wknd notes: Looking for Big Footprints

“But one thing is clear,” said outgoing ECB Chief Economist Praet. And across the world, skeptical ears perked right up. Because of course, if there’s one thing we’ve learned from this monetary experiment, it’s that nothing is clear. “The ECB’s Governing Council will always find ways and means of acting if it needs to,” declared Praet, making his point. But is that really the point? It is one thing to act, and another thing to do. And while there is little doubt that the ECB or any central bank can act, might we be approaching the limits of what they can do? “If the euro-area economy were to slow more sharply, we could adapt our forward guidance on interest rates and this could be complemented by other measures,” explained Praet, assuredly, without explaining why 3yrs of -0.40% overnight deposit rates has left the central bank still talking about new ways to boost growth rather than novel ways to elicit a soft landing. “Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve's asset holdings later this year,” read the January Fed Minutes, “Participants pointed to a variety of considerations that supported a patient approach to monetary policy at this juncture as an appropriate step in managing various risks and uncertainties in the outlook ... maintaining the current target range for the federal funds rate for a time posed few risks at this point.” Having hiked rates from 0.00%-0.25% to 2.25%-2.50%, the Fed abruptly stopped. A $1.5trln tax stimulus, expanded budget deficits, and deregulation provided the cover for the US central bank to attempt to normalize policy. No other major nation has been able to come close. And now they’ve all turned dovish, bumping along the bottom, with rates still at crisis settings.

Week-in-Review (expressed in YoY terms): Mon: Chinese stocks jump 3% on trade deal optimism, British Intelligence believes it can mitigate security risks of Huawei 5G technology, EU threatens retaliation if US imposes auto tariffs, S&P closed (President’s Day); Tue: Chinese banks prepare to issue more perpetual bonds, Pakistan asks UN to intervene in Kashmir after suicide attack, German business sentiment 5yr low, Swedish CPI -0.2 to +2.0%, Whistleblower report claims Whitehouse aides have pushed sale of sensitive nuclear technology to Saudi Arabia, US homebuilder confidence 4mth high, S&P +0.2%; Wed: China pressed to include currency stability in US trade agreement, South Africa to bailout Eskom ($4.8bln), Turkish consumer confidence returns to 2018 lows, Fitch may cut UK rating on risk of no-deal Brexit, Fed minutes “holding rates steady poses few risks given muted inflation and risk of economic slowdown,” S&P +0.2%; Thur: China foreign minister “China does not engage in currency manipulation,” China restricts imports of Aussie coal (retaliation for Huawei), ECB minutes raise concerns over trade wars, EU flash PMI manu falls into contraction -1.3 to 49.2 (6yr low), German manu PMI plunges to 47.6 (6yr low), Trump appears to soften stance on Huawei, Philly Fed -4.1 (exp +14.0), S&P -0.4%; Fri: China/US trade negotiations continue (Trump to meet Xi soon), China home prices +10% (1.5yr high), France/Germany agree to steps toward a common EU budget (in practice it’ll take years even if it approved by Dutch/Finns), German business confidence 4yr lows, Fed’s Williams “persistently weak inflation threaten long-term expectations,” Fed “does not expect to reduce balance sheet to pre-crisis levels,” SEC opens probe into Kraft Heinz (shares fall 27%), S&P +0.6%; Sat/Sun: Venezuelan soldiers leave border posts and aid flows in.

Weekly Close: S&P 500 +0.6% and VIX -1.40 at +13.51. Nikkei +2.5%, Shanghai +4.5%, Euro Stoxx +0.6%, Bovespa +0.4%, MSCI World +0.5%, and MSCI Emerging +2.0%. USD rose +1.2% vs Brazil, +0.7% vs Sweden, +0.7% vs Turkey, +0.2% vs Australia, and +0.2% vs Yen. USD fell -17.9% vs Ethereum, -9.6% vs Bitcoin, -1.9% vs Chile, -1.4% vs Russia, -1.3% vs Sterling, -0.9% vs China, -0.7% vs Canada, -0.7% vs Indonesia, -0.6% vs South Africa, -0.5% vs Mexico, -0.3% vs Euro, and -0.1% vs India. Gold +0.4%, Silver +0.8%, Oil +1.7%, Copper +4.5%, Iron Ore +7.6%, Corn +0.5%. 5y5y inflation swaps (EU -1bp at 1.43%, US +5bps at 2.24%, JP flat at 0.11%, and UK flat at 3.56%). 2yr Notes -2bps at 2.50% and 10yr Notes -1bp at 2.65%.

2019 YTD Equity Index Returns: Russell +17.9% priced in US dollars, Argentina +16.3% in US dollars (+21% in pesos), Canada +15.6% in US dollars (+11.8% in Canadian dollars), Brazil +15.5% (+11.4%), China +15.2% (+12.4%), Chile +14.4% (+7.4%), Colombia +13.6% (+8.4%), NASDAQ +13.4%, Turkey +12.5% (+13.1%), Russia +11.8% (+5%), S&P 500 +11.4%, HK +11.3% (+11.5%), Israel +10.8% (+7.2%), Australia +10.7% (+9.2%), Norway +10.5% (+8.9%), Thailand +10.3% (+6.1%), Netherlands +9.9% (+11%), South Africa +9.7% (+6.4%), Italy +9.7% (+10.6%), UK +9.4% (+6.7%), Austria +9.4% (+10.3%), Greece +9.3% (+10.4%), Switzerland +9.3% (+10.9%), Saudi Arabia +9.2% (+9.2%), France +9.2% (+10.3%), Finland +9.1% (+10.1%), Belgium +9.1% (+10.1%), Ireland +9.1% (+10.1%), Denmark +8.9% (+9.8%), Indonesia +8.7% (+5%), Korea +8.6% (+9.3%), Portugal +8.3% (+9.3%), Sweden +8.3% (+12.8%), Mexico +8.1% (+5%), Euro Stoxx 50 +8% (+9%), New Zealand +7.9% (+5.7%), Philippines +7.6% (+6.6%), Germany +7.6% (+8.5%), Singapore +7.5% (+6.6%), Japan +6.9% (+7%), Czech Republic +6.9% (+7.5%), Spain +6.8% (+7.8%), Taiwan +5.5% (+6.1%), Hungary +4.6% (+4.3%), UAE +3.7% (+3.7%), Malaysia +3.3% (+1.8%), Poland +2.9% (+4.5%), and India -2.5% (-0.7%).

Fishy: “I was a maths major,” said the CEO. “And at one point in my studies, we delved into the realm of relativity. Like the idea that a five-inch ruler is not really five inches if you are traveling close to the speed of light,” he said. “And I remember thinking, well hold on, let’s get back to math. I always like the idea of having a singular correct answer.” Our sushi arrived. Arranged perfectly. Symmetry. “I always thought money had one answer too. But I find myself unsure. If Japan has debt/GDP of 225% but the BOJ owns half of that, what does it mean?”

Fishy II: “What would happen if the BOJ announced they burned the bonds they own?” asked the same CEO. “I know they need never do that, but suppose they did.” Would it matter? “What would happen if we simply extinguished America’s $1.5trln student debt?” No one quite knows. “I’ve come to see money as more philosophical than mathematical.” I smiled, always interested to explore the meaning of money. “And the most interesting thing happening in the world now is this debate about MMT. It is the thing that would truly shift market paradigms, correlations.”  

Fishy III: “There’s a think tank in the UK,” the CEO continued. They surveyed a leading political party, asking each member whether they considered themselves to be reasonably likely to lead the party. “In my firm, perhaps 10 people would think they have a realistic shot at taking my job someday. But 95% of our politicians think they’re reasonably likely to lead their party.” They’re a totally different breed. “Modern Monetary Theory plays into the type of person who becomes a politician. And it’s probably too alluring for them to resist it in some capacity.”

Made in China 2025: “I want 5G, and even 6G technology in the US as soon as possible. It is far more powerful, faster, and smarter than the current standard. American companies must step up their efforts or get left behind. There is no reason that we should be lagging on something that is so obviously the future. I want the US to win through competition, not by blocking out currently more advanced technologies. We must always be the leader in everything we do, especially when it comes to the very exciting world of technology!” tweeted Trump.

Made in China 2025 (II): China’s Huawei leads the field of players capable of delivering 5G technology. Beijing is spending lavishly on a roll out. American tech firms do not have the ability to deploy a completely US-made 5G network, which is the vital infrastructure upon which countless innovations will be built/run (driverless cars, internet-of-things). US corporate capital expenditure growth hit a high of 13% in Sept 2017 and has decelerated ever since. It’s now growing at an anemic 2.5%, despite tax/regulation cuts. They spent $1.1trln in 2018 buybacks.

Selling Rallies: “Economies operate with a lag, and the tightening that has already occurred virtually assures a more dramatic slowdown, or recession later this year or 2020,” said the CIO. The Fed hiked 225bps starting in Dec 2015. “Even if the Fed ends its balance sheet reduction later this year, that tightening will also take time to work its way through the system.” The Fed balance sheet grew from $870bln in 2007 to $4.5trln in May 2015. QT started shrinking it in Oct 2017. It’s roughly $4trln now. “The bear market in equities started with the October sell-off.”

Anecdote: “A lot of alpha players are out there looking for big footprints,” said Sasquatch, hiding in plain sight, making his way through Manhattan. “You need to invest enormous resource into trade execution,” he explained as we walked, stepping carefully. “If you’re even the slightest bit sloppy, you get eaten alive.” As assets concentrate into a smaller number of hulking managers, funds, ETFs and indexes, the impact of their buying and selling becomes more visible. But it’s not the odd sighting that’s most dangerous to their cost of execution, it’s the predictability of their movements. So the most clever firms invest enormously to keep their pursuers guessing. “We believe that very few alpha strategies can scale beyond $1bln-$2bln. But we also believe that to be truly successful in this industry you need to scale. So our challenge is to combine a wide range of unique return streams at scale. And hide our tracks.” As the global savings pool swells, managers of this money search for ways to deploy the assets while reducing fees. Niche strategies no longer move the needle. “Our clients are firms that need a partner who can manage multiple billions for them and generate alpha. Very few firms in the world can do this,” explained Sasquatch, CEO of a giant. “Everything has become more efficient over the past 20-30yrs.” Sharpe ratios have come down across all strategies. There’s less alpha to be had. “We see no evidence that the momentum factor is any less valid today than it has always been. The same holds for various other factors. But the reversals are more abrupt, severe,” he said. “Everything is harder now, but unless equities somehow resume their steady march higher, which I sincerely doubt, weaker players will continue to fail. And our opportunity set will improve,” finished Sasquatch, weaving his way through the crowd. 

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.