Never Ending Story

It was an eventful week on multiple fronts. Inflation continues to be the biggest story, but there was some other fun to be had. The U.S. kicked off the economic reporting on Tuesday morning and the CPI report came in hotter than expected 8.3% YoY versus the Reuters poll expecting 8.1%. The small silver lining was that's still a slow down from the 8.5% reading last month. Markets didn't care about any silver lining at all! Futures drop 2.2% in the minute after the data release and trade down as much as 5% on the day. Europe fell as well on that release, turning negative about halfway through their day, falling more than 2% from the highs and had a hard time catching up the rest of the week, dropping more than 5% from the time of the US CPI release. Part of that might be their hotter than expected CPI results from Sweden and France. The U.K. was slightly less than expected and a little better than last month. Looking at the two charts below, we can see expectations are for inflation to start to subside very soon, but every month that it doesn't starts to freak people out. That's because of the second chart that shows the Fed Funds implied rates approaching 4.5% in mid-2023. Right now, two 75bps hikes are expected and then opinions start to disperse.

The big event in crypto was the merge where Ethereum transitioned from proof-of-work to a proof-of-stake model on Thursday morning. This likely reduces the power needed to secure ETH by 99.95% and more secure. Proof-of-stake requires voting to update the chain amongst holders. This should allow the Web3 opportunities by enabling more scalability.

Thursday ended with a bang in the U.S. equity markets too. FedEx (FDX) came out with some very negative statements after the close. They pulled their fiscal year guidance and noted that they'll undergo a global cost cutting initiative to combat what they are forecasting a major global slow down. The stock had its worst day ever in its roughly 45 year history. I wanted to see how that day compared to the worst days for large cap names in the last five years.

Friday was a big trading day with quad witching and the index rebalances for S&P and NASDAQ, but started with news of an agreement to avert a huge strike by U.S. railway workers. A strike would have crippled logistics and had huge impact on commodities and retail. The day ended with some volatility in the S&P 500 names being shifted in and out of the big index. The two names going into the index Invitation Homes (INVH) and Costar Group (CSGP) traded more than 10x their normal daily volume. In fact, they traded more in the closing auction than they have in most months of late. The auction traded accounted for about six months of auction trading for those two names. Even with all the index buying, traders still kept pressure on the names and they ended the day lower. The index deletions were PVH Corp (PVH) and Penn Entertainment (PENN). Those two traded a bit less, but still much heavier than normal at 6.5x and 7.5x respectively. Oddly enough, the two names coming out were down less than the additions.

Major asset performance on the week was mostly in the red. One of the exceptions in blue, normally green for the non-color blind like me, was the Dollar. It continues to march higher. 17 of the last 25 weeks have been positive. Two out of every three weeks this year have been on the plus side. It's a slow march though, because the index is up only 14.1%. For the Dollar though that would be the the third best year in the last fifty.

Something else I was looking at after hearing The Macro Tourist, Kevin Muir, talk about this. The iShares iBoxx Investment Grade Corporate Bond ETF, LQD, is down over 19% this year. The chart below shows last two years. The thing Kevin mentioned was the LQDH, which is the hedged against interest rates, is only down 5.4% this year and 1.4% over the last two years. This means spread are holding tight and the reason this asset is going down is more because of rising rates than credit exposure. The same holds true for the high yield fund as well. HYGH is only down 6.8% on the year.

As we move into this week, the Fed will continue to be a major part of our conversations. FOMC meets this week with a decision on rates to come. Other than the Fed, we're set to get CPI from Canada, Italy, and Japan, but those shouldn't be a big market movers. I'm interested in the Retail Sales and University of Michigan Sentiment reports. Earnings are very light with AutoZone, General Mills, Costco, and Darden. FedEx is scheduled, but they pretty much let that cat out of the bag already.

Best of the Week

Intriguing conversation with Jared Vennett, aka Greg Lippmann, from The Big Short. Greg talks about his early career. He mentioned that he found his way onto the trading desk by going down there and just sitting there doing his regular job. He then was recognized when an opening came up. He walks through how the Big Short trade came about and that the trade didn't work for at least a year. He went from fighting to keep the trade on to being on the front page of the WSJ. Since the trade those markets are now more connected and correlated. He then took that success into starting his own fund. He describes the challenges of portfolio management. A couple of things stood out in the closing questions. First was Greg noting that it's hard to complain about the movie when one of the sexiest men alive plays you. The second thing was his career advice to figure things out. Figure out how to add value and along the way the company will train you. This isn't summer camp. This was an excellent conversation into a trade we've all heard about. Listening time: 52 minutes

Best of the Rest

I liked the first part of this conversation the most. Evan is a former professional poker player and while this comes up throughout the conversation, it's most prominent in the beginning. Evan says at one point he was playing six on-line poker tables at one time all with a $1,000 buy-in. He noted that the smaller buy-in tables had more reckless activity. Though there were some large buy-in tables with rich people that didn't care about losing $10,000 a hand. This reminded me a bit about the WallSt Bets crowd. He also compared traders trading too much to novice poker players not being able to fold. He noted that most are unwilling to update probabilities. In poker, he referenced folding a pair of Aces versus re-evaluating a cheap stock bought. After poker, Evan went on to work for a friend's dad at a family office, who eventually kicked them out and funded their new fund. There was a long discussion on Kelly criterion, which is sizing bets/trades based on risk. Another good topic covered was Evan's shorting of the meme stocks. He said it was painful for the first six months but then became a good strategy. Listening time: 91 minutes

I mentioned the S&P and NASDAQ rebalances of last week. When these widely followed indices rebalance or have an addition/deletion event, it can be a market mover for the securities involved. I traded these for the NASDAQ 100 back in the day. Well, more like administer them, because we farmed them out to the big banks with prop trading desks. The quant fund I worked for also managed about $20B in index accounts benchmarked to the S&P 500 mostly. This article looks the Russell indices. The size of these have increase dramatically over the past few years. This article walks you through the process of the rebalance, the players, and the impact. Looking at the last three year of price impact, it looks a little more like the old days. Global Crossing was one of the names I remember from my time on the desk as being a quite serious day of trading.

I found this chart via Liz Ann Sonders on Twitter. This shows the equities with suspect ability to pay their debt are struggling to perform even more than the S&P 500. These are the companies most at risk during a downturn in the U.S. economy. Some big names on this list, which I further filtered to $10B+ are Boeing, Airbnb, Uber, Moderna, and Constellation Energy, just to name a few.

Going back into the CV again, I used to trade the equity portion of very large manager transitions. Some of those took days to get into and out of the positions, but when the portfolio was multi-asset and the bond desk was involved, that could take weeks to find liquidity in some of the bonds. Robin Wigglesworth wrote something earlier this year in the FT, "Of the 21,175 corporate bonds outstanding in the US in 2018, only 246 of them traded at least once a day that year." One percent that's all. Without time to do the research, I'll assume that probably a little higher some four years later, but I doubt by much. The thing with this commentary from Tradeweb, who is majority owned by my employer LSEG, these portfolio trades are done on a wholistic basis.

One for the Road

Vertical farming is one of the coolest things around in my opinion. The former CEO of Refinitiv wrote this post and I just had to share it. In the U.S., much of our farming sits in areas at risk of drought and/or some other natural risks. The article notes that in Singapore, only 7% of food is grown locally. In the UK and Switzerland, almost 50% of food is imported and at risk of geopolitical events. I live in the NY metro area and summer and fall is great when the local farmers' markets are around, but winter requires shipping in fruits and vegetables up from Mexico or other areas of South America, where it's warmer. Vertical farming in the U.S. was recently popularized by AppHarvest's IPO in 2020, which to be transparent, I own a small position in. David's post highlights some of the breakthroughs with this method via investment in Europe, but as he notes any real development will require major investment. My retirement dream is to own one of these, where I can grow peppers. For now, I'll have to accept growing them in my yard.

Thanks for reading. Have a spicy week.

Michael