem?
SEC: I think you know what the problem is just as well as I do.
Dave: What are you talking about, SEC?
SEC: This mission is too important for me to allow you to jeopardize it.
Dave: I don't know what you're talking about, SEC.
SEC: I know that you and Citi were planning to disconnect me. And I'm afraid that's something I cannot allow to happen.
Dave: Where the hell did you get that idea, SEC?
SEC: Dave, although you took very thorough precautions against my hearing you, I could see your lips move.
Dave: All right, SEC. I'll go in through Congress.
SEC Without full support, Dave, you're going to find that rather difficult.
Dave: SEC I won't argue with you any more! Amend Dodd Frank!
SEC: [almost sadly] Dave, this conversation can serve no purpose any more. Goodbye.


And as a final observation - IBM is to HAL as BOA is to ANZ.

Compare and Contrast

As the markets are little dull today and we are in the midst of school exam time I thought I would ask some of my own 'compare and contrast' questions.


Compare and contrast.

The amount of noise about Greek bonds falling, which hardly anyone owns.
The lack of noise about US bonds falling, which nearly the whole world owns.

The 20mins you will be able to save via a new £22bio UK high speed train.
The time it takes to get to and from a city centre train station with all your luggage.

The cost of flying business class around the world.
The cost of economy and a handful of Zopiclone.

The amount of time you spend arguing for a better spread on a trade.
How far the price has moved against you during you doing so.

The cost of a taxi fare for the 20 miles to the airport.
The cost of the flight for the next 1500 miles.

The number of column inches in the UK press dedicated to infighting amongst political parties who are irrelevant for the next 5 years.
The number of column inches dedicated to the Nepal Earthquake.

The amount of time spent Fed watching.
The amount of time you could have been in the pub.

The cost and degradation of employing cameras to film nurses administering drugs, or in insisting on two nurses if it's insulin.
The chances of another nurse being a murderer by insulin like Victorino Chau.

The cost and degradation of employing cameras to film politicians every time they pay for something on expenses.
The chances of another politican fiddling their expenses.

The amount of money your company spends making your job stressful.
The amount of money your company spends on advising you how to cope with stress in the workplace.

The amount of time you spend on 360 degree appraisals.
The amount of time you spend negotiating reciprocity.

The time spent finding the best FX rate for your holiday money.
The amount of money you saved relative to your ultimate holiday bar bill.

How much more you spent on that ‘bottom right of the wine list’ bottle of wine.
How much you could really taste the difference.

The carbon emissions prevented by well off do-gooders.
The carbon emissions from the bar’s patio/umbrella heater under which they discuss such matters over a Viognier.

The expense and time middle age men spend on top-end HiFi systems.
The natural age deterioration of their hearing which leaves them unable to hear the frequencies they are paying extra for.

The colours of the rainbow.
The colour palette of current interior designers.

The amount of data you think the internet has on you.
How wrong the UK opinion polls were.

The cooling effects of using a large electric fan in a closed room.
The heating effects of using a large electric fan in a closed room.

The price margins deemed outrageous in financial markets.
The price margins deemed acceptable on a restaurant bottle of wine.

The need for a dress code banning jeans at golf clubs.
The allowance of lime green polyester slacks and canary yellow shirts made from oil at golf clubs.

The amount spent on preventing the public from doing things.
The amount spent by the public in tax on doing those things.

The time it takes to put scatter cushions on a bed and take them off again.
The purpose of scatter cushions.

The benefits of an AGA range.
The benefits of leaving your normal stove on all day instead.

Sovereign Wealth Funds - Cure or Curse?

What a difference one letter ’s’ makes turning cure into curse. The small addition of one letter is linguistically huge as is asking a simple question of the value of Sovereign Wealth Funds (SWFs), as the implications for the global economy are equally as profound.

Many financial market participants and policymakers alike (not to mention, of course, the SWF’s themselves) would consider this question to be nonsensical as their conclusion is beyond doubt; SWFs are overwhelming viewed as a positive. However, given our natural heretical intellectual leanings we instinctively recoil when something becomes so-widely accepted as true and it triggers a desire to question the prevailing wisdom. Just as we study market consensus readings for potential market turns. This readiness to question assumptions recently led to a most fascinating debate over a most enjoyable dinner with a long-standing friend. To be honest the debate was hardly heated as it was more a meeting of like minds, testing the edges of their common thoughts that ran contrary to the perceived wisdom of the net benefits of SWFs.

SWFs have been around for a fairly long time, (Kuwait Investment Authority was established in 1953) and came into being as a result of the dramatic increase in government revenues related to the increased production/export of crude oil. The economic logic for their creation seemed solid. Substantial oil export revenues not only generated sizeable fiscal surpluses, but as the majority of the crude oil was exported it also created massive external trade and current account surpluses. Unchecked these unexpected economic rents would have wreaked havoc given the extremely small size of these oil rich economies relative to the massive positive terms-of-trade shock. The inflow of revenues would have contributed to substantial booms, both in terms of economic activity, inflation and/or domestic asset prices probably on a scale without precedent in modern history or, alternatively, the currencies of these economies would adjust to equilibrate the hugely positive terms of trade shock resulting in massive nominal exchange rate appreciations – “Dutch disease”, (or as we now like to call it “Australian Disease”: a country that has had debates as to the need for their own SWF). At worst both could occur. Fearing the inability of these economies to absorb a shock of such a magnitude their political rulers decided to “save” the windfall gain from oil extraction by investing the excess proceeds offshore.

SWFs are effective at defusing the negative outcomes of trade shock as they effectively export excess returns from the extraction of crude oil/gas, generating an offset to the inflow on the current account. Indeed, as demanded by their decision to use currency pegs as their formal monetary policy anchor, most Gulf States see the current account surplus mirrored by a deficit on the capital account[1].

For the most part, SWFs have tended to be established in countries endowed by substantial mineral resources that they export to the rest of the world[2]. However the exporting of any resource that is vastly in demand by the rest of the world will be subject to the same pressures. China is a good example when, following the reforms of the mid-1990s, it started exporting its greatest natural resource: an abundant supply of cheap labour.

Bringing on-stream the huge supply of what was previously low productivity domestic-orientated labour, provided a substantial positive economic shock to the global economy as it effectively constituted a massive aggregate supply shock, generating a strong disinflationary force in the tradeables sector. Coming at a time when operationally independent central banks were exclusively fixated on achieving their ‘low inflation targets', this was considered a very positive development. It certainly made things much easier for central bankers and allowed them to bask in glory normally reserved for religious leaders. However, the overshoot of such acceptance has come to bite them sorely on the behind as the deflationary pressures are now having to be fought as hard as inflation ever was, leading to central bankers' religious status to be reclassified, in the minds of many, to that of David Koresh or Charles Manson.

What central bankers in the developed world, indeed almost all other global policymakers and the vast majority of investors, missed were the negative consequences following the growth of SWFs - the associated increase in global imbalances.

In a world of free-floating exchange rates global imbalances should, over time, be self-correcting. The currencies of nations running sustained current account deficits tend to experience downward pressure (depreciation) on their currencies which improves the terms-of-trade and hence the relative competitiveness of their export sectors. By contrast, current account surplus nations tend to experience upward pressure (appreciation) on their currencies with the opposite effect (looking at you Switzerland). SWF's are, by design, mandated to recycle current account surpluses by investing in offshore assets, which completely short-circuits such market forces and hence thwarts the natural equilibrating process (again looking at your Switzerland).

This is not a minor economic problem. Even though there were undoubtedly many contributing factors to the Great Recession, in the view of many, including former BIS Chief Economist William White, the huge rise in global imbalances was a significant contributing factor. We totally agree with this assessment.

Despite the recognition of the damage resulting from global imbalances, there has been little criticism directed towards SWFs even though they are an obvious mechanism for their perpetuation. In fact, according to the SWF Institute[3], SWF have total assets under management of USD 7tr (almost 10% of global annual GDP), having more than doubled in just seven years. This accelerated pace of increase is hardly surprising. A nation’s current account balance comprises not just of the external trade surplus but also includes net investment income and other (typically very small) international transfers. Hence, SWF’s not only facilitate the continuation of a positive external trade balance by limiting exchange rate moves but as the net foreign asset position rises, the investment returns from these assets also increases. There is, in other words, a positive compounding effect, which, if unchecked, would result in SWF assets under management rising until they end up owning all of the productive capital in the world or the price of that capital rises due to their demand. [4]

Such an outcome is, of course, inconceivable. Current account imbalances simply cannot be sustained indefinitely, ergo SWFs (the surplus-side of the equation) also cannot – theoretically – exist; at least not in perpetuity.

There are several ways in which the demise of SWFs will occur.

One possibility is that SWF assets are run down as a result of an increased domestic absorption of the savings held by these funds, for example China having to make up for the aging population or Gulf states suffering the reverse problem of having extremely young and fast growing populations. Further compounding the problem in the Gulf is the fact there is a lack of incentive to boost non-resource extraction growth sources combined with an increased sense of entitlement amongst the younger generations (dare we provocatively say again 'Australian Disease’?).

A further possibility is that it is the result of legislation amid increased political opposition in the advanced economies to the increased ownership of domestic assets. Indeed, there have already been instances where SWFs have sought to purchase assets that have been judged to be against the national interest.

There is another, arguably more Machiavellian, possibility – one we would not rule out. The global economy has, and continues, to be plagued by excess debt – both public and private. Indeed, despite all the chatter about deleveraging total debt as a percentage of world GDP is higher now than at the start of the Great Recession, which speaks volumes about the efficacy of the Keynesian policies adopted in response. No matter how you split it, someone, somewhere, will have to bear the cost of this debt crisis.

What better candidate than the pools of foreign capital built-up during the boom years, namely SWFs. They would prove to be very effective, politically acceptable, loss-absorbers. Such an argument might appear far-fetched but it is worth recalling that only a few years ago when the global economy was tail-spinning towards another Great Depression, US policymakers managed to convince leading SWFs to provide much needed capital injections. At the time these investors basked in the glory of their superman role, but as it transpired the quality of the investments was “dubious” to say the least and generated substantial investment losses.

No doubt having been bitten once, SWFs will be more careful in the future, but it will be hard to avoid such an outcome in our opinion. Moreover, such an outcome would have a certain sense of karma. SWFs definitely were a contributing factor behind the debt bubble in the advanced economies. And rather like Syriza is doing presently and US homeowners before them, there is a valid argument that some of the burden of adjustment should fall both on the shoulders of creditors and debtors.

This raises another question. Is there any wisdom in a country creating an environment that facilitates the need for a SWF in the first place? In the broadest sense exporting an asset, whether it be a natural resource or labour supply, in return for cash which is then recycled into assets held overseas is just a version of portfolio diversification. The value of the exported asset may change over time so swapping it for a broader portfolio makes sense if that portfolio is carefully constructed to reflect the future needs of the nation. Much as my personal pension should probably be 30% food, 30% energy and shelter and 40% health care is a nation’s future needs covered by holding trillions of US debt? China’s hoarding of commodities and commodity production in Africa is probably the most sensible use of accumulated reserves. In addition, there is another trade off. SWFs effectively exchange the “commodity” directly under their control for an asset that, while under titular control, is in effect under the control of the nation where that asset is domiciled. The net result, therefore, is risk diversification but this comes at a price in terms of a reduction in total asset control.

Perhaps it would have made more sense for the Gulf states to have only pumped the amount of oil needed to give them a stable and balanced economy without the need for an SWF to soak up the excess. In effect, the SWF asset would be the oil left in the ground for pumping at a later date. Admittedly, there is no diversification but equally there is no ransoming to the whims of overseas asset controllers. For the importing deficit nation encouraging the wisdom of SWFs within exporter nations is to be encouraged. The importing nations gain the assets they need (oil, commodities, labour) in exchange for an IOU as the cash returns via SWFs to the importer’s government debt or company stocks, which the importing nation can always default on (the Greece/ Germany scenario) or impose an asset freeze upon (the US/ Russian or Iranian scenario).

So what has the SWF actually achieved? What do they actually hold? As with any form of ownership of money it buys power and control over other people. Own a company and you tell the staff what to do, to a point. Even a company has to keep its staff sweet, through either pay or conditions. And so it is with owning assets based offshore. The offshore country can renationalise your assets if you become too much of an annoyance.

All that said, we conclude that the economic logic is inescapable: SWFs CANNOT exist in perpetuity. Such institutions might exist for some time, in some place, but the investment behemoths that we have come to recognize over the past few decades will not be around indefinitely. A home truth that is, much to our continued astonishment, not more widely recognized and is one worth remembering the next time you visit one of their shiny glass offices.

The discussion we had over dinner was a relatively straightforward application of basic economic principles, leading us to wonder why such arguments are not more widespread. Most likely this reflects the fact that it is not in the interests of sell-side firms, buy-side firms, SWF host nations domestic political interests, or as mentioned above, debtor nation policymakers to bite the hand that feeds them.

Until of course they need a scapegoat.

[1] For the majority of the Gulf oil exporting nations the currency peg is versus the USD reflecting the fact that crude oil is typically denominated in USDs. Kuwait is, however, a notable exception as it was re-pegged to a basket of currencies in 2007.
[2] Just over a half of SWFs have oil/gas extraction as their funding source.
[3] http://www.swfinstitute.org/
[4] At this point in the dinner debate we wondered if Apple could be considered a form of economy distorting SWF considering its huge stockpiled cash surpluses generated by becoming the monopolistic supplier of a good so much in global demand.

Not out of the woods yet.

I too looked at that bund chart and thought 'typical spike exhaustion sell off'. The rebound amidst a mood of 'get me the hell out of here’ makes a perfect CTA market bottom.

CTA weighting has been a large component of this turndown in Bunds. If they were the only players in town then the next move should be higher especially when we have the oil tanker of the ECB bid still around. You could argue the ECB is grateful having profit transfered from the CTA bin to ECB bin via the better transfer price.

But there are a couple of other background issues. First is that many feel that bunds 'should' be pricing 75-100bp yields and the second is how 'out' did real money get on that move. I am not sure, as on one hand volumes were huge but on the other their belief is that Bunds are a good hold for all the reasons they were buying them since Jan. Apart from price, have they had any BIG reason to change their minds other than all the reasons that I have for selling them. They didn't agree then so why should they now? From the comments about short Dax being used as a hedge against falling bunds by many funds I assume they are still long.

If we look at that chart again and see where we are relative to two weeks ago we see we have only countered two days worth of drop so we are not out of the woods yet, even if mood is trying to say we are. Which in the psychological game is dangerous and translates in the Elliot wave picture into wave Bs.

The bounce in bunds was reflected everywhere with the JBTFDers  (Just Buy The F’n Dip) gaining courage across all assets. This has been helped by the euphoria from UK based traders as the UK election results are 5 bells in a row for business and private growth.  Oil has turned lower too and once again oil stocks led oil. They weren't going up in the last days of the oil rally this week. Oil then turned 4/5 bucks lower also showing a move back from the reflation trade and added to the mood.

So we ended the week on a high which was amplified by the weekend press, which heightens my concern for a turnaround lower again as though the case for a bounce is indeed good, the asymmetry of payoff has me thinking it may well be worth hanging in a bit longer to the short bonds/bunds trade as euphoria wanes and a lower chance of a major dump again outweighs the higher chance of a smaller rally.

As for US markets, I still see them as a side show to Europe which appears to be leading. Not a surprise as now that ECB is in QE mode it is trying to wrestle with controlling the whole of the yield curve serpent, whereas the US is now holding it by the tail (short end) having released its actions on the rest of the curve (stopped QE). Letting go of the long end does leave it free to whip around but not as much as the shocks you can experience when releasing a completely pinned snake as we just saw in Bunds. China rate cuts are probably just short term noise too, though stimulative China policy is unlikely to hold Western bonds.

I am trying to pick causality from correlation but with longer term rates still massively up from a couple of weeks ago, despite the bounce, cross infection possibilities to equities are still high. I have moved my FTSE shorts (losses psychologically nursed as the relatively small cost of a lifestyle hedge against Labour/SNP running the UK) into Nasdaq shorts. It’s been a while since I shorted Nasdaq, 16 years to be precise. No this isn’t a brag, though I made on it I shorted too early and felt pain - just like my recent Bund short. Yet Nasdaq has the hallmarks of a market that can be tipped by a forced deleveraging. All that cash bleeding hope funded by Venture Capital  borrowed money. As we all know it’s leverage that kills and unles you have broken through the ceiling ( Apple et al) the rest of it is lottery ticket stuff where the price of your lottery ticket goes up the more people buy lottery tickets.

Not easy from here.

--------
Afternoon update - So much for US not leading. It looks as though USTs have taken over the reins as the bond selling does indeed pick up.  There has been little effect so far on my newly favoured contagion short but judging by how USTs and Nasdaq have run together over the last 5 day of stress there might be a gap to fill here.

Red - Nasdaq
Green 7-10yr USTreasuries

Edstone Part II

Reflation trades reflating the P+L.

Yours truly can breath again having held his breath for probably longer than is safe, losing a few brain cells along the way. The enforced hypoxia experienced in my short bund holdings has been somewhat similar to that portrayed in movies where the hero manages to free himself from the sinking car and make it to the surface with only a second to spare. In fact it's better than that, the short bund position has launched through the P+L surface like a Trident ballistic missile. Trident - soon to be banned by the new USSR (Union of Scottish Socialist Regions).

A 3% move lower in price over the last couple of weeks takes a lot of years of 0.07% yield to compensate. About 42 years in fact, which is a tad problematic on a 10yr bond. Of course not everyone bought at the top. The ECB started buying on March the 9th but yields are now higher than when they started. Not a problem when you are funding the QE at -0.20% cash rates and can run to maturity but are 10 years without a rate hike to over 25bp likely? But apart from ECB reputation it's the good old pension funds and real money accounts who are going to get hosed. My mind turns back to our friend at JPMorgan Asset Management -here

Oil stocks and other commodity linked overweights are all looking perky. Even the ones hedged against short FTSE. Long the FTSE global commodity names against short FTSE index is one way to cope with the impending mayhem that domestic stocks are likely to experience on Friday when every UK political leader prostitutes their principles in a bid to put together a coalition government whilst insisting their moral integrity. Ed Miliband may even have to call for the stone tablet equivalent of tippex. Polyfilla I guess.

Oil is still grinding upwards and completes the picture for the reflation trade. WTI through $60 which, being $18 above the low, is far enough away from the $24 it would have been if it had fallen $18, to call the $20 buck oilers just plain wrong. Despite the size of long positions in the futures markets I am not too concerned about oil topping soon. There are plenty of hastily applied commercial hedges that won’t be looking too clever when presented at the next oil company AGM. I continue to run long oily stuff since buying when the oil stocks showed us the base in March- here

And throughout all of the above it still feels that the market is trying to fight the move. The bund bulls, oil bears and general deflationistas have gone quiet but there hasn’t been a deafening roar that things have turned. This is apparently a correction. A term that marks the first touch of red hot steel on the posterior as the call of the cuckoo marks the start of spring.

I remain concerned that bonds are the San Andreas fault of the global markets and are going to trigger high leverage unwinds. Particularly stupidly priced tech and biotech stocks. So I am happy to remain long commodity stuff (even my dormant long AUD/USD is paying handsomely) and despite EM knock-on concerns via bonds I am also happily owning African commodity stocks (ex-South Africa I add).

Inflation is coming and with it a test of Draghi's 'til the end' QE commitment.

UK Labour Party's new LPad

Today, Ed Miliband and the Labour Party launched their plan to make the UK the hub of global technological expertise with the launch of their iPad beating tablet system which they have christened the LPad.

LPad Specifications

Operating system - Stonemason 1.0

CPU - None. Cloud based.

Internal memory - 0.5kb ROM

External memory - None

Display - Monochrome, 1 pixel / square inch.

Display Latency - 7500 years.

Internal battery - None

Power source - User

Input device - Mallet and cold chisel

Water resistant - Yes, but avoid acid rain.

Compatibility - Cemeteries, holy mountains, museums, cult worshiper's secret lairs.

Dimensions: H 2.5m, W 1m,  D 0.15m

Weight - 860kg

Available finishes - Limestone.

In the box - 2.5 square meters of polished limestone. Cold chisel and mallet sold separately

The first of these devices will be used to store Ed Miliband's short 'do list' and will be left in his garden where only he can see it.

The launch of such an exciting new initiative promises a sorely needed boost to the UK's limestone quarrying industry which has been reliant on the falling demand for monumental stonework and type one hardcore. Jack Johnson, 58, president of the Portland Stonemasons Guild said "Even though, as stonemasons, we will feel the benefits directly we can see the whole stone based economy experiencing a significant lift"

He makes a fair point. Whereas the delivery of 2000 iPads to an Apple store could be made in a small Ford Transit, the delivery of the same quantity of LPads would employ 200 low loaders giving a 20,000% boost to the transport industry.

"It doesn't stop there" added Jim Jones, Chairman of the National Union of Bedside Table Manufacturers. "We are already developing new technologies to produce world beating bedside tables capable of supporting the new 860kg LPad"

The launch has the full support of the Green Party who have hailed the project as a huge step forward in power saving eco-computing, however concerns have been raised by the monumental stone industry who warn of steep price rises due to anticipated shortages in limestone. Security experts have also warned Ed Miliband of the risks from Syrian based vandals of burying a large stone tablet dedicated to false gods in his garden.

Apple have refused to comment on the Labour Party initiative but are said to be developing a papyrus based system in response.

Angels and Demons - Draghi and the ECBERN

I used to like Draghi, he was the force of reason behind the chaos of European politics. The man trying to keep the whole political mess together and, having been given limited powers by his political overlords, has done the best he can and done a pretty good job of it too. But the latest ECB press meeting appeared to betray another side. A darker, harder side, the emergence of which appears to coincide with his aquisition of the QE weapon which, almost Gollum’esque, he will not give up.  He intends to see it through to the end. He sees no bond bubble, he sees no shortage of bonds to buy and he cannot understand why anyone would think otherwise. No wonder that Bunds went flying up again in response.

But is he really that inflexible? Whereas the Fed is, to the chagrin of Fed watchers, presenting a future guidance of ‘well we will see and do what we feel is suitable at the time’ the ECB appears to be laying down an eight lane expectation road of type one hardcore topped with finest asphalt stretching out to sept 2016. Draghi’s deliverance of convicted determination towards future policy has been the past saviour of EU crises (the mythical OMT) but is a message of single minded policy execution, come what may, the right one to now be sending as doing so builds even greater pent up stresses in a spring that has to unwind at some point.

This cold eyed determination in the man, a servant of his political masters, who up until now has been seen as the hand of good guidance has reminded me of a the character in the Dan Brown’s book and film Angels and Demons. The Camerlengo.

'The Camerlengo of the Holy Roman Church is an office of the Papal household. The Camerlengo is the administrator of the property and revenues of the Holy See. Formerly, his responsibilities included the fiscal administration of the Patrimony of St. Peter. After the death of a pope, until a successor can be elected, the Camerlengo serves as the Vatican City's acting head of state'

In Dan Brown’s story the Carmelengo turns rogue and tries to create a new order of hard-line traditionalists. To do so he utilises anti-matter stolen from CERN. Now if we imagine that anti-matter is an analogy for negative interest rates and the ECB is in fact CERN, let’s call it ECBERN, then Draghi as Carmelengo still fits. But I’m not the first to notice a sinister overtone to the ECB. A young lady at the meeting also expressed her concern.

Lets push this one stage further and have a look at Draghi's ECBERN

ECBERN is a massive European experiment where huge amounts of debt are fired at enormous speeds around and around in a massive circle in the hope of finding the answers to the structure of future European economic success. The experiment has been running for 17 years and despite costing trillions has failed to fuse a stable particle of growth and a stable particle of inflation into the God Particle of a stable economy. All components have so far proven highly unstable leading to the Prodi Exclusion Principle stating it is impossible for stable inflation and stable growth to exist in the same EU State.

ECBERN has however seen other successes. The discovery of monetary antimatter (negative interest rates) was hailed by many as a triumph over the laws of financial nature. Though theoreticians had proposed negative interest rates could  be possible no one ever thought they would be proven to physically exist. Negative interest rates have to be contained within the containment of a high QE field in a deflationary bubble otherwise they will react with the normal rules of economics and annihilate the future.

ECBERN has also been attempting to prove String Theory where pushing on a piece of string causes the other end to move. They are determined that this is the case and will make it work through brute force by applying massive nuclear blasts to one end of the string. Unsurprisingly the other end has twitched but the transmission mechanism is now completely broken.

Experiments also seek to prove the existence of the economic dark matter needed in order to explain how the EUniverse is still holding together. First thoughts are that it could be something to do with the black market or local fiscal policy but ECBERN aren’t allowed by their political masters to experiment, or even pass judgement, on fiscal policy.

Inflation theory is used by ECBERN to explain the origin of the large-scale structure of the economic cosmos. Quantum fluctuations in the microscopic inflationary region, magnified to cosmic size, become the seeds for the growth of economies in the EUniverse. The inflationary epoch lasted for 10^-32 seconds after original EU creation but has been elusive ever since despite their best efforts to recreate it.

ECBERN definitions-

Bosons - General term applied to all components of economic policy but is more befittingly a description of the policy makers as they are characterised by their spin. “They are all Bosons’. The wavefunction for a collection of bosons is symmetric as they all have the same spin.

Higgs Boson - The God Particle. A stable economy. The carrier of future happiness and economic contentment and the glue that, in theory, holds the EUniverse together.

Anti-matter - negative interest rates

Quark - A component of overall monetary policy. Comes in two varieties, the down quark and the up quark. Modern policy consists mostly of the up version hence the cry from observers 'Jeez it’s another policy quark-up’

Anti-Quark - A particle that opposes quarks. Greece.

Meson - Composing of a quark and an anti-quark. Formed by putting Varoufakis and Schauble in the same room.

Electrons - Not present at ECBERN as none of them are elected by the public.

Atlas Detector - Eurostat. A massive machine that cost billions to build designed to detect stable economy. So far has detected nothing.

Baryon - from the Greek for ‘heavy'. Baryons are just heavy Greek debt.


All good fun and the idea that the EU is modelling its economic policy on a huge experiment is no doubt fitting. But as with all experiments, we have to have trust in the scientists involved as to whether their discoveries are of benefit to humankind and not instead the forebearer of our own destruction.

Current ECB policy is toeing the line.



---------------------
I should credit George Cooper for a post he guided me to when I first proposed a post this subject. Much better depth than mine.
http://georgecooper.org/2014/09/11/money-and-the-magical-mathematics-of-brahmagupta/

Premium Bonds With Negative Yields.

I have always maintained that crossing the zero bound to negative yield results in behaviour that doesn’t cross as easily and instead diverges into a new dimension of imaginary numbers that leads to craziness. But here is a thought to add to the interest rate negative absurdum files. Premium Bonds.

For non-UK readers, Premium Bonds are a UK Government perpetual bond that instead of paying the coupon as a fixed guaranteed payment, pools the interest due and allocates it to the bond holders by a lottery type draw. Bond numbers are drawn each month and prizes paid that equate to the total interest pot. There are multiple small prizes but they scale down in number to a single £1,000,000 prize per month. The bonds are always redeemable for original face value. The average yield on the bonds is currently 1.35%.

The UK National Lottery, by contrast, has a negative yield as about half of the money from the ticket sales is paid back in prize money. As we all know the ticket is not redeemable for face. So the expected yield on a lottery ticket is about -50%. Despite this monstrously negative yield people still buy them for the dream.

With public willingness to buy -50% yield you can see why the regulator has to step in and licence lotteries so that we all can’t cash in and borrow at such negative yields from the pool of dream money. But what if the State were to cross the zero yield line with their Premium Bond issues and move into negative yield territory?

The dullest and probably the most predictable way to do this would be to sell the bonds at a premium to face but as these are perpetuals pricing to maturity is not possible so instead the amount of bonds held could be scaled back depending upon the purchase date and time the Premium Bond is held, letting the holding effectively decline to near zero in a half life function.

But the really fun way of taking Premium Bonds negative yield is to follow the rules they currently abide by where the pool of interest is allocated by lottery. Now imagine if that pool of interest is negative. One (un)lucky owner of the Bond that is drawn now receives a letter

“Dear Mrs Smith, Congratulations! Your Premium Bond has been drawn and you owe the state £1,000,000”

A few thousand others will be receiving a letter saying they owe the state smaller sums.

Would they sell? Of course not because no one would like to own (in personal finance terms) unlimited downside even if the maths says there is huge chance of escaping any negative yield with a ‘miss’. The organiser of a lottery has the advantage of knowing the averaging will work for them as they own the whole market. An individual buying or issuing one ticket does not and will risk the vagaries of probability.

Which then leads me to ask how great does the capital gain of a premium bond have to be before an individual is willing to buy one to compensate the perceived risk of a one off down side hit. If you receive a 20% capital yield on your ticket what maximum down side would you be willing to bear, even at a tiny probability, to buy the ticket.

The balance between capital return and prize coupon is one of complexity that could be part of a behavioural finance study. Perhaps the way to run it is by setting up a real market test and let the market find its own level. The payoff between capital return and coupon is relatively easy in bond maths but how interesting it would be if the government was to issue a form of Premium Bond where the individual could choose the balance between negative coupon they may wear, if they are unfortunate enough to get drawn, against the yield if they don’t get drawn. As an issuer the State can gear it so the pay-off on average is always the national interest rate but it is up to the individual to choose their preference. Or they could let the market find its own level and with the proven bias towards paying over the odds for hope, as expressed by the market for -50% lottery tickets) the State may well find its borrowing cost go pleasantly negative without them even having to try. Bizarre but probable.

Credit risk on the individuals ability to pay an enormous penalty loss is of course a massive consideration, but as an experiment the results would be a benchmark in behavioural finance and risk perception.

Greek Dictionary

We all know about Grexits, but it is probably worth covering all further derivations of the Grex meme.

Grexcell - How good the Greeks are at avoiding tax.

Grextacy - The feeling Greece has when an EU payment arrives.

Grexcitable - The market when it comes to Greek deadlines.

Grexodus - Bob Marlios song about the movement of da Greek people to Germany

Grexistentialism - Greek philosophy characterised by what has been called "the Grexistential attitude", or a sense of disorientation and confusion in the face of an apparently meaningless or absurd world.

Grexposed - EU discovery that Greece never had any money.

Grexploited - What both sides are feeling.

Grextortion - What both sides feel the other is applying.

Grexwife - Merkel

Grextraction - EU attempt to receive a debt repayment.

Grexception - What Greece hope the EU will make when it comes to the rules.

Grexcessive - Greek Debt.

Grexchange - What Greece would like to do with their debt, preferably for a Grexpectation.

Grexpectation - What Greece offers instead of a promise. See Dickens' novel "Eat Grexpectations"

Grexcitement - The short lived Greek hope after the election of Tsipras.

Grexcluded - Greece’s invitation to the EU christmas party.

Grexcreta - What Greek bank shareholders can expect to hit the Grextractor fan

Grexcentric - The behaviour of the Greek Finance Minster

Grexcrutiating - The whole process.

Grexcellent - The weather rather than the outlook.

Grexcuses - Greek explanations.

Grexplanations - Greek esoteric theory that bypasses reality.

Grexcursion - The trip Greece may be making out of the EU.

Grexpulsion  - The German for Grexit.

Grexaltations - German mood after a Grexpulsion.

Grexecution - Greece carrying out a plan, charactised by the infinite time it takes.

Grexparrot - Monty Python's definition of Greece

Grextrapolation - Assumptions as to what other peripheries will to do on a Grexit.

Grexotic - A Greek proposal

Grexclaimation - An EU response to a Greek proposal.

Grexuvia - The remains of the exoskeleton that is left after the EU has sloughed off Greece

Tyrannosaurus Grex - What Greece likes to think it is to the soft underbelly of European cohesion.

"Which leads me on to" - A collection of observations.

Take a share, any share. If it pays a dividend how do you calculate its theoretical price? To be honest I don’t know because it would appear that if there was a right way then a share price wouldn’t move much at all as the efficient market hypothesis, which let me make clear right now, is the biggest load of tosh ever unleashed on the poor economics student, would, in its completely tosh way, dictate that the price is fairly priced.

Which leads me on to asking - Is a price a fair reflection of what it is meant to be? A reverse argument if you like. If we look at a price can we deduce the components that make it up? I ask as one of my greatest bugbears is the way the price of credit default swaps is examined and backward assumptions made that the price reflects the actual probability of default. We had it with Greece and we have it now with Austria. CDS is examined and the cry goes out in media land “There is a x% chance of y defaulting’. This is also tosh. The price is an ‘implied’ probability just as implied volatility in option pricing isn’t the actual volatility, instead being where people think it will be.

The difference between what people think the chances are of something defaulting and what the actual chance is are very different. Think of it this way. There is a horse in a stall quietly munching on its hay waiting for the start of its race. The horse is unknown and as such no one is betting on it and it is pricing at 100/1. Someone sees the price and thinks that's a fair bet on an unknown and bets on it in good size. The price moves to 33/1. This attracts attention and others bet on it and even some of the other jockeys bet on it in case they lose as a hedge (this happens in CDS). The price comes in to 15/1. At which point a rather drunken fellow fancies impressing his drunken friends by placing a massive wager on it and drives the price to evens. Meanwhile the horse is still quietly standing in its stall wondering what all the fuss outside is about. So at which point in all of that did the actual likelihood of the horse winning the race change from 100/1 to 50/50? The horse didn’t get any fitter nor did the competition get nobbled. Nothing has changed with respect to the actual probability of outcome. Yet the market price has. So it is with CDS.

The assumption that is used to counter this argument is that of the wisdom of crowds - "Well if everyone thinks that, then there is a pretty good chance I am wrong". But for many outcomes the wisdom of crowds is no better than random. If you were to ask the whole population to guess the outcome of the next lottery and then bet on the modal forecast you would have no better outcome than betting on any other set of numbers. Yet the belief that mass market behaviour can effect independent outcomes is rife. In a market where the guesser can interact and effect the outcome then yes, market prices and beliefs in them will move hand in hand. But in markets where the outcomes cannot be influenced by the actions in that market then they cannot.

Which leads me on to the #NFPGuesses twitter tag, where we all have a lottery type guess at what the Non Farm Payroll data will be that Friday. All fun and games but under no circumstance should the analysis of all the results be deemed to indicate the correct outcome. Yet they are often cited as such. Short of the participants running off to get jobs or to resign their posts to get the result they are betting on, it really is not linked. Where of course this analysis is useful is determining how the market may react after the announcement, but not what the announcement will be.

Which leads me on to recommend that prices that are estimates are not turned into inputs into further models that are used to create further estimates. If they are then there will be horrible feedback loops where the likes of CDS are used as an input into the probability of default in a model that then sees that default risk rising because CDS prices are higher and so buys.. errr CDS. And on we go.

Which leads me on to Central Banks and Goodhart’s law, whereby CB policy influences market behaviour towards the assets and indicators that are themselves inputs into policy models. Here we are talking inflation expectations as measured through the 5yr/5yr which are driven by bond purchases anticipating CBS loosening because the 5yr/5yr is moving down as much because funds are buying bonds in anticipation of.. etc. More excitingly though, the reverse will apply in an unwind.

Which leads me on to government borrowing. There is simply gaaarillions of it and none of it is really seen as a problem as the interest payments on it are so stupidly low. To the point that Germany get paid. But should prices of bonds start to fall, yields will go up as will the running costs. Most unpleasant. But isn’t there some sort of borrowing cap that is applied to governments for risk reasons? No, as long as the coupon is paid the government can keep borrowing. The fact that the debt can probably never be repaid is rarely taken into consideration.

Which leads me on to mortgages.  Lets talk about the UK to start with. The government has knee-jerk reacted to the last banking crisis by laying down affordability tests for you and me that they themselves would have failed and failed in evermore spectacular style since 1823. If you are to be allowed to buy a house in the UK you have to be able to argue convincingly that you will be able to repay the whole of the debt within a relatively short space of time. That’s pay interest AND capital. A test any government would fail. Yet if I was to have retired (I haven’t) own a house worth £5 million have a pile of cash in the bank of £1m off which I am living then the bank would not be allowed to lend me a bean as I don’t have an income. The value of the underlying asset is ignored as you are not allowed to consider that the debt could be paid off by selling the asset.

Which leads me on to unaffordable housing. Which first begs the question “If it is unaffordable then how come it sells”? Ahh! You mean people who can’t afford it can’t afford it. That’s different. Someone is now making a judgement call as to who should be allowed to afford it. I notice that the government is reintroducing 'right to buy, whereby state tenants can buy their property from the state. Fine, create another first generation of cash winners, but the benefit doesn’t last further than the gentrification of some prime location hell holes. But the right to buy should not be confused with the right to have enough money to buy. It’s a market. I am a firm believer that market interference in the case of property leads to further distortions and that natural market forces should play out, even if, like a nature film, that involves big lions eating cute deer (note that there always seem to be plenty of deer left or the lions would have died out). If areas of London are too expensive for people who want to live there to live there then sorry, that’s life. I would like an Aston Martin DB5 yet I don’t launch a campaign protesting over unaffordable Aston Martins.

‘But that's where the jobs are” - Well they won’t be if no one can afford to live there. The employers will move and that would be the best thing for London, the workers and the rest of the country.

“But my family have always lived here, I was brought up here and I can’t afford to live here and I’m local’ - Well if your parents have lived here all there lives, what’s happened to all the cash they have made on their property? Just wait, as the greatest redistributer of cash between the generations is death.

Which leads me on to bubbles. Does it matter how high the price of something goes? I am inclined to answer "no, as long as no one borrows against its theoretical value". Whether that’s directly to buy it, as in a mortgage, or to use it as collateral to borrow against to spend on something else. If my humble cottage is worth a billion trillion pounds and I continue to live in it and don’t raise debt agaist it, nor spend profligately on other thing in the belief I can sell my cottage (effectively borrowing) then its price is immaterial to me or the rest of the economy. Should someone purchase my cottage from me for a billion trillion pounds and they haven’t borrowed to do so and carry on as I had, unborrowed, then nothing in the world is effected, we have just exchanged positions.

If house prices are moving to infinity why do you want to own a property in the first place? To live in of course! But there are alternatives.

Which leads me neatly back to central banks, theoretical prices and equities. In a world of super low interest rates, let's say zero in many cases, a stock paying a dividend can be priced to infinity and still have a better yield than a zero yield bond. I have often mentioned the lunacies involved in negative yield land but we can now expand the collection of absurdities to the housing market. As with stocks, house prices can go to infinity and, as long as the tenant is paying maintenance costs, the rent can be infinitesimal and the owner is still yielding more than they will be getting on zero yield bonds. Looking at that in reverse it means, dear friends, that rather than paying £10^21 for a shoebox you do the owner a favour and rent it from them for £0.0000001.

In fact, if European yields are negative, the efficient boundary would suggest that a property owner could buy a property and pay you to live there and still outperform German government debt. Now how about that? Being paid to live in your house! Yet you still insist you have to be able to borrow money to buy your own house whatever the price?

Pray, tell me why you are so completely stupid?

Baby I Don't Care

Turn up the music LOUD and sing along with the words below as we tell Yellen just what we really think to the her weasely Fed timing words. 

BABY I DON'T CARE! 

Transvision Vamp 

This embed may not play,  if not open it here and crank it up. 

Waaaaaahhhhh!

Well you can tell me your a dove

And you won’t raise rates in quarter two

But I knows what’s on your mind

You think that growth may cool

And deflation’s due to dollar

Give me ‘bullshit' forever and a day yeah 

But there's just one thing 

You don't have to say

You don't have to say when hikes'll be

You're the chair of FOMC

We"ll just have to wait and see.

Baby it's alright

Cos honey I don't care

Oh baby I don't care

Oh honey I don't care

Oh honey I don't care

Well you can turn expectations down low

Sometimes it's best for stocks that way 

So you can tell me all your stories

But please spare me the plays

Cos you don't have to say your a dove, see?

You don't have to allay rate hike fears

No you don't have to say when the date'll be.

Baby it's alright

Cos honey I don't care

Oh honey I don't care

Oh baby I don't care

Oh honey I don't care

Deep in your eyes

I see it in your dots

I know you'll wait and see

Sometimes it hurts

But you know that some things

Are best left never said

Cos you may never want to raise, see?

Though you have to say you can

You don't have to say when it'll be

Baby it's alright

Cos honey I don't care

Oh when I tell you baby

I don't care

Oh baby please believe me

I don't care

Oh when I tell you baby

I don't care

When your raise will be

I don't care

Oh baby please believe me

Don't you see that I don't care

I don't care

Oh honey I don't care

You know, you know that I don't care

You know, you know

That you don't have to say you’ll hike rates

And you don't have to say you'll cut

You don't have to say when it’ll be

Baby it's alright, oh honey it's alright

Oh baby I don't care

Whale Oil Beef Hooked

Whale oil beef hooked. Look at the price of oil and oil stocks.

Though I have been out of oil for a while I have been watching it with keen interest and a couple of associated stocks. Of interest is the timing of relative highs and lows.

Lets look at the charts below of Tullow, BP and Premier ( the candles) and Brent oil (the black line)

We can see that the lift off from the base in Jan was led by the stocks rather than oil and the turn lower kicked off in the smaller more speculative stocks like Tullow and Premier before oil finally got around to catching up. Even the mighty BP refused to go up after the start of February. 

So what is going on here if oil stocks are meant to follow the oil price? Well could it be that oil actually follows the stocks? If so how? 

I am wondering if we have a speculative interest, or even model interest in the markets that has worked out that the profits to be had influencing lead/lag correlaters is greater than playing in the underlying commodity alone due to influences of liquidity and market capitalisation.

Option 1 - So you are going to sell oil and you know that the amount you are going to sell is going push the market down as you know that once it starts to go everyone will chase it. So instead while oil is steady you instead you start selling oil stocks. the spreads between oil and the stock widen and other players support the stock as it now begins to look out of line, giving you a stronger bid into which to sell. You carry on selling stocks until the spread widens to such a point that others start to buy the stock and sell oil on the spread trade, which finally gets oil going down. At which point you start to sell that oil you were planning to sell. Which reacts as you predicted and accelerates downwards. With it the floor for the stocks goes and they melt below levels that they would normally be at relative to that oil price. At which point you buy your stocks back for a healthy profit. 

Option 2  is that you never have any oil to sell. You follow the strategy above ( including the selling oil part) but after buying your oil stock back you buy your oil back. 

This is not a new tactic and may have been famously employed in the gold markets where gold mining stocks have greater liquidity than the gold market 

Shares surge: Gold prices and the stock of mining...

April 26, 1993

Shares surge: Gold prices and the stock of mining companies soared Monday after money manager George Soros bought a 10 percent share in Newmont Mining, one of the U.S.'s largest gold mining companies. Soros, who heads the Quantum Group of investment funds, purchased the stake from European tycoon Sir James Goldsmith, Newmont officials confirmed. Gold prices have climbed 7 percent since March 10.

Gold surges after the completion of buying a miner? Hmm. Someone buying back their shorts now that their use for holding down prices during negotiations for the stock has run its course perhaps? 

Now of course there could be lot of other reasons for the price of oil and stocks behaving in the way they do but the suspicious cynic in me would be reading the massive bounce in a couple of those stocks today as an indication that oil will also base today ...  for a while at least. 

IT Dementia

I was once considered the IT Geek. I used to be able to write programs in machine code and I always knew which bit of tech was top of the pile, I knew ALL the functions of every latest phone and I had a Windows based smartphone in 2002 that played mp3s when everyone else relied on iPods. I knew every setting in Windows, I could fix the wiring in the house, I even knew what every button on a 1990s VCR remote control did.

But but but…. I am now swamped. My brain just can’t cope with it all and I want to turn into an Apple zombie where the nice men in Apple white coats just make the shiny thing work without me having to trouble my little brain as to how. I have hit the equivalent of IT dementia.

I am currently having to cope seeing my dear old Dad slip into that dark land of dementia, a land from which you know there is no return, only a one way trip down a tunnel of engulfing gloom as the light of the past recedes leaving only a memory of growing darkness. My mother said something very astute about him the other day, but then as a high flying consultant neurophysiologist in her day I should have guessed she would. When I asked how he had gone downhill so much recently she replied, “Well his dementia hasn’t accelerated, it’s just that he has been able to cope without the bits he has lost so far. But having denuded the excess capacity it is now eating into what he needs to function so the effects are much more noticeable". Poor Dad.

But IT is the same. We can fill up so much of our brains with its complexities before they suddenly hit the ‘full’ mark, at which point our brains have a choice. Forget the less important facts and replace them with those of a greater importance ’sort by rating’, or they can just forget the oldest stuff leaving space ’sort by date’, or it can do what my BLOODY MAIL SERVER HAS DONE. Sorry to shout, but I am only just holding enough brain CPU in reserve to type this, so stress levels are a little high as my brain has done exactly what my bloody mail server has done.

"Your mailbox has exceeded its quota, please delete messages from your inbox.” Yes, that’s my brain re IT ability.

I try to delete -

"The IMAP command “UID COPY” (to INBOX.Deleted Messages) failed for the mailbox “INBOX” with server error: You exceeded your mail quota.”

All the more annoyingly someone says that they have forwarded me a mail with how to rationalise my IT knowlege. Which leaves me with a paradox. Just as with my mailbox, my brain is full of IT yet I need to learn more IT in order to relinquish IT. Yet as my brain is at maximum quota of IT so I can’t learn any more in order to get rid of it.

In a large organisation at this point you pick up the phone to the help desk and act the dementia patient as the World of Warcraft playing spotty youths flock around your desk, not so much to fix the problem with one deft keystroke, but more to gawp in barely suppressed mirth and the gibbering IT demented moron who doesn’t know how to archive his mail box. However I don’t have that privilege anymore, working for a boutique operation it is often quicker to google the problem and embark upon a mission into the depths of system setups that rivals Frodo’s travails in the Mines of Moria, as I tiptoe through the darkness trying not to upset the smallest setting that will call the Balrog of irretrievable system failure upon me.

Having said that, it is most likely NOT the quickest solution, as Google swiftly refers one to chat rooms that need logins, or whose remedy involves a 7th dan in wonkishness. The other course of action is to try one of those YouTube entries purporting to solve just your problem. Now, I’m not being racist nor nuffink, not that I call 'identifying a larger than average population of wonks’ racist but is it my imagination or is the national pastime of 17-20year old Canadian young men to sit in their rooms and make incredibly badly communicated videos of themselves offering solutions to basic problems over a time frame of 20 minutes that can mostly be answered with a ‘just flip that switch there’ 0.3 second subliminal mind flash? You guys really are making it impossible for the self-help needing IT dementia sufferers like me from finding that self-help. I give up on you.

So I now turn to the half bottle of Amaretto that was by my side. I know the image is not as hard as an old hack in a Saigon steam-shop, garbed in a once white, sweat soaked vest, pummelling out his diatribe on an old Underwood No. 5 typewriter, swigging from a once-corkstoppered unlabelled bottle of firewater, but hey, allow me some leeway here. It was all I had. "Had" being the word as it appears to have evaporated. So with the last sticky sweet essences of almond evaporating away I turn to my last port of call. It may be late, but when a man is in trouble a man is in trouble.

“Darling, do you know how to make my letters thing on my computer thing work please? I was about to send your mother an invitation to join us for Christmas, a message to your sister offering to pay for her children’s education, an apology to your friends we were at dinner with last week for upsetting them with my dreadful sense of humour and a large donation to that donkey orphanage you so want to help. But it won’t let me as apparently the IMAP command “UID COPY” (to INBOX.Deleted Messages) failed for the mailbox “INBOX” with server error: You exceeded your mail quota, what ever that is”

Backward Engineering.

I have recently read a few good pieces on why Germany needs to do more to iron-out its internal structure problems.  They focus largely on the demographic imbalances caused by an ageing population and a falling birthrate. Whilst they correctly cite various remedies that need to be implemented to stop it following the demographic trajectory of Japan they tend only very briefly to mention the most obvious quick fix answer, the one that Japan has failed to implement for all its cultural and xenophobic reasons and the UK Prime Minister only today is citing as one of the reasons the UK is doing OK -  Immigration.

The Eurozone was constructed by applying a wardrobe of artificial straightjackets designed to hold itself together. But as with most regulation, or even complex financial product pricing, if you contain one variable then stresses will display themselves through another (what is ‘implied volatility' in options calculations other than the remaining free variable once all the others in the Black and Scholes equation have been tethered). It’s like grasping a balloon between your fingers. Squeeze one part and it will pop out somewhere else.

I saw this marvellously demonstrated years ago at a Michael Jackson concert in the Singapore national stadium. We, the expats, sorry I mean 'immigrants',  in the crowd, were not used to having to sit still (as required) throughout an MJ style concert and so clumps of people would spontaneously leap to their feet and start dancing at which point a posse of security guards would rush over and demand they sat down again. It didn’t take long for the crowd to realise that the guards could not cover all bases so when one part of the audience was quelled another would rise on the opposite side of the stadium causing the guards to race over to quell them. This became a game with the crowd actively playing the guards, rising and falling just for the merriment of driving the guards in futile hot heeled persuits across the vast stadium. But basically they could not contain the natural forces that dictated that at a Michael Jackson concert the crowd were going to get to their feet and move.

The straightjacket of the EU is the Euro. Its unionised monetary policy without fiscal union has led to a veritable monetary buffet. Stimulus is provided through a centralised monetary buffet free-for-all from which all countries benefit, yet those who excessively benefit from it never have to pay through tightening domestic fiscal measures. As the feeding continues those with the best credit take more and get fatter and their credit improves further and they take yet more, meanwhile the hungry ones at the back find the table bare and demand it be refilled. The ECB kindly oblige.

Greece is the diner who fills his pockets and when challenged replies 'Who me? I only had the tomato soup”
Spain and Italy hide the piles of smoked salmon under a lettuce leaf so they aren’t spotted heading off with the best bits.
Portugal is under the table feeding on everything that hits the floor and hopping no one will notice it is there.
France is seen as polite and thankful, only taking what the waiter brings over to her. But the waiter is of course French.
Ireland meanwhile can’t believe they are being given free grub when they are actually meant to be dining with the UK.
The UK haven’t got a ticket to the buffet and though their mouth is watering they guess the food is poisoned.
Austria say they are a friend of Germany's and Germany says it's ok for them to have some of theirs.
Holland is trying to explain how the buffet works and is smacking the hands of anyone who leans past them.
Denmark was just walking past and is trying to explain that although it has a food sharing deal could people please stop eating off its plate.
And then there is Germany who protests the cost of the buffet and demands it should stop being refilled but when presented with another tray of low EUR/USD and negative funding foie gras helps itself and does nothing in the way of fiscal exercise to burn it off.

Everyone knows that if you don’t take your share at a free-for-all, someone else will. So Germany is growing fatter than them all. The best credit gives them the lowest borrowing costs and of course people always lend first to those who don't need it. With monetary policy generalised and fiscal policy local, there is a policy bias towards continuing looser monetary policy and relatively tighter fiscal policy. Why eat your own packed lunch when a free one is being provided?

So where do the adjustments occur? If a country will not voluntarily adjust its fiscal policy for the greater good but takes advantage of the generalised monetary policy, the last resort to adjust imbalances is for people to physically move and take jobs in booming areas, thus increasing labour supply and dampening wage pressures. This leads us back to the beginning. Germany needs immigration to counter its own demographics and the rest of Europe needs Germany to take immigrants to dampen economic cross border stresses.

So why hasn’t the whole of Greece upped sticks and headed off to Germany? The rich probably have and are there doing well and not paying taxes back in Greece (exaserbating a different problem that could also do with the unionising of fiscal policy) and the poor haven’t because they aren’t welcomed and don’t speak German.

Germany does exhibit the highest immigration figures in Europe but the fact that demographic failures are discussed at all is a sign that immigration is not doing enough to dampen the stresses. More can be done. But when economies suffer and disparities and national wealth inequalities extend, nationalism and protectionism start to dominate. These are natural barriers to migration. Until a European can head off to another part of Europe without being perceived as a foreigner stealing a job, the ultimate balancing function of migration that the EU has to rely upon (having artificially restricted all other variables) is less likely to work just when it has too.

Whilst the EU was originally formed to prevent wars, the mantle of cultural unity that has recently solidified over the cooling magma of past European conflicts is not yet strong enough to see swathes of non local lingo speaking arrivers taking from the buffet table of those who only have a buffet table due to them taking more from the original buffet table that the arrivers didn’t take as much from in the first place. So to speak.

Which leads me back to a tenet that I have been mumbling under my breath since 1998. -
"It won’t be the Euro that unifies Europe. It will be the English language."

QE QAR QRASH - Driving by committee

I am beginning to feel that the talk of QE did more good than its actual execution. This could fast turn into a QE QAR QRASH. EU QE is like driving an F1 car by committee and no one really knows the course.

QE buying running up the yield curve taking us further into the negative yield twilight zone is just compressing the inevitable spring of unwinds from this abhorrent state.

But in the meantime we have equities going down because of fear of US rate hike fears and bonds going up because of EU QE. It's nuts m'lord.

Still think both should go down ultimately as we have the next deleveraging saga. Only this time it won't be in personal debt but where that debt went - into state hands so soveriegn debt deleveraging. But of course the man in the middle is corporate debt who have been loading up thinking they are as bullet proof as sovereigns, mostly due to the investor market treating them as kings in the hope of currying some Maundy Yield Money.

If that debt is associated with its own currency then it will be FX dampened, but where its tied to a 3rd party currency (EU) all the pain will be in the debt and we will be back where we started in EU.

Be interesting to see who gets the blame. In 2008 it was the naughty lenders who took the social wrap. Next time around I predict it will be the naughty state borrowers who are blamed. Always blame the bigger entity it seems.

Euro issues.

To paraphrase Churchill "Never in the field of EU bond buying has so much been expected to be bought by so few from so many."

The monstrously low EU rates have, to no surprise, triggered a glut of Euro issuances with another swathe hitting the wires.

Berkshire Hathaway
Ghana
Romania
Hosts of Chinese names

The effect on the Euro depends on how the proceeds are then handled. If they are to be used to fund Euro investments and paid off with euro returns then they self hedge . But if, as is the case with Berkshire and the majority of these, they are to be used to repay non EU debt load or to fund non EU investments then FX exposure opens up. Which can be then hedged or left exposed.

If they are fully hedged with FX swaps then currency risk is removed but so is the EU low yield advantage through the forward points. If it is partially hedged with rolling short date FX swaps then there is yield curve exposure and cash flow differentials on on each roll  date due to FX spot moves. If it is left unhedged then low rates are fully utilised at the cost of opening up FX risk. The risks of which are now being seen by emerging market countries who loaded up on USD debt and are now being squeezed by a strong USD and rising US rates.

But of course the EU is different isn’t it? The Euro is going to keep falling and rates are going to stay low forever. Basically the same arguments that were applied to the US two or three years ago. Hmmm.

As these bond issues pick up, the Euro will feel continued pressure in a self fulfilling way. Issue, sell the proceeds for which ever country currency they are needed in, see FX fall and feel justified to have left the FX exposure open. This is basically the ‘low yields mean currency falls’ mechanics from the debt issuance side rather than the ‘lower rates so won’t invest there’ investor side. Yet someone has to be buying these bonds and they will have to buy Euros to do so if they are non EU players. But the demand for EU based investment at stupid low yield is not so much coming from new overseas investors. It’s mostly ‘Have to be in Euro’ investors who are just looking for anything of good credit that is paying more than 0%, which results in portfolios switching along the curves of both duration and credit. Which means that local institutions, banks and pension funds have to buy the negative yield and take the pain or buy these new issues. Basically, I cant see the Euro being supported by a wave of overseas money arriving especially to buy these new Euro issues.

So it would no be a huge surprise to see Euro keep falling encouraging more to issue and keep the cycle going switching from Usd funding to Euro. Right up until all bases are loaded and rates are perceived to be going up again. So the best way of running your Euro bond issue is to run it unFX hedged until the Euro bases and then hedge as rates outlook change or the last issue is done. But that is a game of chicken watching the issuance calendar and being ready to hedge when the last player is in.

With all the Euro issuing going on I do wonder if the calculating minds of the structures and investment bankers have worked out a way to palm the stuff off into the whale shark grazing mouth of the ECB. As the ECB is allowed to buy covered bonds and ABS as part of its program, how much of this nonEU issued Euro debt will end up buried in ABS structures that end up in the ECBs vaults?They may well end up holding non-EU issued Euro debt via a complicated back door.

Meanwhile I also wonder exactly how legged over the ECB is going to get buying their bonds. The world has preloaded and anyone who has worked in a dealing room will know the drill when a CB calls up for a price. Very much like Gordon Brown and his gold sales.  Ok, I know that this is being done through e-platforms, but the moment the name is seen then the response will be the same. The cry goes out ‘ECB is in! Offers vanish and clients are sent messages along the lines of ‘ We are seeing very good demand right now from a good European, I said GOOD European, name’ and spec buying pushes things against them. Then the game of 'guess the amount they have done' kicks off and the guesses then correlated against price action in order to work out a rule of thumb guide to future price action, which will then be anticipated and so work less well going forward.

Unless of course there is a rerun of the apocryphal story from a 1990’s FX trading room.

Sales Guy - “USD/DEM in 10 for a bank please’
Spot trader “10/15”
Sales Guy - “Mine”
[Prices leap about 200points]
Spot trader - “WTF .. Who was that???"
Sales Guy - “Err.. Federal Reserve Bank"
Spot trader - “********* YOU ***ing MORON ******NEXT TIME THE FED IS IN ***** YELL IT OUT!  MINE MINE MINE MINE ’

2 weeks later
Sales Guy- ‘ Hi guys, Fed's in"
Spot Traders “MINE MINE MINE MINE’
[Price barely budges]
Spot trader - ‘Mate are you sure? WTF it’s offered! Who told you they are in?’
Sales Guy - ‘Reception, they just called up to say they are here for our meeting’
Spot trader - “**** *******  *** ******* MORON!! .. YOURS YOURS YOURS YOURS'