Month: September 2018

It had been a tough several years for LPs in Cripsin Odey’s hedge fund, who has for years predicted a market crash which, well, has yet to happen, and suffered dramatic losses as his predictions failed to panned out, with his flagship hedge fund plummeting in 2016 and 2017. That did not change his outlook, however, and in his latest newsletter sent earlier this month, he once again flagged his bearish views.

His funds are “positioned for more difficult times, invested in those companies that would be able to take advantage of a crisis, should it come along,” he wrote. “Who knows when that happens? As Noah said to the doubters, ‘How long can you tread water?’”

However, thanks to a correct bet on Italian bond volatility earlier in the year, The Odey European Inc. fund, which manages about $700 million, gained about 29% this year through Sep. 14, according to the latest HSBC weekly hedge fund tracker, making it the top performing hedge fund in 2018 ranked by HSBC.

And now, in a delightful irony, Odey is taking on even greater gains – on the long side of his book.

As Bloomberg rerorts, the London-based manager is one of the largest shareholders of both Sky Plc and Randgold Resources, the two-biggest gainers of the STOXX Europe 600 Index on Monday, amid a flurry of merger announcements. Randgold surged more than 6% after Canada’s Barrick Gold agreed to buy the gold miner in a $18 billion deal, while Sky surged as much as 8.8% after Comcast won the auction for the U.K. broadcaster with a bid of 17.28 pounds a share, a premium of 9% to Sky’s Friday closing price.

“I’m very pleased. It was a great price,” Odey told Bloomberg of Sky the final Sky deal in a phone interview, adding that he added to his bets when the shares traded at 14.92 pounds. Odey had previously predicted that a deal could fetch as much as 18 pounds a share.

And so, if the world really does end tomorrow, all the pain his LPs took for so many years will finally have been worth it. The only question is how many of them are left.

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Brett Kavanaugh defied his accusers on Monday when he said that he will “not be intimidated into withdrawing” his Supreme Court nomination after a second woman emerged late on Sunday with a sexual misconduct allegation against him. In a letter from Kavanaugh to Senators Chuck Grassley and Dianne Feinstein – the chairman and ranking member of the Judiciary Committee – the SCOTUS candidate said the accusations against him are “smears, pure and simple.”

“They debase our public discourse. But they are also a threat to any man or woman who wishes to serve our country. Such grotesque and obvious character assassination – if allowed to succeed -will dissuade competent and good people of all political persuasions from service,” Kavanaugh said in the letter to Grassley and Feinstein.

“I will not be intimidated into withdrawing from this process. The coordinated effort to destroy my good name will not drive me out. The vile threats of violence against my family will not drive me out. The last-minute character assassination will not succeed,” an exasperated Kavanaugh write.

He sent the letter after The New Yorker reported that Senate Democrats are investigating a sexual misconduct allegation dating back to Kavanaugh’s freshman year at Yale University, Deborah Ramirez says Kavanaugh exposed himself in front of her during a dorm party at Yale. She told The New Yorker that Kavanaugh thrust his penis in her face, causing her to touch it without her consent. The latest allegation emerged not long after Kavanaugh had faced earlier sexual assault allegations from Christine Blasey Ford, who says that at a party in the early 1980s Kavanaugh pinned her down to a bed and tried to remove her clothing.

Kavanaugh and Ford are both scheduled to testify before the Judiciary Committee on Thursday.

Earlier, president Trump said he backs Kavanaugh “all the way” and the accusations against him “totally political”, and with other republicans joining in, it appears there will be a drawn out fight over his nomination. Republcian senator Orrin Hatch said the New Yorker piece was a “smear campaign.” Sen. Lindsey Graham (R-S.C.) meanwhile said Democrats are engaged in “wholesale character assassination.”

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Authored by Christopher Cole via Artemis Capital Management,

Read Part 1: Fragility In The Market’s Medium, here…

“The post-modern volatility regime poses the question whether VIX ETNs and futures are large enough to influence the much deeper SPX options market. The existence of this dynamic would represent a self-reinforcing feedback loop with potentially dangerous repercussions.” -Artemis, “Volatility at Worlds End” March 2012 

“The wrong ‘risk-off’ event may expose a hidden liquidity gap in the short VIX complex that could unleash a monster.” – Artemis, “Volatility and Allegory of Prisoners Dilemma” October 2015 

“ The Global Short Volatility trade now represents an estimated $2+ trillion in financial engineering strategies that simultaneously exert influence over, and are influenced by, stock market volatility… Like a snake blind to the fact it is devouring its own body, the same factors that appear stabilizing can reverse into chaos.” – Artemis, “Volatility and the Alchemy of Risk, October 2017

Reflexivity in volatility has been a core focus of Artemis research for nearly a decade. The Artemis paper “Volatility at World’s End” published in 2012 contained the first of many warnings about the danger of VIX exchange traded products (see above).  More importantly, before they imploded, short-VIX ETPs ($3 billion) were the smallest constituent of the $2 trillion Global Short Volatility trade. The impact they had on global markets and market liquidity is just the canary in the coal mine.  

By now you know the story, a routine decline in equities caused a liquidity squeeze in retail-dominated short VIX products resulting in a self-reflexive spiral of buying pressure. At the end of the trading session, the VIX levered and short ETPs required more vega notional exposure than was available in the entire market, resulting in a feedback loop. The VIX registered the second largest draw up (+177%) and single largest drawdown (-43% over 5 days) in its 28-year history over a two-week span. During this wild round-trip to nowhere, the popular short VIX exchange traded products (“XIV”) were wiped out and many strategies that have consistently made money lost years of profits in an hour. 

The volatility spike in February is widely misunderstood… it was not a “volatility event” but instead a “liquidity crisis” resulting in rapid repricing of tail risk. Put simply, it was the moment where many ignorant market players learned what ‘water’ really is. During a true volatility event implied variance and demand for options increases across the board. Fixed strike and at-the-money volatility actually moved more in January (+3.5%) than it did in February (+3%). The early-February spike in VIX was driven by unprecedented demand for far out-of-the-money S&P 500 index puts, or tail options. Normally these options comprise about 10% of the VIX price, but in early February these tail risk options comprised upward of 35% of the VIX price.

Traders were not buying options because they thought volatility would increase, they were buying options because they were facing insolvency.  If you are a fish on dry land, how much will you pay for a glass of water?

Look, there has been so much talk about volatility and VIX exchange traded products lately… but that is yesterday’s news and is irrelevant.  Everyone is missing the forest from the trees… the pond from the ripples … In April, the commissioner of a major regulatory agency visited Artemis to discuss my research on short-volatility from last year. He asked whether I thought the VIX eco-system represented a systemic risk. I told him, “Forget VIX, that’s over. Done. But you should be VERY worried about how the bigger implicit short volatility trade affects liquidity in the overall market… THAT is the systemic risk.”

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The US mid-term election is fully in swing. But for market participants it is important to understand the actual expectations for results, rather than apparent expectations of “blue waves” and such. To get a handle of expectations, we can look at polls, prediction markets and betting markets (see table):

• The latest polling shows the Democrats as having a 76% to 80% chance of winning the House and the Republicans a 69% to 72% of retaining control of the Senate.
• Prediction markets have the Democrats at a less optimistic 66% to 76% for the House and the Republicans at a similar 68% to 71% for the Senate.
• Finally, betting markets have the Democrats at the less optimistic 66% to 68% range for the House and the Republicans at a much higher 82% to 87% for the Senate.

So it looks like prediction and betting markets are skewing risks to the downside for the Democrats compared to the polls for the House and they are skewing risks to the topside for the Republicans compared to polls for the Senate.

In general, expectations are for the Democrats to win the House and the Republicans to retain the Senate. This has been the case for much of the year (see FiveThirtyEight charts) and compared to the 2010 mid-term election in Obama’s first term, the Democrats advantage appears to be more stable going into the elections (see second set of line charts). Our US Economist, Lew Alexander, laid out the implications for a split Congress – no more fiscal actions, more trouble for Trump in terms of investigations and continued protectionism. So for markets, it is not too different from recent months.

Finally, as an aside, it’s fun to see what betting markets are saying as potential Presidential challengers to Trump. Kamala Harris, Elizabeth Warren and Bernie Sanders are leading the pack, followed by Mike Pence (on impeachment risk?). But there are few non-politicians entering the list – Dwayne ‘The Rock’ Johnson, the lawyer Michael Avanetti (he represents Stormy Daniels), Oprah and Jamie Dimon. The odds are small, and so this more for amusement than anything else, but it suggests a much less conventional field in coming elections.

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With the Fed set to hike rates in 48 hours, it was hardly a surprise that investor demand for today’s sale of $37 billion in 2 year paper would be lacking. However, the final result was downright ugly.

Pricing at a high yield of 2.829%, the auction tailed the When Issued 2.825% by 0.4bps, the biggest tail since April, and the highest yield since June 2008.

But it was the internals that were especially ugly, with the Bid to Cover plunging to 2.437 from 2.894 a month prior, and well below the 2.82 6 auction average. And while the Direct Bid was in line with recent auctions, at 13.40%, down from the 13.68% in August, and below the 14.7% average, it was the Indirects that were less than excited, taking only 40.0% of the $37BN for sale, the lowest since May, and leaving Dealers holding 46.6%, the highest since December 2016.

Overall, a sloppy auction which is likely the result of the imminent push higher in short-term rates which are expected to rise by 25 basis point in just two days.

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Authored by Nick Cunningham via Oilprice.com,

Are we nearing another financial crisis?

The supply-side story for oil prices is heavily skewed to the upside, with production losses from Iran and Venezuela causing a rapid tightening of the market. But the demand side of the equation is much more complex and harder to pin down.

Economists and investment banks are increasingly sounding the alarm on the global economy, raising red flags about the potential dangers ahead. Goldman Sachs and JPMorgan Chase recently suggested that a full-scale trade war would lead the steep corporate losses and a bear market for stocks.

The Trump administration just took its trade war with China to a new level, adding $200 billion worth of tariffs on imported Chinese goods. That was met with swift retaliation. Trump promised another $267 billion in tariffs are in the offing.

JPMorgan said that after scanning through more than 7,000 earnings transcripts, the topic of tariffs was widely discussed and feared. Around 35 percent of companies said tariffs were a threat to their business, JPMorgan said, as reported by Bloomberg.

But the risks don’t stop there. The Federal Reserve is steadily hiking interest rates, making borrowing more expensive around the world and upsetting a long line of currencies. The strength of the U.S. dollar has led to havoc in Argentina and Turkey, with slightly less but still significant currency turmoil in India, Indonesia, South Africa, Russia and an array of other emerging markets. Currency problems could morph into bigger debt crises, as governments struggle to repay debt, and companies and individuals get crushed by dollar-denominated liabilities.

Finally, the economic expansion is very mature, now about a decade old. Another downturn is only a matter of time. Global “synchronized growth” ended earlier this year, with emerging markets running into trouble. The U.S. is largely alone with robust GDP figures, and it is hard to believe that this rate of growth can be sustained with the expansion slowing elsewhere.

More to the point, the U.S. tax cuts in late 2017 opened up a wave of cash on the corporate sector, a steroid that will lose its efficacy, especially if it the resulting deficits result in higher interest rates or fiscal austerity down the road. To top it off, stock markets are very frothy, and already overpriced.

That sentiment is growing. “We’re not that bullish on equities anywhere globally at Morgan Stanley right now,” Jonathan Garner, chief strategist for Asia and emerging markets, told Bloomberg on September 13. “The latest move that we made on the U.S. side was to recommend reducing positions in U.S. equities.”

The icing on the cake could be high oil prices. The supply losses from Iran and Venezuela are tightening the market, draining inventories and forcing Saudi Arabia to cut into spare capacity levels. High prices could trim demand growth, but that hasn’t happened in a big way just yet. That puts the market on track for higher prices in the months ahead, which could be ill-timed if the global economy takes a turn for the worse.

The stage is set for a downturn in the next year or two. “[B]y 2020, the conditions will be ripe for a financial crisis, followed by a global recession,” Nouriel Roubini and Brunello Rosa wrote in a recent piece for Project Syndicate.

JPMorgan mostly agreed, arguing recently that another financial crisis is possible by 2020, and the lack of monetary and fiscal firepower to respond to such a crisis creates a “wildcard” on how severe the downturn might be.

Even though interest rates are rising, they are still low by historical standards and public debt held by so many governments around the world leaves little room for fiscal stimulus measures. Roubini and Rosa argue that “financial-sector bailouts will be intolerable in countries with resurgent populist movements and near-insolvent governments.”

Roubini and Rosa worry that backed against a wall, politically-endangered Trump administration might lash out against Iran in order to “wag the dog,” a scenario that would have catastrophic consequences. “By provoking a military confrontation with that country, he would trigger a stagflationary geopolitical shock not unlike the oil-price spikes of 1973, 1979, and 1990,” they argue. “Needless to say, that would make the oncoming global recession even more severe.”

The current economic indicators paint a false sense of security. The seeds are already in place for another downturn in the next year or two. A financial crisis – or even a more modest recession – would severely undercut oil demand forecasts, which have been steady and strong for several years.

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This week, the FOMC will hike 25bp and a few more Fed officials should signal their comfort with four rates hikes for this year in the dot plot. The Fed is expected to note that risks should remain balanced, with Chair Powell potentially de-emphasizing some of the downside risks – and certainly the mounting trade war tensions –  that have preoccupied markets of late.

Notably, the Fed’s Summary of Economic Projections (SEP) will for the first time contain 2021 economic and policy projections for the first time (although it is unlikely that the Fed will indicate a recession is coming). According to TD, while the 2021 economic forecasts may be closer to their longer-run values, the 2021 dots need not be, as it may take a period of mildly restrictive policy to push the economy back to its long-run equilibrium.

That said, projections that suggest Fed officials have become more cautious about the future, perhaps due to a belief that fiscal stimulus is more front-loaded than previously thought, or downside risks have become more salient, would be dovish. While some market commentary suggests this may occur, recent Fed speeches do not suggest such a shift is likely

Also of note, there will be a change in the FOMC participants, namely the addition of Vice Chair Clarida, the replacement of New York Fed President Dudley with the projections from the First Vice President at the San Francisco Fed (as Williams moved from SF to NY), which could add some volatility to the projections at this meeting, although TD Securities does not expect any of these changes to deviate too sharply from the consensus on the FOMC.

As always the market will be most focused on the dot plot. Importantly, economic forecasts barely change between end-2018 and end-2020 in the June SEP, yet the median number of hikes is four during this two-year period. That, to TD’s Priya Misra, “reflects the widespread belief on the Committee that policy needs to return to neutral, and even potentially move somewhat higher as growth remains above potential, unemployment below NAIRU, and inflation above target in 2020.” However, contrary to the prevailing dovish take post Jackson Hole, TD expects most of the 2019 and 2020 dots to suggest a tendency toward modestly outright restrictive policy relative to the longer-run dots.

In fact, a sizable majority supports hiking beyond neutral, even though the median longer-run dot could drift down to 2.75% thanks to newly added participants. This then raises the odds that the statement language is modified to suggest “policy remains somewhat accommodative.”

Some additional observations from Misra:

• The net addition of one new participant in September (add Clarida and SF Fed stand-in, lose Dudley) means the longer-run dot will move: right now the median dot is between 2.75 and 3%, as only 14 were submitted in June. (Bullard has refrained from submitting a longer-run dot for a while.) There is a slightly better-than-even chance that the median will settle at 2.75% in September, although it is a very close call. Over time, the median longer-run dot will settle at 3%. The outcomes here are fairly bimodal: dipping back down to 2.75% will be seen as modestly dovish for a market that has struggled to price the Fed hiking to its median longer-run dot; rising back to 3% would likely be seen as somewhat hawkish.
• A reading of the collection of speeches heading into the September meeting suggests that one or two 2018 dots could shift up from three hikes for this year to four. That reinforcement of the June median should primarily serve to reinforce the recent move higher in market pricing for the December meeting.
• For 2019 it would only take one dot at the median to move lower to shift the median down to two hikes for 2019 from three currently. (At least four dots at the June median would have to rise to shift the median to four hikes for 2019.) TD does not see a “strong case for the median dot in 2019 to change, but there is some chance it could drift lower — and markets would take a dovish view of that shift.”
• For 2020, there is also no compelling case for any change to the median dot: it would take two moving up to get a higher median, and three moving down to get a lower median. The 2020 dots will continue to show a sizable majority of Fed officials expect it will be appropriate to hike somewhat above neutral during this hiking cycle.
• The outlook for the 2021 dots is less certain, and may not be all that market relevant given how far they are into the future. That said, our base case is for a similar median as the 2020 dots (perhaps with a tighter range or central tendency). If some number of Fed officials think it will be necessary to tighten further to cool an overheating economy, the 2021 median dot would be higher than the 2020 one; if some number think that earlier hikes already achieved that objective and policy itself needs to revert to neutral, the 2021 median dot would be lower than the 2020 one. TD notes that the former is slightly more likely than the latter given the size of the gap between the unemployment rate and NAIRU in 2020 and the expectation that it will not close quickly in 2021.

Finally, here are the rates market implications per Misra:

The September hike is fully priced and the rates market is pricing in more than 80% odds of a December hike and about 2 hikes next year. The market is pricing in a Fed terminal rate of 2.85% and Fed pricing has moved significantly higher in recent days. Not only did the market take December hike odds from 65% in late August to 82% currently, but the market has increased the pricing for 2019 hikes from 1.5 to almost 2 hikes.

Given recent price action, our base case scenario for the Fed should result in a modest bullish reaction for Treasuries. As discussed above, we think that the trifecta of Fed communication at this meeting should reinforce a gradual hiking stance, but much of that is already priced in. Historically the market has been impacted more by the near-term dots than the long run dots. While some dots will likely move from 3 hikes in 2018 to 4 hikes, we think that this is already penciled into the 80% odds of a December hike. A shift lower in the long run dot (even though it may well be driven by just one dot) should be viewed dovishly. This should also help the curve bull steepen slightly on a tactical basis.

Note that the market is not pricing in hikes beyond neutral, which could make it vulnerable to a bear flattener if the Fed stresses an overshoot of the neutral rate. While 2021 dots will be new, the market has historically not been impacted by dots that far out. Further, the Fed has been careful about emphasizing too much on their estimate of r* itself. In fact, Chair Powell stressed the uncertainty around r* (as well as u* and y*) in his Jackson Hole address. We think that the Fed wants to downplay forward guidance that far out into the future. Thus even if the dot plot suggests an overshoot of neutral, we don’t think that it will be enough to move market pricing above r*.

Thus we remain long US rates, both outright via receiving long 5y5y swaps and against Europe (receiving in 10y US swaps versus paying in 10y Euro swaps). We also hold on to our 5s30s Treasury flattener even though we acknowledge the bull steepening risk from the Fed next week. But on a strategic basis, additional hikes should continue to exert upward pressure on the front end while the long end should stay more anchored due to global rates, low r* and structural pension demand for the long end.

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