The titles of our recent publications are below. To see them for free, please contact us!
Feb 3, 2020
Fear the fear itself. Don’t you worry? But there are magic financial pills for the coronavirus – easier monetary policy. Since the GFC, monetary policy has been the omnipotent prescription to cure all economic and geopolitical ills – QE1, QE2, operation twist, QE3, global QE, and most recently, “Not QE” balance sheet expansion. European sovereign crisis? Brexit? Trade war with China? Falling stock prices? Repo disruption? Global pandemic concerns? No problem. Easing monetary policies cure them all. No wonder, BOJ’s Kuroda once declared that central bankers are magic people.
Since October 2019, the Fed has put interest rate policy on hold and assured investors that it was a “mid-cycle” insurance cut with a goal to extend the current business cycle. Since the beginning of the year, we have been biased towards lower rates. Two weeks ago, we specifically recommended long US rates either through delta one or option strategies to hedge risk exposure. We still like these positions, though we now suggest booking some partial profits for those who have benefited from the positions. We now recommend rotating some of those positions...
Jan 27, 2020
Over the past week, the outbreak of the CoronaVirus has become the focus of markets. While we continue to believe that the Fed’s liquidity provisions and economic fundamentals remain the key drivers of capital markets, we think we may start to experience some market volatility out of pandemic fears, albeit for a brief period of time. During the Ebola outbreak in the fall of 2014, the S&P 500 dropped around 10%. .
The macro backdrop of the Ebola episode in fall 2014 was quite different from today. At the time, economic developments were generally positive and the Fed was about to end QE. The S&P 500 Index was plateauing in anticipation of the withdrawal of Fed liquidity. The market was vulnerable and Ebola fears provided a perfect catalyst...
The Raven of Zurich
Jan 20, 2020
...In 1996, former Fed Chair Alan Greenspan delivered a famous speech on “Irrational Exuberance”, warning against stock speculation. Afterwards, the S&P 500 more than doubled and NASDAQ composite roughly tripled before the peak in year 2000. In 1926, seventy years before Greenspan’s famous speech, Felix Somary, Austrian-Swiss political economist and banker, warned that a stock crash would come because of the “gap of appearance and reality,” while internationally renowned economist John Maynard Keynes disagreed, believing that a “crash will never come in our time” because of the efficacy of cheap money. Somary was wrong and Keynes was right… for two years. From the beginning of 1927 to the peak of the US stock market in 1929, the Dow Jones Industrial Index went up more than 150%. Somary’s dire prediction was later vindicated as the Dow Jones index would peak in the fall of 1929, dropping 90% in the following three years, earning him the name “Raven of Zurich”....
Riding the Liauidity Wave
Jan 13, 2020
...we think stocks will continue to be supported very possibly through April 15th because of continued liquidity provisions from the Fed and other global central banks. However, the ascending slope will not be as steep as we saw in Q4 last year because the liquidity growth rate is decreasing. We don’t have clear visibility beyond Q2, as we need to see the economic data pick up and catch up with financial assets for a more sustainable reflation cycle. In the absence of a pickup of the data, and if there is a withdrawal of liquidity this spring, it is highly likely that we will recommend derisking strategies and hedging strategies. Please reach out to us for a discussion.
However, in the very short-term (next 1-2 weeks), we think the likelihood to a short-term pullback is very high given the following reasons: 1. Overly optimistic investor sentiments and positioning. 2. Reduced liquidity provisions. 3. Corporate entering buyback blackout. We would advise investors to scale out of overweights to risk assets to be more neutral until the spring to be better positioned for the bifurcated risks....."
Dec 20, 2019
We take a look at long term petroleum projections, and the evolving electric vehicle market. And we find some very interesting marks for Private Equity valuations.
No Falling Angels Allowed
Dec 8, 2019
Since the GFC, US corporations have emerged as the largest buyers of their own shares, driving equity outperformance. Therefore, it is critical to have a forward-looking view on corporate buybacks. Back in fall 2018, we predicted that corporate buybacks could be peaking, and it seems that we may be proved right.
Why this is important? According to Federal Reserve Board Flow of Funds data, US buyback activity is the dominant driving force of this bull market, followed distantly by small foreign demand – refer to the chart below. Household and other domestic entities are net sellers of stocks rather than buyers. If corporate buyback activities have indeed peaked, the longer-term implications for stock market are negative. Note the last peak in corporate buybacks was in 2007, one year before the GFC.
Our peak corporate buybacks thesis last year remains intact due to the following reasons...
Reminiscences of year 1999-2000
Nov 17, 2019
Readers are probably familiar with various comparisons of our current market status vs. history. Many compared our current period of asset valuation, leverage and income inequality to that of 1929, while Ray Dalio at Bridgewater thinks that our current period is most analogous to that of 1937. Others find similarities between the extended period of low inflation today with the 1960s as precursors to the roaring inflation in 1970s. We agree with some of those observations. We also find some remarkable resemblances to the market cycle of the late 1990s.
To be sure, we are not saying that capital market behavior will repeat exactly. As the cliché goes, “The past does not repeat itself, but it rhymes.” However, we think it is the symptoms that rhyme, while the reaction functions between the market, economy and fiscal/monetary authorities always repeat themselves.
Our current economic cycle is now the longest in US history, followed by the one in 1990s, which lasted 120 months. Between the two cycles, we find that the macro backdrops are very similar.
Taxes and Capital Markets
Nov 10, 2019
As the Democratic candidates begin stumping in Iowa, this is a good time to begin considering the different fiscal issues that are likely to impact the investment landscape. This is the first of several articles we have planned discussing taxes and fiscal policy and the impact on capital markets.
But before we discuss fiscal impacts, let’s take a moment to acknowledge the historical nature of the polarization in the political landscape, especially across age. The Boomer generation, with their high voter participation rate but declining numbers, is increasingly facing off versus the Millennials and Gen-Xers, whose participation rates have spiked. In fact, the 2018 midterms was the first election whereby the younger generation outvoted the Boomers and older generations, according to the Pew Research Center.
The anti-ageism sentiment by the younger cohorts is now pervasive enough that it has its own meme...
Nov 2, 2019
As stocks and risky assets continue to rally despite decelerating economic growth and falling earnings, we acknowledge the frustrations of many market participants. We can trade rates, stocks, currencies and commodities, but cannot trade GDP. Our readers and clients know that our framework is built upon the three-way interaction between capital market, economic development and monetary/fiscal activism. From our perspective, asset price action has been broadly in line with our expectations, with equity risk premiums reflecting falling growth expectations.
.Our readers and clients know that we have tilted towards a reflationary scenario for a while, as our report noted that “We think there is a decent chance for risk asset prices to break to the upside next week….” Sure enough, S&P 500 broke out on the first day of the week.
This week, we will examine whether various asset prices confirm the reflationary hypothesis.
Oct 27, 2019
Our clients have often asked how we were able to predict the peak in US growth rates in the summer of 2018 and the subsequent sell off in the equity markets. Like everyone else, we don’t have a crystal ball. However, we do have a systematic framework utilizing an array of leading economic indicators and asset price patterns that paints a mosaic on where we stand. Most of our readers know that our framework is based on the three-way relationship between economic development, asset prices and fiscal/monetary authorities. We start by understanding the messages conveyed by the asset prices. Today, we will share some of our charts in volatility space.
The chart below calculates the daily z-score (3y rolling window) for the VIX (SP 500 implied vol), CVIX ((currency implied vol) and Move Index ( interest rate implied vol). What stands out is the upward trend and still elevated level of Move Index (+ 0.7 sigma above mean), reflecting uncertainty around growth expectations, while stock implied vol ( -0.4 sigma below mean), indicating the easing monetary expectations have stabilized stock markets. The currency implied vol is 1.35 sigma below mean), consistent with the global synchronized slowdown and central bank reactions thus far.
A Note on Hong Kong
Oct 21, 2019
We can understand why investors may be worried about the situation in Hong Kong given that the current protests, which started on March 31st this year, is the longest since Hong Kong’s return to China and shows no signs of ending. It appears to be getting more violent. More importantly, this is occurring alongside an acrimonious trade war between the two largest economies in the world, with the weakest economic growth in China in 3 decades, and the worst economic and political relationship between Washington and Beijing in past two decades. No wonder that two months ago, Steve Eisman, the investor of “Big Short” fame, said on CNBC that this could be a black swan event. Many China bears are getting very excited with the catalysts, especially those wagering on the de-pegging of Hong Kong Dollar.
But before we dive into this topic, we would like to share a story. Back in 2012, I interviewed several well-known hedge fund managers who had successfully bet on the US subprime crisis. I asked them about their views on the depreciation of the Chinese RMB as a result of the credit binge post Great Recession..
Oct 14th, 2019
FOMO – aka fear of missing out, is not a feeling that is unique to retail investors. It is also a predictable institutional behavior based on the institutional setups common in our investment industry – fund managers have a strong need to generate alpha vs. relative benchmarks or absolute returns by year-end. At stake are not only the year-end bonuses, but job security or even the firms’ survival.
It is not surprising that investors are bearishly positioned for seemingly the right reasons: 1. Weak global economic growth outlook with real risks of recession. 2. Trade wars. 3. Brexit risks 4. Presidential impeachment and socialist democratic presidential candidates. The list goes on.
The chart below shows SP 500 index (blue line) and the differential between AAII US investors’ bullish sentiment readings vs bearish readings (green line). The gap shows that investors are as pessimistic as we saw in late December 2018 when stocks bottomed out...
Not Decision Time Yet
Oct 6th, 2019
Most of our friends and clients know that while we recognize the importance of talent, investment process and risk management, we believe that the starting point of a successful investment is the institutional setup... Why is this relevant now? We currently see great opportunities that can only be capitalized by long-term patient investors. While others complain about the market distortions created by central bank policy, we are thankful because the central banks have created these opportunities with great risk/reward asymmetry.
We have discussed previously that we are in the classical stage one period of an economic growth slowdown: financial assets rally, supported by central banks’ easing measures (announced and expected) in reaction to the economic growth slowdown. We have shared with our readers and clients before, while our numerous leading indicators continue point to the downside of economic growth momentum, we nonetheless see some emerging signs of reflation, which is yet to be confirmed. We are open-minded to either scenario. In the past few reports, we have shared many of the indicators that we watch. We think we will get better clarity in weeks ahead. Did the poor ISM data release this week US tilt our view one way or another?
A Crossroad for Inflation
Sept 29th, 2019
Since we published our report on emerging signs of reflation two weeks ago, we have received many questions regarding our outlook on inflation. This topic is very timely. Following the highly inflationary period in the 1970s, central banks learned to get ahead of inflation once economic growth is at full capacity – as the cliché goes “ ..to take away the punch bowl just as the party gets going..”. After a decade of quantitative easing with NIRP and ZIRP (negative and zero interest rates), inflation continues to be muted. As a result, central banks’ reaction functions have been quietly changing – they are increasingly willing to tolerate higher inflation for a longer period of time. More importantly, it is has become consensus that fiscal measures need to take the front seat as monetary ammunition has been exhausted. We have said that we have no doubt that upon next downturn, fiscal measures will be launched and will be monetized by central banks – MP3 (monetary policy 3.0) per Bridgewater, MMT (modern monetary theory) per Stephanie Kelton or fiscal monetary policy coordination per central bank verbiage, planting the seeds for an inflationary period to come.
A risk to this view is that we don’t need an economic downturn to launch MMT. We are already starting to take the incremental steps. If indeed there is a long-term inflationary regime shift, we believe that there will be far-reaching implications for portfolio construction and probably for the entire asset management framework based on static asset allocation...
The Status of the Market
Sept 21st, 2019
Unlike those with developed narratives who fit the data to their outlook, we look at all relevant economic and financial data and try to put the puzzle together to get an evolving picture of the market status. The message from the market prices of various asset classes and economic indicators may or may not agree with each other. When they don’t, they provoke our thinking and often lead to differentiated insights. We are neither bulls nor bears, we simply want to be in sync with the market. We don’t argue that the market is right or wrong. Rather, we accept it as is. We simply want to be one step ahead of the next stage of market development and be in sync. Unlike those who have deterministic views on the “outcome” and “eventuality” of asset prices, we have probability assessments on potential direction and magnitude of the movement of asset prices. They are path dependent based on the three-way reaction function between capital markets, economic development and government policies. Where do we stand now?
We shared with our clients and readers recently that we have identified some emerging signs of reflation (please refer to our last weekly report for further details). However, we highlighted in same report that these reflation signs are not confirmed yet and we are not ready to make the call for another reflation period at the current juncture. On the contrary, most of our leading economic indicators continue to point to the downside.
Emerging Signs of Reflation
Sept 15th, 2019
When facts change, it is too late to change. What do you do sir?
Many quote “when facts change, I change, what do you do sir?” when they adjust their positions after facing losses. We believe that change is the only constant thing in capital markets, where the so-called “equilibrium” is a constant moving target. It is no surprise for most investors that when you see facts change, your PnL (or relative performance vs. benchmark) is already in the red. As Jesse Livermore used to say, narratives follow market prices, not the other way around.
James Grant once said that “successful investing is having everyone agree with you….later.” Our hard-learned lessons taught us that “successful investing is having everyone agree with you….tomorrow.” We believe that to be successful, investors need to be one step ahead of others, but not two steps. If we can help our clients be one step ahead of others, we will have accomplished our mission. To do this, we have built an investment process by systemizing our past lessons. While we recognize some validity of the claim that “financial assets are forward discounting mechanism”, what drives our framework is the three-way reinforcing feedback loop of asset prices, economic/fundamental and fiscal/monetary policies. Late summer of last year, we saw the peak of growth and stock markets, while the mainstream narrative was still on “global synchronized growth” Today, recession talk is the consensus narrative, while we see emerging signs of potential reflation.
Diminishing Policy Choices: a Case Study of Japan
Sept 7th, 2019
In this Weekly report, we wanted to highlight our thematic report, “Diminishing Policy Choices and the Implications, A Case Study of Japan”.
As the monetary policy ammunition is running out across the globe, we think global central banks will eventually cut interest rates further into negative territory and after that start purchases of risky assets such as equities and REITs. Ultimately, fiscal measures will have to be launched upon the next downturn, and since global leverage is at all time highs, fiscal stimuli have to be underwritten by central banks - i.e. fiscal and monetary policy coordination.
Our case study in Japan indicates that further large scale asset purchases, including stocks, may not be enough to compress the risk premium of equities unless done in a global fashion. We acknowledge that Japan has chronical demographic headwinds, which is also true in Europe and many Asian countries such as South Korea and China. We recognize that in a world of free capital flows, the effects of any country’s monetary stimulus are global rather than local and local assets will benefit more from such stimulus, which explains why Japanese REITs have been more responsive to BoJ’s asset purchases than Japanese equities. It is no surprise that in countries with closed capital accounts like China, the stimulus will have a large response from domestic asset markets. Therefore we argue that to support global equity markets, a synchronized and coordinated large scale asset purchase program of shares may be needed upon next downturn...
Art of Deal – Win the War Without a Fight
Sept 2nd, 2019
“It is nice to win 100% of the battles, but the ideal is to win the war without a single fight.”Sun Tzu, the ancient Chinese military strategist believed that wars are suboptimal ways to defeat opponents, because your strength will be weakened even if you win all the battles and you’ll be more vulnerable to other threats. President Trump, the author of “the Art of Deal”, seems to strongly disagree. He famously declared that a “trade war is easy to win”.
In this report, we offered our thoughts on the trade war - both long term and short-term. we pointed out that "in the short-run, unlike the consensus view that the trade war will escalate immediately to a new level, we think that both Trump and China have an incentive to ease the tensions"
We highlighted key risk events in September and why this month is critical. We recommended fast money traders to buy calls on equities to position for a breakout to the upside and to take gains or short safe haven assets such as long-dated treasuries, gold and Yen.
From J-Hole to B-Hole
August 26th, 2019
Today, President Trump asked the same question, “… who is our bigger enemy, Jay Powell or Chairman Xi?” This basically lays bare the intention to escalate the trade war – to create enough trade headwinds so that Fed can cut rates aggressively and start QE as he demanded. On the one hand, he can show how strong he is to take on China and on the other hand, he gets significant monetary stimulus ahead of the election – indeed one stone kills two birds. It is no coincidence that Trump announced recent trade escalation measures on July 31st - one day after last FOMC meeting, which Trump lambasted for not delivering enough stimulus. We wrote last week that the 80 point drop of the S&P 500 tested the pain threshold of Trump as he started to walk back from the escalation and showed a willingness to re-engage in negotiations with “personal friend, Xi”. This Friday morning, he was watching carefully whether this is the pain threshold for Jay Powell – “Now the Fed can show their stuff!” he tweeted right before the speech of Chairman Powell at Jackson Hole, eagerly expecting some big announcement. Right after Powell’s speech, he released a series of angry tweets, promising further trade escalation measures.
Fight the Fed
August 19th, 2019
Before we dive into current market discussions, it is helpful to have a big picture and review our framework on cycles. In our thematic report “Navigating the End of Market Cycle," we pointed out that “we are in a rare period when some major cycles are near inflection points: the 1-3 year mini-reflation cycle, 5-10 economic (market) cycle, 50-100 years inflation cycle.”
Will central banks be able to re-engineer another 1-3 year reflation cycle? We have argued that it is more difficult this time around given the following reasons:
Navigating the End of the Cycle
“History doesn't repeat itself, but it often rhymes,” says Mark Twain. In our framework, the mechanism of cause and effects of the law of economics always repeats itself, what rhymes are the symptoms. We believe that we are in a rare period of time when some major cycles are converging for inflections: 1-3 year mini-reflation cycle, 5-10 economic (market) cycle, 50-100 years of inflation cycle. While driving on the highway, we never realize that the earth is a sphere – similarly, as we monitor capital markets and economic development day-to-day and month-to-month, we may forget where we are in the cycle. The transition of different stages of cycles are a process, rather than an exact moment or point and the evolution process is path dependent. History always happens in a non-linear fashion (whether in capital markets or in geopolitics), as Vladimir Lenin points out that “There are decades where nothing happens; and there are weeks where decades happen.”