Friday, September 2, 2016

Jim Grant on Rates and Moral Hazard.

Nice interview below with Jim Grant of Grant's Interest Rate Observer. He's refreshingly old school and heavily erudite on rates and moral hazard.

James Grant, Wall Street expert and editor of the investment newsletter «Grant’s Interest Rate Observer», warns of a crash in sovereign debt, is puzzled over the actions of the Swiss National Bank and bets on gold.

From multi-billion bond buying programs to negative interest rates and probably soon helicopter money: Around the globe, central bankers are experimenting with ever more extreme measures to stimulate the sluggish economy. This will end in tears, believes James Grant. The sharp thinking editor of the iconic Wall Street newsletter «Grant’s Interest Rate Observer» is one of the most ardent critics when it comes to super easy monetary policy. Highly proficient in financial history, Mr. Grant warns of today’s reckless hunt for yield and spots one of the biggest risks in government debt. He’s also scratching his head over the massive investments which the Swiss National Bank undertakes in the US stock market.
Jim, for more than three decades Grant’s has been observing interest rates. Is there anything left to be observed with rates this low?
Interest rates may be almost invisible but there is still plenty to observe. I observe that they are shrinking and that the shrinkage is causing a lot of turmoil because people in need of income are in full hot pursuit of what little of yields remains.
What are the consequences of that?
It reminds me of the great Victorian English journalist Walter Bagehot. He once said that John Law can stand anything but he can’t stand 2%, meaning that very low interest rates induced speculation and reckless investing and misallocation of capital. So I think Bagehot’s epigraph is very timely today.
John Law was mainly responsible for the great Mississippi bubble which caused a chaotic economic collapse in France in the early 18th century. How is the story going to end this time?
It will turn out to be very bad for many people. If Swiss insurance and reinsurance executives are reading this right now they might be rolling their eyes and they might be frustrated to hear an American scolding from a distance of 3000 miles about the risk of chasing yield. After all, if you’re in the business of matching long term liabilities with long term assets you have little choice but to wish for a better, more sensible world. But you have to take the world as it is and today’s world is barren of interest income. The fact is, that these are very risk fraught times.
Where do you see the biggest risks?
Sovereign debt is my nomination for the number one overvalued market around the world. You are earning nothing or less than nothing for the privilege of lending your money to a government that has pledged to depreciate the currency that you’re investing in. The central banks of the world are striving to achieve a rate of inflation of 2% or more and you are lending certainly at much less than 2% and in many  cases at less than nominal 0%. The experience of losing money is common in investing. But where is the certitude of loss even before your check clears? That’s the situation with sovereign debt right now.
On a worldwide basis, more than a third of sovereign debt is already yielding less than zero percent.
There is not quite a bestseller, but a very substantial book called «The History of Interest Rates». It was written by Sidney Homer and Richard Sylla. Sidney Homer is no longer with us, but Richard Sylla is alive and well at New York University. So I called him and said: « Richard, I’ve read many pages but not every single page in your book which traces the history of interest rates from 3000 BC to the present. Have you ever come across negative bond yields?» He said no and I thought that would be kind of a major news scoop: For the first time in at least 5000 years we have driven interest rates below the zero marker. I thought that was an exceptional piece of intelligence. But I notice however that nobody seems to have picked up on it.
It’s now already two years ago since the ECB was the first major central bank to introduce negative rates.
There are some other historical settings: In Europe, ??Monte dei Paschi di Siena, this 500 and plus year old bank in Italy, is struggling and as broke as you can be without being legally broke. Monte dei Paschi has survived for half a millennium and now it is on the ropes. Meanwhile, the Bank of England is doing things today that it has never done in its history which is 300 plus years. So I suggest that these are at least interesting times and in many respects unprecedented ones.
So what’s the true meaning of all this?
In finance, mostly nothing is ever new. Human behavior doesn’t change and money is a very old institution and so are our markets. Of course, techniques evolve, but mostly nothing is really new. However, with respect to interest rates and monetary policy we are truly breaking new ground.
Now central bankers are even talking openly about helicopter money. Will they really go for it?
I already hear the telltale of beating rotor blades in the sky. I also hear the tom-toms of fiscal policy being pounded. There seems to be some kind of a growing consensus that monetary policy has done what it can do and that what me must do now – so say the «wise ones» – is to tax and spend and spend and spend. That seems to be the new big idea in policy. In any case, it is not good for bondholders.
Interestingly, nobody seems to be talking about the growing government debt anymore. Also, budget politics are just a side note in the ongoing presidential elections.
The trouble with this election is that somebody has to win it. I have no use for Donald Trump but I have equally no use for Hillary Clinton. The point is that one of those two is going to win. That is the tragedy! So we at Grant’s regret that one of them is going to win.
The financial crisis and the weak economic recovery likely have spurred the rise of Donald Trump. Why isn’t the US economy in better shape after all those monetary programs?
I wonder how it would have been if markets had been allowed to clear and if prices had been allowed to find their own level in real estate in 2008. Central banks have intervened to quell financial panics for at least 200 years. For instance, in 1825 the bank of England lent without stint and was not – as they said – overnice about the kind of collateral. That was a very dramatic intervention. So it’s not as if we have never before seen the lender of last resort at work. But what is new is the medication of markets through this opiate of quantitative easing year after year after year following the financial crisis. I think that this kind of intervention has not only not worked but it has been very harmful. Around the world, the economies are not responding despite radical monetary measures. To some degree, I believe,  they are not recovering because of radical monetary measures.
What’s exactly the problem with the US economy?
There is another side of what we are seeing now: In America certainly the Federal Reserve and bank regulators generally are very heavy handed in their interventions. I’m sure they have every good intention. But with their regulatory charges they are suppressing the recovery in credit that takes place  in a normal economic recovery and in this particular case after a depression or after a liquidation.
Then again, a revisit of the financial crisis would be catastrophic.
The new rules with respect to financial reform have absorbed not only forests worth of paper but also the time and attention of legions of lawyers. If you talk to a banking executive what you hear is that the banks have been overwhelmed by the need to hire compliance and regulatory people. This is especially bearing on the smaller banks. I think that’s part of the story of the lackluster recovery: Monetary policy has been radically open in the creation of new credit. But it has been radically restrictive with regard to risk taking in the private world.
So what should be done to get the economy back on track?
There are guides in history on how to do this. For more than a hundred years in Britain, in the United States and probably as well in Switzerland, the owners of the equity of a bank themselves were responsible for the solvency of the bank. If the bank became impaired or insolvent they had to stump up more capital to pay off the liability holders, including the depositors. But over the past hundred years collective responsibility in banking has gradually replaced individual responsibility. The government, with the introduction of deposit insurance, new regulations and interventions has superseded the old doctrine of the responsibility of the owners of a property. That’s why I think we need to go away from government intervention and go more towards market oriented solutions such as the old doctrine of responsibility of the bank owners.
At least in the US, the Fed is trying to go back to a more normal monetary policy. Do you think Fed chief Janet Yellen will make the case for another rate hike at the Jackson Hole meeting next week?
Janet Yellen is by no means an impulsive person. According to the « Wall Street Journal», she arrives for a flight at the airport hours early – and that’s plural! So this is a most deliberative and risk averse person. Also, as a labor economist, she’s a most empathetic person. She believes what most interventionist minded economists believe: They have very little faith in the institution of markets and they don’t believe that the price mechanism is anything special. They want to normalize rates and yet they can always find an excuse for not doing so. We have been hearing for years now that the next time, the next quarter, the next fiscal year they will act. So I believe what I’m seeing: None of these days the Federal Funds Rate will go higher than 0.5%. I can’t see that happening.
Wall Street seems to think along the same lines. So far, many investors don’t take the renewed chatter of a rate hike too seriously.
The Fed is now hostage to Wall Street. If the stock market pulls back a few percent the Fed becomes frightened. In a way I suppose, the Fed is justified in that belief because it is responsible to a great degree for the elevation of financial asset values. Real estate cap rates are very low, price-earnings-ratios of stocks  are very high and interest rates are extremely low. One can’t be certain about cause and effect. But it seems to me that the central banks of the world are responsible for a great deal of this levitation in values. So perhaps they feel some responsibility for letting the world down easy in a bear market. It has come to a point where the Fed is virtually a hostage of the financial markets. When they sputter, let alone fall, the Fed frets and steps in.
Obviously, the financial markets like this cautious mindset of the Fed. Earlier this week, US stocks climbed to another record high.
Isn’t that a funny thing? The stock market is at record highs and the bond market is acting as if this were the Great Depression. Meanwhile, the Swiss National Bank is buying a great deal of American equity.
Indeed, according to the latest SEC filings the SNB’s portfolio of US stocks has grown to more than $60 billion.
Yes, they own a lot of everything. Let us consider how they get the money for that: They create Swiss francs from the thin alpine air where the Swiss money grows. Then they buy Euros and translate them into Dollars. So far nobody’s raised a sweat. All this is done with a tab of a computer key. And then the SNB calls its friendly broker – I guess UBS – and buys the ears off of the US stock exchange. All of it with money that didn’t exist. That too, is something a little bit new.
Other central banks, too, have become big buyers in the global securities markets. Basically, it all started with the QE-programs of the Federal Reserve.
It is a truism that central banks do this. They’ve done this of course for generations. But there is something especially vivid about the Swiss National Bank’s purchases of billions of Dollars of American equity. These are actual profit making, substantial corporations in the S&P 500. So the SNB is piling up big positions in them with money that really comes from nothing. That’s a little bit of an existential head scratcher, isn’t?
So what are investors supposed to do in these bizarre financial markets?
I’m very bullish on gold and I’m very bullish on gold mining shares. That’s because I think that the world will lose faith in the PhD standard in monetary management. Gold is by no means the best investment. Gold is money and money is sterile, as Aristotle would remind us. It does not pay dividends or earn income. So keep in mind that gold is not a conventional investment. That’s why I don’t want to suggest that it is the one and only thing that people should have their money in. But to me, gold is a very timely way to invest in monetary disorder.

Article Link 

Tuesday, August 2, 2016

German Bund Safe Haven Trade Showing Elevated Risk of a Size Unwind

So I'm crunching numbers with my quant testing and portfolio management engine Trading Blox Builder II. Im testing a cool idea on a US Equity ETF program with TBlox doing a brute force number crunch. I've got an hour of time to kill and a thought pops in my head:

Italian banks are gasping for air.  Note the ascending cone price formation in the MSCI Italian index. This shows increasing volatility.

And its trend following kryptonite. Higher highs then lower lows. Yuk. 

So how go German banks?

Nicht so gut.

Here's Deutsche Bank. Note the 13 year support trend line break.

(For more German banking detritus, you can see Commerzbank here.)

That's a whole lotta technical ugly goin' on from bellwether DB. Without being ZeroHistrionic, it's more-than-faintly Bear Stearns-ish. I remember it well. Lived right through that running our fund.

Could get a little bumpy for giddy US stocks.

I don't have BBerg access for quotes on German CoCo bonds, but they are quite the brilliant  shade of leading indicator canary yellow. They are a useful carbide lamp to illuminate this unfolding systemic stressor.

And finally we reach the title of this post in a scenic preambulatory thoroghfare.

The 2yr Bund stages a sharp rally:

Note the two prior sharp, fast bear rallies which immediately stalled.

The slope of this rally is still strong, but less sharp a short pop 'n drop move. Second, note the key resistance trend line. Break it and higher odds of an unwind is underway.

The issue is the ill's of Deutsche Bank and the cost to the German economy/Bundesbank to bail the financial Hindenberg.

Coupled this with the institutionalized, common sense, and conventional wisdom of the Bund safe haven trade. Which has been in play for a number of years now.

Its the EU's US Treasury. Kind of.

Until its not.

The ills of DB and Commerzbank coupled with the Bund's One Way, Flight-To-Quality trade

Quite the deadwood tinder pile.

And I smell smoke.

Thursday, July 28, 2016

Is High Beta Finally Ready to Outperform Low Beta?

The past year has been very difficult for momentum investors. There’s an old trading aphorism – “markets can scare you out or wear you out.” We’ve had the pleasure of both from June 2015 to the first part of July 2016.

And this had a profoundly negative impact on high relative strength stocks. High RS thrives in periods of low volatility. And it does quite poorly in markets like the buzz saw above.

Back in late May, put out a great study. They took Fama/French volatility data and compared the highest decile beta to the lowest decile. They found over the past year high beta lost 30% while low beta gained 10%. That’s a 40% spread against high beta.

That is the definition of a gale force headwind. It’s also stealth bear market for high RS stocks.

And at the worst of the dual nadirs above, the S&P 500 declined just a third of that huge -40% spread.  Stealth indeed!

But times are changing.

First, we’ve just seen a 15 year extreme. For perspective: we’re already in the basement - not the roof and climbing the chimney.

Second, the relationship between high and low beta nears important inflection points.

The Fama/French data comes with a lag so let’s look at a couple of high/low beta SP500 ETF’s: SPLV (low) and SPHB (high).

The following chart has three panels. The top shows a closing line chart of the high vol ETF. The middle shows a closing line chart of low vol. The bottom panel is the ratio between the two: high/low (down means low beta outperforms).

Point 1: Notice the February low in high beta. Notice the current July low is higher. This is a negative divergence for low beta. Despite low beta making a price high in late June, the ratio between the two did not make a new low like February. This shows faltering low beta nonperformance. Momentum slows.

Point 2 shows the ratio bumping up against a key 14-month resistance trend line. It remains intact. Trend favors low beta.

But the ratio has touched it three times in six months after going a full year without hitting it. Momentum slows.
Point three and four show key support and resistance trend lines for the ETF’s themselves. Note high beta point 4 especially. It is a huge complex head and shoulders bottom covering two years of long term high beta under-performance.

When price breaks above that line, I expect a sharp move back into high beta. This bodes well for high relative strength momentum stocks.

So stick with the current trend favoring lo-vol. But note the lessening momentum behind the trend and the power built up behind the technical bottom pattern if/when it breaks. 

I’ll update as conditions warrant.  

Wednesday, July 13, 2016

Amazon Jeff Bezos Gloating Magazine Cover: Hubris Risk

I wrote about the importance of emotional magazine covers as societal abreaction events here. It was subsequently published by the Market Technicians Association in their monthly journal "Technically Speaking."

Yesterday, I saw this:


One of the great Slip 'n Slides of human existence.

This is an emotionally charged cover on a major tabloid. Big letters with the words Conquer and PRIME. Huge smile from Dr Evil. It's all there. We're only missing a .wav file of his proprietary laugh.

It reminds me of another cover back in 2013 - a cover from Time on Carl Icahn as "Master of the Universe."

No smile from Carl, though. He masked NYC dour arrogance instead.

I wrote about it when I saw it here and here.  Go take a look.

And the long term result?

IEP was in a parabolic blowoff pattern when the cover appeared.  It was closing on a 150% gain from its $40-$50 dollar two year (Mar 2010-Dec 2012) base. 

Archetypal cover.  

And now establishmentarian Bezos graces the Pillars of Pride:

The chart is different. No blowoff. 

The trend is up on the recent, low volume all-time new high breakout. Earnings come due July 28 aftermarket - about a week away. 

Tactically, I'd scale back my position risk anyway ahead of the binary earnings event.  With the cover, I'd probably take a little more off the top. 

A blowoff move catalyst for AMZN - like IEP - may be this report. A big gap higher on positive earnings I'd use as as a "gift" sell signal.  

Here is a trend following supportive sell tactic. 

Use a close below the 7 day exponential average to sell. Check the stock price through the last half hour for a break confirmation to sell same day. Or let price close below the 7 day ea and sell on the next day's open.

If the stock suffers a large gap down, the cover likely coincided with an abreactive top. Thus, my suggestion of reducing position size a bit more than usual ahead of the release.  

I'll update next week.  

Monday, July 11, 2016

Boom! All Time New High with Day 2 Follow-Through in the SPX

I wrote this educational article on the importance of the all time high, whipsaw and systematic trend following. I detailed in a real trade of DDD.

I provide the link above for my readers to reacquaint themselves with these importance concepts. 

The US equity markets last 18 months is filled with whipsaw. 

Right now, the S&P 500 has broken out of a long term consolidation to a new all time high despite the EU upheaval over Brexit, the Italian Banking System

This is what Bini Smaghi, the chairman of Societe Generale, said last week:
Italy’s banking crisis could spread to the rest of Europe, and rules limiting state aid to lenders should be reconsidered to prevent greater upheaval, Societe Generale SA Chairman Lorenzo Bini Smaghi said.
“The whole banking market is under pressure,” the former European Central Bank executive board member said in an interview with Bloomberg Television on Wednesday. “We adopted rules on public money; these rules must be assessed in a market that has a potential crisis to decide whether some suspension needs to be applied.”

and the woes of systemically important Deutsche Bank inextricably tied to those Italian banks through a web of counterparty derivatives contracts. 

The market smells and discounts a bailout. Heck, the heads of the EU banks are now rattling the cages to scare up euros. What a far cry from 2008 when no one painted anything but the rosiest of pictures while Rome burned. 

And the U.S market is the nicest house in a run down neighborhood.

Sometimes the hardest breakouts to buy is the first all time new high...