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America’s largest banks and their shareholders were quick to celebrate a recovery in trading revenues over the past year. But they may have spoken too soon.

Wall Street vets know they can’t fight the Fed – especially with the ostensibly “data-dependent” central bank committing to returning the Fed funds rate to 3% over the next two years.  But with the arrival of the summer doldrums ushering in low trading volumes across markets, traders are acknowledging that they can’t fight the seasons, either.

“After four straight quarters of rising income from trading, the biggest U.S. investment banks spent the past few months in a renewed slump. Shareholders will soon see how dull it’s been. Analysts estimate the five largest firms will say their combined revenue from trading dropped 11 percent from a year earlier to $18.4 billion — the smallest haul for a second quarter since 2012. The banks start posting results July 1.”

Many Wall Street traders are opting to wait out the summer slowdown, focusing on their families, or their online dating profiles, instead of desperately trying to drum up business.

Indeed, one bond trader who spoke with Bloomberg said he’s been slipping out early to watch his kids play sports. A fund manager says his office just staged a golf retreat. And a trading supervisor at another bank confided that he’s spending more time swiping through potential romantic partners on the dating app Tinder.

"Among the hardest hit are fixed-income traders. Five investment banks – Bank of America’s Merrill Lynch, Goldman Sachs, J.P. Morgan Chase & Co., Citigroup and Morgan Stanley – are likely to see revenue from that business fall 16 percent to $11.2 billion, according to estimates gathered from nine analysts. At Goldman Sachs Group Inc., it probably tumbled 23 percent to about $1.5 billion, the estimates show. At JPMorgan Chase & Co., it likely fell 17 percent to $3.3 billion."

If these forecasts are accurate, the declines would represent the smallest haul for a second quarter since 2012. The banks start posting results July 1.

"But fixed-income trading isn’t the only area where banks are expecting a pullback: In equities trading, analysts estimate total revenue slipped 2 percent to $7.2 billion. Stock-trading leader Morgan Stanley may post the sharpest decline, about 6 percent."

Traders are grousing about a lack of market-moving news. Congressional gridlock is eroding optimism that President Donald Trump can enact a sweeping, pro-business agenda. Other geopolitical frictions have yet to jolt markets.

And while bank CEOs probably wish they could chain their clients and counterparties to their desks to keep them trading at all costs, the leaders of the biggest banks have been priming the market to expect a second-quarter slowdown in trading profits.

“Bank leaders began tamping down expectations at investor conferences six weeks ago. JPMorgan Chief Financial Officer Marianne Lake delivered the first warning, telling investors trading revenue was down roughly 15 percent in the quarter’s initial two months, hurt most by fixed-income trading. Equities held up better, she said, especially in derivatives and among units that cater to hedge funds.

 

Trading results are closely watched. The business generates about 25 percent of total revenue at the five banks and tends to be their most volatile major business. And to be sure, analysts — often drawing on banks’ own commentary — usually underestimate results. Citigroup Inc.’s net income, for example, has beaten their average estimate for 13 straight quarters. This time, the depth of a trading dip may be curtailed by an expected boost in lending fees.

 

That same day, Bank of America Corp. Chief Executive Officer Brian Moynihan added to investors’ dismay by revealing his firm’s trading decline would probably be between 10 percent and 12 percent. Both executives blamed diminished client activity and low volatility. Citigroup CEO Michael Corbat soon echoed the prognosis, saying his firm is ‘right in line.’”

Corporate-bond trading is also expected to take a hit, though the size of the drop has been distorted by an exceptionally strong first-quarter.

“Altogether, corporate-bond trading volume on Wall Street dropped 13 percent in the second quarter to $1.14 trillion compared with the first quarter, according to data compiled by Bloomberg. And in equities, the VIX Index, a closely watched measure of volatility developed in the 1990s, dropped to its lowest level in more than 23 years.”

To be sure, some of the slowdown is also a matter of perception. As the drama of President Donald Trump’s first months in office – characterized by battles over the president’s legislative agenda, escalating tensions with North Korea and investigations into both Trump’s inner circle and Democratic stalwarts like former AG Loretta Lynch and Berne and Jane Sanders – gives way to the slowing summertime newsflow, traders are more cognizant of the slowdown this year.

“One bank trader said the quarter felt particularly dull because of the months-long crescendo of activity that led up to it. Britain’s vote to exit the European Union jolted markets last June. Trump’s election victory in November extended the run.

But in the second quarter, the flurry subsided. The slowdown soon began to chip away at the so-called Trump Bump that once boosted bank stocks. Investors are concerned the president and his Republican allies may struggle to enact policies to help big Wall Street banks.”

But excitement promises to make a comeback in the third quarter, as the battle over raising the debt ceiling looks poised to rattle markets, while traders are also waiting with bated breath to see if Trump can enact his proposals to repeal and replace Obamacare, as well as what’s shaping up to be the most sweepinof g tax reform agenda since the 1980s.

“What’s frustrating people more than anything is the lack of movement,” said Thomas Roth, head Treasury trading at MUFG Securities Americas Inc. At this point, traders need a major overhaul of U.S. regulations, a significant shift in fiscal or monetary policy, or some other surprise to trigger sustained investor action, he said.”

And yet, there’s also the possibility of a summer surprise that could shake the market out of its sense of complacency and cause trading volumes to skyrocket. Last year, we had Brexit. The year before, it was China's decision to devalue the yuan. The only question is, what will it be this year? An armed conflict with North Korea? Or perhaps a de-escalation and diplomatic resolution? Will we see a sudden breakthrough on Trump’s legislative agenda? Looking further afield, maybe the long-awaited Chinese debt implosion will finally arrive? Or perhaps the US subprime auto-loan market will topple over like a house of cards.

“Something always blows up over summer,” he said. “We’ve seen it for many years.”

In the meantime, traders should probably appreciate the downtime while they have it, because once their kids head back to school and the news cycle picks up, they might not have another moment to breath until the holidays.

“As a salesman or trader, it does get to the stage where you go, ‘Christ, what am I going to do for the rest of the day?’” said Chris Wheeler, a bank analyst at Atlantic Equities. “I don’t think anyone is going to be that keen to be on the desk when it’s so quiet. The danger is people get quite bored.”
 

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Authored by Mike Krieger via Liberty Blitzkrieg blog,

Late last week, I came across a fascinating article published at Mondoweiss highlighting a recent study positing that Hilary Clinton may have lost the election to Donald Trump partly as a result of her well documented lust for imperial war and aggression.

Here are a few excerpts from the piece:

An important new study has come out showing that Clinton paid for this arrogance: professors argue that Clinton lost the battleground states of Wisconsin, Pennsylvania, and Michigan in last year’s presidential election because they had some of the highest casualty rates during the Iraq and Afghanistan wars and voters there saw Clinton as the pro-war candidate.

 

By contrast, her pro-war positions did not hurt her in New York, New Jersey, Connecticut, and California, the study says; because those states were relatively unscathed by the Middle East wars.

 

The study is titled “Battlefield Casualties and Ballot Box Defeat: Did the Bush-Obama Wars Cost Clinton the White House?” Authors Francis Shen, associate professor at the University of Minnesota Law School, and Dougas Kriner, a political science professor at Boston University, strike a populist note.

And here are the authors themselves on the moral hazard at work here. The people who decide are not suffering as much.

 

America has been at war continuously for over 15 years, but few Americans seem to notice. This is because the vast majority of citizens have no direct connection to those soldiers fighting, dying, and returning wounded from combat. Increasingly, a divide is emerging between communities whose young people are dying to defend the country, and those communities whose young people are not.

No nation can remain a cohesive unit for long under the above circumstances. Not to mention the fact that it’s extraordinarily unethical.

Here is another powerful excerpt from the paper:

 

Imagine a country continuously at war for nearly two decades. Imagine that the wars were supported by both Democratic and Republican presidents. Continue to imagine that the country fighting these wars relied only on a small group of citizens—a group so small that those who served in theater constituted less than 1 percent of the nation’s population, while those who died or were wounded in battle comprised far less than 1/10th of 1 percent of the nation’s population.

 

And finally, imagine that these soldiers, their families, friends, and neighbors felt that their sacrifice and needs had long been ignored by politicians in Washington. Would voters in these hard hit communities get angry? And would they seize an opportunity to express that anger at both political parties? We think the answer is yes.

 

Their argument is obviously aimed at coastal elites, which have more power than rural communities over decision-making, but far less to lose. The authors are unsparing about the very different experience of war for different communities. 

 

When the United States goes to war, the sacrifice that war exacts in blood is far from uniformly distributed across the country. And in the Civil War, Korea, Vietnam, and Iraq, constituencies that have suffered the highest casualty rates have proven most likely to punish the ruling party at the polls.

In the Iraq and Afghanistan wars, for example, seven states have suffered casualty rates of thirty or more deaths per million residents. By contrast, four states have suffered casualty rates of fifteen or fewer deaths per million. As a result, Americans living in these states have had different exposure to the war’s human costs through the experiences of their friends and neighbors and local media coverage.

 

The four states with the lowest rates are NY, NJ, CT and Utah. All but Utah voted Democratic. Overall, rural states have higher casualty rates, and the authors find pretty significant inverse correlations between state income and education medians and casualty rates. Though it must be noted that Vermont suffered the worst casualty rate– more than 41 deaths per million– and it is home to the most vociferous antiwar candidate, Bernie Sanders, but was also very safe for Clinton.

People in the tristate area where I grew up should think a bit more deeply about support for imperial wars abroad, especially when their families aren’t as willing to make the necessary sacrifices.

Here’s Krayewski’s summary again, emphasizing the policy takeaway from the study:

 

The president’s electoral fate in 2020 “may well rest on the administration’s approach to the human costs of war,” the paper suggests. “If Trump wants to maintain his connection to this part of his base, his foreign policy would do well to be highly sensitive to American combat casualties.” More broadly, the authors argue that “politicians from both parties would do well to more directly recognize and address the needs of those communities whose young women and men are making the ultimate sacrifice for the country.”

The most effective way of addressing their needs is to advance a foreign policy that does not see Washington as the world’s policeman, that treats U.S. military operations as a last resort, and that rethinks the foreign policy establishment’s expansive and often vague definition of national security interests.

Reason also covered the study:

The paper—written by Douglas Kriner, a political scientist at Boston University, and Francis Shen, a law professor at the University of Minnesota—provides powerful lessons about the electoral viability of principled non-intervention, a stance that Trump was able to emulate somewhat on the campaign trail but so far has been incapable of putting into practice.

 

The study, available at SSRN, found a “significant and meaningful relationship between a community’s rate of military sacrifice and its support for Trump.” The statistical model it used suggested that if Pennsylvania, Michigan, and Wisconsin had suffered “even a modestly lower casualty rate,” all three could have flipped to Hillary Clinton, making her the president. The study controlled for party identification, comparing Trump’s performance in the communities selected to Mitt Romney’s performance in 2012. It also controlled for other relevant factors, including median family income, college education, race, the percentage of a community that is rural, and even how many veterans there were.

 

“Even after including all of these demographic control variables, the relationship between a county’s casualty rate and Trump’s electoral performance remains positive and statistically significant,” the paper noted. “Trump significantly outperformed Romney in counties that shouldered a disproportionate share of the war burden in Iraq and Afghanistan.”

For all his nice campaign rhetoric, Liberty Blitzkrieg readers will be well aware of my serious concerns when it comes to Trump’s foreign policy and his sincerity regarding keeping the nation out of unnecessary imperial wars. Nevertheless, if it’s true that Hillary’s war lust materially impacted the 2016 election, this unquestionably would be a great thing. It means real issues are finally coming to the fore of U.S. politics, and that populism truly is ascendant and isn’t going away. Hopefully members of Trump’s team are aware of the study and will make him memorize its contents.

If less imperial violence can in fact become a winning election theme, then we are indeed making some real progress.

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Long walks on the beach, holding hands in a hottub overlooking the ocean, working on your golf game…in Hawaii, treating the kids and grandkids to treats and trips – we have all seen the commercials of how great 'retirement' can be (or could have been), if you just put a little more money into the stock market via your friendly local asset gatherer.

Well, sad to say, as Bloomberg reports, more and more Americans are spending their golden years on the job.

Almost 19 percent of people 65 or older were working at least part-time in the second quarter of 2017, according to the U.S. jobs report released on Friday. The age group’s employment/population ratio hasn’t been higher in 55 years, before American retirees won better health care and Social Security benefits starting in the late 1960s.

And the trend looks likely to continue. Millennials, prepare yourselves.

Older Americans are working more even as those under 65 are working less, a trend that the Bureau of Labor Statistics expects to continue. By 2024, 36 percent of 65- to 69-year-olds will be active participants in the labor market, the BLS says. That’s up from just 22 percent in 1994.

A number of factors are keeping older Americans in the workforce. Many are healthier and living longer than previous generations. Some decide not to fully retire because they enjoy their jobs or just want to stay active and alert.

Others need the money. One glance at the chart above may help indicate one big driver of pain – notice that as each major market crash occurs, the prime-working-age cohort and the senior-generation cohort inflects and diverges, as the wealthier, older generation comes face to face with reality as their long-term savings are decimated by reality stepping into stock markets.

The share of older people in the workforce is higher than at any point since before the creation of Medicare. Even more older Americans might be out there working, though, if they were healthier and had better job prospects.

And it's not just Americans that are 'not' living-the-dream they were sold by various asset managers…

Around the globe, workers of all ages are moving their retirement goals later and later in life.

If Yellen will just keep the dream alive for another 30 years then the enitre boomer generation can retire wealthy… right?

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Authored by Mac Slavo via SHTFplan.com,

For decades suburbia was home to the highest concentration of wealth in America, and perhaps even the entire world. It was the seat of our nation’s thriving middle class and a beacon of economic mobility. The streets were clean and safe, the schools were highly regarded, and there were plenty of middle class jobs to be had.

But something has changed in suburbia. While offshoring and automation have destroyed millions of jobs across the country, the decimation of brick and mortar stores by online retailers has pounded the wealth base of suburbia. So much so, that there are more people living in poverty in suburbia than any other place in America.

According to a new book, “Places in Need: The Changing Geography of Poverty,” by University of Washington professor Scott Allard, American suburbs are facing economic hardship on a massive, if poorly understood, scale.

 

As of 2014, urban areas in the US had 13 million people living in poverty. Meanwhile, the suburbs had just shy of 17 million.

 

The Great Recession of 2008 helped accelerate much of the poverty that emerged in the early 2000s, Allard’s research has found. But another disrupting factor was the technological shift that enabled — and continues to enable — online retailers like Amazon and other e-commerce sites to replace shopping malls and big-box stores.

 

This ongoing demise has hollowed out many of the jobs suburban Americans once turned to as a means of supporting themselves.

So where did the wealth go? It appears to have fled suburbia, and made its way back to the cities.

The kinds of jobs that do entice younger people — mostly higher-skill, white-collar work — are increasingly found in cities. Suburban office parks are becoming a thing of the past as millennials flock to nearby metropolitan areas for work, accelerating the speed at which the suburban workforce hollows out overall.

 

Allard said it’s a reversal of several decades ago, when businesses moved to the suburbs to attract people who had recently vacated the city in search of a safer, greener place to live

Of course there are many factors that have killed jobs and wealth creation in suburbia, and those factors are contributing to poverty across the board. When you look at the data, you’ll find that the number of people living under the poverty line has skyrocketed in the suburbs, the cities, and rural areas. It’s happening everywhere. But suburbia is being hit the hardest.

Between 2000 and 2015, the poor population in smaller metropolitan areas grew at double the pace of the urban and rural poor populations, outstripped only by poverty’s growth in the nation’s suburbs. Suburbs in the country’s largest metro areas saw the number of residents living below the poverty line grow by 57 percent between 2000 and 2015. All together, suburbs accounted for nearly half (48 percent) of the total national increase in the poor population over that time period.

The truth is this is emblematic of a much wider trend. The middle class in America is clearly dying, and the suburbs are where the middle class used to be concentrated. But like I said, it’s happening all over the place.

It used to be that you could escape poverty by moving from one place to another. During the industrial revolution, millions fled the subsistence living conditions in the countryside for factory jobs in the city. After World War Two, millions more left the cities for the suburbs.

But where can people run to now for economic opportunity? The middle class jobs in the suburbs have been hollowed out by the digital age. Offshoring, automation, environmental regulations, and illegal immigration have driven down wages and killed many of the highest paying jobs in rural areas. For most people, the only good paying jobs are in the cities, where the cost of living is so high that you can barely raise a family on a six figure income, which of course negates any of the benefits of having a high paying urban job.

If trends like this continue, then someday we’re going to wake up in a country that is like many that came before, where a few coastal elites are incredibly wealthy, and poverty is the norm for everyone else.

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One week ago, Illinois passed its three year-overdue budget in hopes of avoiding a downgrade to junk status, however in an unexpected twist, Moody’s said that it may still downgrade the near-insolvent state, regardless of the so-called budget “deal.” In fact, a downgrade of Illinois may come at any moment, making it the first U.S. state whose bond ratings tip into junk, although as of yesterday, credit rating agencies said they were still reviewing the state’s newly enacted budget and tax package. The most likely outcome is, unfortunately for Illinois, adverse: “I think Moody’s has been pretty clear that they view the state’s political dysfunction combined with continued unaddressed long-term liabilities, and unfavorable baseline revenue performance as casting some degree of skepticism on the state’s ability to manage out of the very fragile financial situation they are in,” said John Humphrey, co-head of credit research at Gurtin Municipal Bond Management.

And yet, while Illinois squirms in the agony of the unknown, another municipality that as recently as a month ago was rumored to be looking at a bankruptcy filing, the state capital of Connecticut, Hartford, no longer has to dread the unknown: on Tuesday afternoon, S&P pulled off the band-aid, and downgraded the city’s bond rating by two notches to BB from BBB-, also known as junk, citing “growing liquidity pressures” and “weaker market access prospects”, while keeping the city’s General Obligation bonds on Creditwatch negative meaning more downgrades are likely imminent.

“The downgrade to ‘BB’ reflects our opinion of very weak diminished liquidity, including uncertain access to external liquidity and very weak management conditions as multiple city officials have publicly indicated they are actively considering bankruptcy,” said S&P Global Ratings credit analyst Victor Medeiros. Hartford has engaged an outside law firm with expertise in financial restructuring. Officials also mentioned that the city would initiate discussions with bondholders for concessions to implement a debt restructuring if it didn’t receive the necessary support in the state’s 2019 biennial budget.

S&P also said that Hartford may be downgraded again if the state passage of a budget is significantly delayed, or if the city were not to receive sufficient support in a timely manner that would enable it to manage liquidity and allow it to meet obligations in a timely manner.

In short: the capital of America’s richest state (on a per capita basis), will – according to S&P – be one of the first to default in the coming months.

Full S&P note below.

Hartford, CT GO Debt Rating Lowered Two Notches To ‘BB’ On Growing Liquidity Pressures, Weaker Market Access Prospects

 

S&P Global Ratings has lowered its  rating on Hartford, Conn.’s general obligation (GO) bonds two notches to ‘BB’  from ‘BBB-‘ and its rating on the Hartford Stadium Authority’s lease revenue  bonds to ‘BB-‘ from ‘BB+’. The ratings remain on CreditWatch with negative  implications, where they were placed on May 15, 2017.

 

“The downgrade to ‘BB’ reflects our opinion of very weak diminished liquidity, including uncertain access to external liquidity and very weak management conditions as multiple city officials have publicly indicated they are actively considering bankruptcy,” said S&P Global Ratings credit analyst Victor Medeiros. Hartford has engaged an outside law firm with expertise in financial restructuring. Officials also mentioned that the city would initiate discussions with bondholders for concessions to implement a debt restructuring if it didn’t receive the necessary support in the state’s 2019 biennial budget.

 

“Maintaining the CreditWatch with negative implication reflects our opinion of continued liquidity pressures related to whether the state will provide timely extraordinary aid to the city as outlined in the governor’s proposed biennial budget and included in the city’s adopted budget,” said Mr. Medeiros. Connecticut is facing its own fiscal challenges, and there has been very little indication by the legislature on how it intends to address local government aid and specifically the level of budgetary support it would provide the city of Hartford.

 

The city’s full faith and credit GO pledge secures the bonds and notes outstanding. The ‘BB-‘ rating on the lease-revenue bonds issued by The Hartford Stadium Authority reflects the appropriation risk of the city of Hartford.

 

“We expect to resolve the CreditWatch on the long-term rating with the enactment of a state budget that will provide additional information and allow us to evaluate the level of state support and the city’s overall liquidity,” added Mr. Medeiros. At the moment, we believe there is a one-in-two likelihood of a negative rating action, potentially by multiple notches. Factors that could lead to a downgrade would be if the state passage of a budget is significantly delayed, or if the city were not to receive sufficient support in a timely manner that would enable it to manage liquidity and allow it to meet obligations in a timely manner. Alternatively, if timely budget adoption translates into stabilized liquidity, and provides long-term structural support, we could remove the ratings from CreditWatch.

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Authored by Jim Quinn via The Burning Platform blog,

Are we on the verge of a rebellion against technology?

Yesterday I was taken aback when I noticed an elderly Wal-mart greeter amusing herself with a fidget spinner.

What the hell is a fidget spinner? It’s a toy you just spin with your fingers.

It’s the hottest selling summer entertainment item that retails between $2.99-$8.99 depending on wether it lights up or makes noise.

To compare, last summer the over-hyped fad was Pokemon Go which was a ho-hum attempt at the first virtual reality game which turned out to have multiple technology problems such as being underdeveloped for rural areas and worldwide server crashes.

Why does the fidget spinner trend matter? Because it doesn’t involve any technology at all. It’s as low-grade technology wise as playing with a hula-hoop or yo-yo.

The trend peaked my interest as I believe we’ve reached the end game of the social media and app crazes of the past 10 years. Social Media IPO’s have slowed down to nil.

Why would we need another iTech item when we’ve got too many flooding the market already?

At a time when companies are replacing low-skilled workers with robots and kiosk machines, it’s not promising for their business models for customers to turn their backs on technology. Which is exactly why I’m predicting it’s going to happen.

We are no longer living in an era where people are adopting technological advancements; rather it’s being imposed on us. When pushed too far towards the direction of technology the equal and opposite reaction would be to turn a generation into neo-luddites.

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While on the surface the market last week did nothing all that exciting, below it things were in abrupt turmoil – driven by the decoupling between stocks and bonds and the volatile, countertrend move in commodities and oil in particular – which was nowhere more evident than in the world of Risk-Parity funds and CTA, which suffered their worst two-week plunge since 2003.

A subsequent report from Bloomberg revealed that the damage among trend-following CTA was especially severe, “by some measures, commodity trading advisers are on track to post the worst yearly return since 1987, when data were first collected on the group.” It also prompted the WSJ to write “Oil Up? Oil Down? Blame the Algorithms.”

But what really happened last week, and will it happen again?

For the answer we go to one of the foremost vol experts on Wall Street, the team of Chintan Kotecha, Ben Bowler et al at Bank of America, who today described what took place last week “Quant quake”, and who continues a long trend of pointing out just how “weird” and fragile the market is (no really, in late May he wrote “While not obvious on the surface, these Markets Are Very Weird“) by noting that markets continue to set long-term records for price instability or “fragility”, with a five standard deviation (5-sigma) sell-off in the S&P 500 on 17-May, a 3-sigma drop in the Nasdaq 100 on 9-Jun, and most recently a sharp rise in the bank’s cross-asset Fragility Indicator.

The latest examples? A 3-sigma rally on average across commodities last week (chart 7) that was even more acute in agricultural commodities like wheat, soybeans, and soybean meal, and a 3-sigma sell-off on average across global bonds (chart 8) that was most acute in longer-duration Bunds. But the worst news for the systematic funds is that the average CTA (Commodity Trading Advisor) was caught offside by both moves, with a popular CTA benchmark experiencing a nearly 5-sigma drawdown last week (chart 9) its worst since 2000 (outside of the Feb-07 shock).

Focusing on CTAs in particular, BofA notes that trend followers were particularly hurt by outsized reversals in bonds and commodities. In a prior report, BofA showed that a significant portion of assets in CTAs
appear to be in cross-asset, risk controlled, trend following strategies and, more specifically, CTA allocations across multiple asset classes are primarily a function of two factors: (1) the asset’s current price trend and (2) the asset’s prevailing volatility. Consequently, BofA writes that “the largest downside risk for CTAs comes from reversals in price trends that are driven by ‘high-sigma’ moves. By high-sigma, we mean moves that are sufficiently large in absolute terms relative to prevailing volatility.”

Just like what happened last week. And, as BofA confirms, the recent historical decline for CTAs appears to have been driven in large part by high-sigma moves in Fixed Income and Commodity asset class futures.

To see this, first start with a universe of futures investments across Equity, Fixed Income, Commodity, and Currency asset classes (refer to footnote in Chart 10 for more information). Then, for each cross-asset futures investment, quantify its trend strength (from -1 (short) to 1 (long)) and measure its volatility. Calculate the percentile of the ratio of trend strength to volatility over a long horizon. High percentiles are indicative of more long futures positions via CTAs and vice-a-versa for low percentiles and shorts. Next compare a given day’s sigma-move (daily move over prevailing volatility) to the prior day’s percentile of the  ratio of trend strength to volatility. The upshot: large negative sigma moves for high percentile ratios indicate longs that were subject to losses and vice-aversa for large positive sigma moves and shorts

The above chart presents this analysis for cross-asset futures daily moves from 26-Jun-2017 through 7-Jul-2017. The boxes in the lower right and upper left corners indicate positions that may have driven declines for CTAs over the last two weeks. Specifically, it looks like high-sigma declines in Fixed Income as well as high sigma increases in Commodities could have been a large driver of recent underperformance. BofA also adds that equity futures may have also contributed to losses as they appear in the lower right corner but in this case via less outsized sigma-moves (that is, the recent grind lower in equities may have also been a driver of poor CTA performance).

* * *

What happens next? Well, if last week was any indication, anywhere CTAs are overexposed is suddenly risky. In the aftermath of last week’s commodity and fixed income mauling, two such leftover spaces are equities, where CTA remain long, and the USD, where they are short.

As Kotecha writes, the reversal in trend alongside a pickup in volatility for Fixed Income and Commodity asset classes could indicate that CTAs have now limited their exposure in those areas. However, the percentile of the ratio of trend strength to volatility remains elevated for a collection of global equity index futures as well as for certain currency pairs.

Furthermore, despite the recent sharp reversals in US 10Yr Bonds and Oil, their percentiles remain stretched, which could be indicative of a long bond and short oil position. However,  CTAs do appear to have risk control mechanisms that include stop losses which may have been triggered in these two asset classes (hence why in Chart 11 BofA has depicted the US 10Yr Bond and Oil with hollow bars).

In summary: while the risk of a CTA unwind in oil and bonds is now negligible, it is quite high for equities and the USD.

* * *

What about other systematic strategies, of which the most notable is of course, risk-parity. As a reminder, risk parity strategies are often also considered alongside CTAs as they both (1) use rules-based models that can at times make them price-insensitive buyers or sellers, (2) typically increase leverage when volatility is lower, and (3) can deleverage in response to a shock from low vol levels.

As we also showed last Friday, risk-parity strategies were performing well year-to-date but like CTAs were also subject to sharp declines over the last two weeks. The just released BofA chart show the same.

However, while price trends and vols indicate CTAs may have unwound Fixed Income and Commodity positions, according to BofA risk parity portfolios have yet to adjust their leverage. In other words, despite the volatile market gyrations, risk-par did not deleverage. For risk parity, it is important to distinguish between changes arising from slower-moving shifts in cross-asset allocation versus dynamic adjustments in leverage due to target volatility overlays. Typically the larger and more significant deleveraging comes from vol control overlays. The amount of deleveraging is a function of a risk parity strategy’s target volatility and maximum leverage allowed. But more significantly, the deleveraging is a function of the prevailing volatility prior to a large move and the specific magnitude of those large moves.

Furthermore, as we repeatedly pointed out during last week’s coordinated selloff between equities and stocks, i.e. surging correlation, the risk of a rapid deleveraging has spiked. Here’s BofA:

Equity/bond correl has risen sharply, but asset volatilities simply remain too low Negative Equity and Fixed Income correlation (correlation between equity and bond price returns) has provided diversification for risk parity portfolios year-to-date and helped drive unlevered risk parity vol to multi-decade lows. However, the recent rise in equity/bond correlation has increased focus on the potential deleveraging pressure from risk parity funds.

 

Despite the changing equity/bond correlation dynamic, unlevered risk parity vol remains muted in part because Equity, Fixed Income, and Commodity component vols have not risen sufficiently through this recent downturn. To see this, using a target volatility overlay (10% target vol, max leverage 2x) on a hypothetical risk parity investment, we tallied in Table 2 3-day changes in leverage and ranked the 10 largest  deleveraging events since the early 1970s. For each event, we also compiled component vols, pairwise correlations, and unlevered risk parity portfolio vol. Then, we listed the current component vols, correlations, and portfolio vol.

 

Indeed, despite the rise in equity/bond correlation (see red box in Table 2), component and unlevered risk parity portfolio vol still remain well below the levels observed during the most significant historical episodes that could have led to a theoretical deleveraging in vol controlled risk parity portfolios.

In plain English, the above means that while pairwise correlations between the two key risk-parity asset classes have spiked, overall asset volatility still remains low enough. However, another steep cross-asset selloff, coupled with the VIX spiking above the “Kolanovic Line” of 15 or so, and things get interesting.

* * *

Putting the above together, with the “quant” space now almost exclusively still long equities, does this suggest that the crash risk for the asset class is higher? 

Here is one calculation from BofA according to which while risks are higher, an imminent crash is probably unlikely, absent some gating factor (for more on that see the recent Harley Bassman note we posted).

By our estimates, global equity index futures volume is currently about $300bn while fixed income and commodity futures turnover another $300bn and $100bn daily (Chart 13). Next assume that longer-term average equal risk weighted allocations to Equity, Fixed Income, and Commodity asset classes are near 22%, 54%, and 22% respectively. Or assume that an equal risk weighted exposure that includes FX would allocate on average 20% to Currencies and 15%, 50%, and 15% to Equity, Fixed Income, and Commodity asset classes. In either case, global equity futures markets are at least twice as liquid as both bond and commodity futures when accounting for the typical risk-weighted exposures applied by CTAs and risk parity. Moreover, once spread out over multiple days to reflect realistic model diversity, even estimates on the order of $125-225bn of global equities potentially for sale would amount to only 4%-8% of weekly futures volumes in high stress periods.

While is good news for the bulls, unless of course BofA’s concentration and leverage assumptions are off. In any, the bank does warn that “both strategies remain at risk for selling material equity positions.” Incidentally, nobody predicted last week’s CTA crash, and yet it happened. It is logical that as more assets are allocated to a smaller universe of asset classes (i.e. stocks), the higher the delta to underlying vol shifts, especially when these become self-sustaining, and lead to an avalanche of selling once vega thresholds for short-vix funds are broken.

And while nobody can predict the next crash, we’ll close with what BofA wrote two months ago for anyone who still harbors the false belief that these “markets” make sense.

via http://ift.tt/2t1zQ7e Tyler Durden

Authored by Charles Hugh Smith via OfTwoMinds blog,

An investment that can be gutted by financial rules changing overnight is not safe.

What's the safest investment as the global economy enters increasingly risky, troubled times? I've reviewed hundreds of academic papers, investment reports and newsletters and researched long-term strategies and backtests and reached one conclusion.

I won't keep you in suspense: it's bat guano (or seabird guano if you can't get the bat stuff). Yes, bat doo-doo is the safest single investment on the planet.

OK, so I didn't do a lot of fancy research because that would have been a waste of time. If the era we're entering is fundamentally unlike the previous eras, then studying past investment results and strategies will generate dangerously misleading conclusions.

Here's the thinking that leads to bat guano being the number one Safest Investment.

1. The safest investment must have permanent, substantial demand supporting the bid. People need to eat, and nowadays that means having access to high-quality, organic fertilizers like bat and seabird guano.

No matter what happens in the global economy, people will still need to eat and they will need fertilizer to grow enough food to avoid mass starvation. People will trade oil, gold, whatever they have of value for food, and while everybody knows about fresh water, good soil and oil to run the tractors and delivery vehicles, the essential role of wide-spectrum fertilizers is often unappreciated.

2. There can't be super-cheap substitutes that are extracted/manufactured everywhere. You can get the various components of fertilizer from other sources, but bat/seabird guano is an excellent source of Nitrogen, Phosphorous, and Potash (Potassium), the essential N-P-K of fertilizers.

The sources for P and K are not all that abundant. In my view, there are no readily available dirt-cheap substitutes for bat guano.

3. An investment that can be gutted by financial rules changing overnight is not safe. If there's one thing we know about real financial crises, it's that the rules will change overnight, and keep on changing.

You thought the money in your bank account was yours? Silly you! The rules changed and the bank bailed-in your dough–at the behest of your wunnerful government.

You thought your retirement funds were safe? Silly you! The rules changed overnight and "for your own safety" (heh) your retirement funds were invested in negative interest rate government bonds.

Want to sell your stock ETFs before the market falls any further? Silly you! The market is closed until things stabilize.

And so on. Now the government can expropriate your bat guano along with all your other wealth, but being a physical asset, it isn't all that cheap or easy for the government to control what happens to your bat guano–especially if it's overseas.

What the government loves is financial assets that must flow through chokepoints the government can control–like banking. These assets are very easy to expropriate/tax/control.

This is why governments fear bitcoin and cryptocurrencies, and why they want to corral cryptocurrencies into the banking system where they can control it all and change the rules with a few keystrokes.

But the governments of the world face a problem when it comes to bitcoin et al.–they aren't centralized like all the other financial assets. The government can track that you bought bitcoin (BTC) with some of your dollars, but once you distribute your BTC into a handful of encrypted thumb-drives (USB memory sticks), they can't keep track of your BTC.

If they demand to know where you BTC are, you report that you lost them, as they were on a thumb-drive that fell out of your pocket. Bad luck, and all that.

Meanwhile, you slip the handful of USB drives into packages of books, artwork, etc. for delivery to trusted folks overseas. This movement of assets is impossible to track, as it flows through vast pipes of physical commerce with tens of thousands of nodes (local post offices, UPS and FedEX offices and vehicles, etc.)

Maybe an enterprising government will scan every letter, package and box, or require the shippers to perform the scan, and such scans could certainly detect gold doubloons in a package, but a USB drive? It's small and mostly plastic.

And even if some super-duper scan could detect a thumb drive, what's the state going to do, open every package with a USB drive and attempt to break the drive's encryption? That is non-trivial, and some believe (based on various leaks) that even the NSA can't break pretty good encryption–and it certainly can't check thousands of thumb drives to see if they might have some bitcoin in their innards.

Searching for bitcoin on thumb drives in tens of thousands of letters and packages is a lot more difficult and costly than announcing a bank bail-in or imposing a wealth tax on all those scoundrels with more than $10,000 in their retirement accounts. (Yes, you're obviously too rich for your own good, and we're fixing that tomorrow–the rules change tonight.)

4. An asset valued by virtue of a crowded trade is not safe. Right now, to take one example of many, the consensus is that inflation is not just dormant but essentially impossible in a deflationary world. As a result, the consensus is anticipating not just low interest rates and bond yields, but declining rates and yields should the global economy cool off/slow.

That's a very crowded trade. Crowded trades aren't safe, because when every punter is on the same side of the boat, the boat is destabilized. It doesn't take much to tip the boat over. Also, Mr. Market usually doesn't reward everyone in a crowded trade for long.

Here's a crowded trade: all that super-safe Treasury debt. The gummit/central bank can't go broke because it can always print more currency. That's the acme of safety, or so we're told. Nobody mentions that the gummit/central bank can also debauch its currency in the process of maintaining the illusion of solvency:

It doesn't seem that bat guano qualifies as a crowded trade, at least not yet.

So go ahead and laugh, but the owners of caves loaded with bat guano and islands covered in seabird guano might have the last laugh.

via http://ift.tt/2tFvcuE Tyler Durden