May 7, 2015
Things are tough.
I was reading in an article that 2014 was a very bad year for hedge funds, similar to 2009, despite the strong trends in equity markets.
I was also reading recently, in the news: “Odey Asset Management founder Crispin Odey’s flagship hedge fund slumped 19.3 per cent in April, after the fund was caught out when the US dollar strengthened against the Aussie dollar…”
Then I started considering, why is it such a tough environment?
Let’s go back to the basic principles and starting points of global macro analysis.
What is the current inflation outlook amongst G10? How would we describe the current environment?
Is this a correction within a deflationary trend? Has inflation bottomed and now we experience a reversal due to the QE’s? Or are we instead at the beginning of a stagflation cycle, where inflation is expected to move higher but growth and economic activity are going to be soft?
Of course, everyone has his own favourite view but the truth of the matter is that it is simply an unclear environment with lots of “noise”. For every view / opinion towards one direction, we have a counter argument suggesting the opposite. We have many mixed signals that don’t make it easy for us. I read research, for example, indicating that this is clearly a disinflationary environment, only then to read another report explaining how we enter a stagflation period.
And what about forecasts and expectations / projections about the next few months?
Yes, clearly the US numbers are soft and the GDP has been revised lower, while at the same time inflation expectations are higher in the Euro-zone as well as the GDP projections. But could the Q1 results in the US be like this because of the very bad weather conditions and the LA port strikes? Is it going to pick up during Q2? And in the Euro-zone let’s not forget that they are committed to an important size QE that is going to last for a couple of years at least.
This “confusion” and uncertainty regarding fundamentals is clearly shown in the fluctuations of prices and we haven’t even mentioned the distortion that the Central Banks have caused in the markets! The correlations that work on Monday, don’t work on Tuesday and they work again on Wednesday! I have one simple question: where exactly are we on the business cycle? It’s hard to say, isn’t it?
So where do we go from here? Aren’t there any opportunities right now?
Of course there are! But it is a tough environment for traditional fundamental and valuation methodologies and this is attributed mainly to the impact caused by central banks.
We have to become more flexible and open minded and track the flows and the search for liquidity! We have to follow the business stories and their possible impact in the marketplace, that’s how we will uncover opportunities.
This is what I think could be interesting over the next few months:
Trading Bonds, Equities & Forex
I follow the story of the successful launch of the Shanghai – Hong Kong Stock Connect back in autumn 2014. We are also going to have another launch of the Shenzhen-Hong Kong Stock Connect in the second part of 2015.
Furthermore, besides the Shanghai – Taiwan Stock Connect, the Taiwan Exchange is also planning to connect with other markets: we are going to have a connection between Taiwan – Singapore on the 1st of July 2015. They are also in talks with Tokyo and with LSE to enhance market access.
What is the impact of all of the above?
The TWSE is up 3.3% since the 21st of April, led mostly by banks, insurers and brokers. Foreign buying in equities, in Taiwan, has risen to three year highs. I also believe that valuations are still rather “cheap” as the forward P/E ratio is one standard deviation below its five year average.
I will remain in the same region and discuss the ishares China Large-Cap (FXI). Currently there is a correction underway and many argue that there is going to be more trouble ahead given the current state of China’s economy.
But I read in the WSJ (http://www.wsj.com/articles/china-prepares-mergers-for-big-state-owned-enterprises-1426053543) that China plans to merge and cut the numbers of central SOE’S from 112 to just 40.
Someone is going to make lots of money and I assure you there will be demand for Chinese equities!
The above stories that I mention provide a much more stronger conviction to me than trying to understand if the US equities have topped or not, or wondering if we should buy European equity again at these lower levels.
Talking about the US equities, I will not try to pick a top but there could be an opportunity in the financial sector in US (symbol XLF). We see that 30y bond yields rise faster than 10y, indicating that the yield curve is steepening. If that is the case then the financials will benefit, since they make their money by borrowing short term and lending to their clients in the longer term.
The other asset class that will benefit from a potential rise in inflation is Gold. I would definitely recommend some longer term calls on GLD ETF at these levels.
Talking about commodities, there could be a rise in demand in Q2 regarding Crude Oil and there are expectations for a rise next year. Again longer term calls start to have an appeal to me.
I am extremely cautious and stay mostly flat until it is absolutely clear when is the FED going to start tightening and the likely pace of it. I could be tempted to suggest selling Bunds at appropriate resistance levels but things can change so fast, one comment from an official, a black swan event, a strong economic report and the lack of liquidity, together with the algos provide a very dangerous mix! Let us not forget that in 1998 we had a crash because of the Russian crisis and in 2010-2011 it was the Euro-zone debt situation and the Greek crisis. The same catalysts still exist nowadays!
I remember back in the glorious days of the bull market towards the end of the 90’s, there were some amazing stocks in the Athens Stock Exchange. One of them was Klonatex (Textiles) of Lanaras group of companies. At some point I think it had a bigger capitalization than Benneton itself! The swings were phenomenal, from limit down to limit up within minutes; if you used to trade NASDAQ stocks then you know what I mean!
Well, unfortunately the currency market reminds me of something like this lately.
It’s hard to have mid to longer term targets since conditions and expectations fluctuate so fast. Again the QE’s and the interventions have seriously distorted the markets.
I believe it is prudent to have shorter term targets and be more willing to take profits faster.
I see a trade, that is supported by fundamentals and has nice risk/reward characteristics and that’s going long the USDJPY, especially through the use of calls. But be warned, this Friday’s NFP numbers will definetely bring volatility in the markets. Applying a straddle strategy makes more sense at least in the short term.
Another theme is the AUD which is unjustifiable high given the fact that the Trade Balance is suffering due to the strong AUD. You cannot just rely on spikes in commodity prices. Exporters’ margins will continue to shrink, if they are going to maintain their current market share.
We can also discuss the UK elections and the awful deficit that the new government is going to inherit, as well as the NFP numbers that come out this week and they are very important.
Because these events are important market catalysts we will provide further insight after these events when the situation is clearer.