Weekly Observations: Central Bankers as Gamemasters

Blocknote-2

An excerpt from a week’s journal:

20 August 2018: Observations & Thoughts

Today was generally a risk-on environment, with Chinese equity indexes leading the way in Asia Pacific (Japan and South Korea lagged). Indian equities continued to climb higher.

The Yuan has also somewhat stabilised and has strengthened against the USD since last week. Chinese bond markets also had a good session today.

European bourses also opened in the green, with the DAX and France’s CAC 40 Index leading. As of the time of writing, the US indexes have opened slightly up.

I found it interesting that CLSA did some coverage on Chinese property stocks in their August report.

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They believe that a rerating has not happened because the markets are concerned over change in policy. This was released early-August, and it seems that Beijing is still keeping cooling measures in place for certain tier 1 cities on the mainland.

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Some of the players look interesting at current prices and they have been down quite a lot from their highs this year. I missed playing them from the short side this year, and perhaps I should take a look if there could now be buying opportunities given how valuations have improved tremendously, how terrible sentiment is, and whether or not policy-easing could come (depends on trade-tensions).

FT reported that speculators are overwhelmingly short Gold as prices of the barbarous relic has continued to fall.

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This was the reason why I held back from shorting the shiny yellow metal since it’s price fell below it’s 200-week moving average. Lopsided positioning is egging the contrarian in me, and should the Dollar turn or pull-back, a long in gold or gold-miner stocks could be a good near-term trade.

Oh, this chart from the Bank of International Settlements (BIS) pretty much summarises why EMs are now so weak with the stronger USD:

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It’s an old argument and those investors who have lived through several credit cycles are probably familiar with it. And this dynamic is reflexive in nature, meaning that it feeds on itself in a vicious or benign cycle: a stronger USD and higher risk-free rates in the US will accelerate more capital outflows from EMs and make it harder for governments and corporations to refinance and repay debt if they face asset-liability mismatches.

EM governments and corporations that are scrambling to repay and refinance also causes the demand for USD to rise, which tends to feed on itself if everyone is seeking out dollars…

What makes the situation worse this year is that the US Treasury is increasing issuance by a great deal and the Fed is in QT mode, which means there is a huge amount of USD liquidity being sucked out of the system and not enough greenbacks in offshore/ Eurodollar markets. This was the reason why I was bullish on USD for some time now.

I also read a report from the BIS a couple of years ago about how a stronger Dollar tends to lead to tighter financial conditions and slow real economic conditions in some EMs (like Indonesia). They did so via some of their internal regression studies. This implies that if the USD continues its broad-based ascent from here, we could really see a further slowdown in the real economy over the next few months (since we are already experiencing slower momentum since June).

It’s central bank watch-week as the Jackson Hole summit approaches.

2312H.

21 August 2018:

Another risk-on day in markets. Equity bourses opened in the green throughout Asia, Europe and the US sessions. The S&P 500’s VIX has fallen to 12.26 and the USD weakened broadly again.

Headline on Bloomberg today:

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LOL! From bashing the Fed to this overnight.

Markets are also starting to focus on risks stemming from the debacle in Italy.

À la Credit Suisse:

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A look at European sovereign yields over the past 3 years tells us that differentiation is now happening, with the direction Italian govt bond yields moving a lot higher in recent weeks (spreads between German Bunds have also risen a lot higher as compared to Portuguese and Spanish spreads to Bunds).

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I probably need to think and dig into this if I want to play an event trade strategy for Italy.

And Bloomberg reported that the world is in a ‘stealth bear market’ given how much the non-US equity world has literally under-performed the US:

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And it seems that the consensus is recognising this divergence.

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Hmmm.

2230H.

22 August 2018:

Today was a PH in Singapore, but market movements were relatively muted as well.

I’m tempted to go long some US Treasury bonds with yields coming down:

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The Dollar Index (DXY) continues to weaken, contributed by a rally in both Sterling and Euro.

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Heheh perhaps this is a start of a big pull-back in the DXY and if that’s true, a lot of speculative positions (long USD) have to be scaled back!

Wheat prices got smashed over the past 2 trading sessions after hitting a new high last week. I’m currently watching the price action for any potential long entry should it rebound…

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In the US equity market, retailers are generally rebounding across the board. Target (TGT) beat their 2Q results and share prices of many of them have been on an uptrend year-to-date. They include companies like Tiffany & Co, Michael Kors, Nordstrom, Ralph Lauren, etc.

Here’s Ralph Lauren:

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Turns out my suspicion on the ‘death of retail’ narrative is right. 2017 was the exact bottom of the industry as a whole and with the consensus totally hell-bent on how retail is dead. Many retailers have made efforts to revamp their business models to adapt to the times.

The industry definitely has many more challenges to surmount, but it seems that the consensus is still pretty pessimistic on prospects. I’m even more bullish on SFIX now given this development and given that the industry is enjoying a cyclical tailwind of healthy consumer spending in the US (at least for this and perhaps next year).

Interestingly, Bloomberg had this article today:

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LOL. Seems like the consensus out there is that many have given up on calling the top. And they try to explain their failure in that via various reasons and explanations that may or may not be logical.

I recall that legendary speculator Bernard Baruch once said that anyone who says that they bought at the bottom or sold at the top is a liar. Let’s face it, no one can exactly call the top or bottom in anything, and a lot of it depends on the referencing of the investment horizon too.

But this is something to monitor as well. As more and more people begin to feel less cautious and are getting their feet wet again back into equities, a top is building in the process.

Luckily, we don’t have to call the top to make our living in the financial markets – we only need to understand how market prices are a reflection of how participants price various scenarios and whether other possible scenarios are mispriced in a probabilistic fashion…

2131H.

23 August 2018:

The FOMC’s minutes of its August meeting revealed that policy-makers are still fairly confident of the US economy but are increasingly concerned over trade tensions.

The meeting summary showed that “all participants pointed to ongoing trade disagreements and proposed trade measures as an important source of uncertainty and risks. Participants observed that if a large-scale and prolonged dispute over trade policies developed, there would likely be adverse effects on business sentiment, investment spending, and employment.”

“Wide-ranging tariff increases would also reduce the purchasing power of U.S. households,” the minutes said. “Further negative effects in such a scenario could include reductions in productivity and disruptions of supply chains. Other downside risks cited included the possibility of a significant weakening in the housing sector, a sharp increase in oil prices, or a severe slowdown in [emerging market economies].”

Officials noted that “an escalation in international trade disputes was a potentially consequential downside risk for real activity. Some participants suggested that, in the event of a major escalation in trade disputes, the complex nature of trade issues, including the entire range of their effects on output and inflation, presented a challenge in determining the appropriate monetary policy response.”

The Dollar crawled back up in today’s session, strengthening against the EUR, GBP, JPY, AUD, NZD, CNY and the SGD.

Equity indexes generally opened in the green in Asia, with Singapore’s STI being one of the stronger performers today. European bourses however saw more muted gains (Italy, Spain and Portugal saw slight losses).

Just like the previous day, the consensus is increasingly noticing the divergence between the resilience of US equity indexes and the rest of the world (like EMs & European bourses). CNBC reported on it via a client note from JPMorgan:

19.pngJPMorgan thinks that the divergent trend will converge by end of the year:

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If sentiment improves because of whatever (un)expected catalyst out there, this could materialise fairly quickly.

I’m also trying to find out if Sino-US trade tensions and the ‘trade war’ narrative is increasingly priced in. It’s really difficult to quantify the effects although what I’m more certain of at this juncture is the damage to business / consumer sentiment.

I see trade war concerns on:

  • Discussion topics from government civil services
  • Charities’ newsletters
  • Religious organisations’ notices
  • A topic of conversation among the layman on the street

Bloomberg has some interesting coverage on the situation recently, claiming that China has the leverage in the situation given the sizeable commercial interests that corporate America has in the Chinese market. Additionally, firms have already diversified their supply chain and have been shifting operations across Asia to lower-wage countries like those of Southeast Asia.

Combing through the numerous sell-side reports that have covered on the topic left me with the conclusion that many are just as clueless.

À la Citi:

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This puts the possibility of a settlement/resolution come Mid-Terms on a higher probability.

Oh, and the weekly price chart of Japan’s Nikkei 225 Index looks really interesting:

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2044H.

24 August 2018:

If financial markets are just one huge den where players from everywhere gather to seek their fortune, central bankers are the gamemasters.

Thus, it behooves the players to understand what these gamemasters are thinking. It behooves them to know what the gamemasters believe about the world, what models do they use and what cards they have and will use in order to govern the game.

Players who do that will improve their odds at their spins and tables. As active investors, it’s imperative to understand what the Fed is thinking at the moment.

Bloomberg has this to say today.

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As I understood it, the article looks at how a similar analog (the late 90s) our current environment is in could be used to view how the Fed is thinking about policy-making. And the conclusion is that policy-makers should be aggressive if they are unsure about how the economy has changed structurally.

I quote:

“Stock’s 1998 paper is all about what central bankers should do in such a situation. He crunched the numbers on how various rate strategies perform when such things as the natural rate of unemployment — and the relationship between interest rates and unemployment — are unknown, possibly because they’ve changed over time.

“The results are surprising,” Stock wrote. “A monetary authority facing uncertainty about how the economy is evolving should be willing to pursue policies that are somewhat more aggressive” because such an approach “guards against the possibility that monetary policy is less effective” than a model without uncertainty would suggest.”

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“On Thursday, just ahead of Powell’s speech, the Fed published a paper on the same topic, authored by top economists at the central bank. In it, the authors warned that even though there is uncertainty about estimates of the natural rate of unemployment, it’s still better to set rates based on those estimates than to just wait for inflation to show up.”

Jerome Powell’s Jackson Hole speech tonight may indicate if this is what the Fed is thinking…

 


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