wknd notes: In Retrospect it was Inevitable

"Hear that scream?" he whispered from one of those multi-manager monstrosities. “That’s the sound of someone’s face being ripped off,” he said, uneasy, flashing me a couple risk reports. “Another quarter, another million-year flood,” he said, exasperated, the cataclysms appearing ever more frequently. “They’re grossing us down, they got to. No choice.” In the background, a cacophony of sickening howls, grown men begging for mercy, crying like babies, to each his own. “My book is airtight, got my head down,” he said, his factors lightly touched. The wrath of deleverage, passing mercifully by. “What a terrible way to earn a living.” 

Overall: “In retrospect it was inevitable,” tweeted Elon. No doubt that’s true. Everything in retrospect is inevitable. Musk had just posted “#bitcoin” onto his Twitter bio, a journey complete, destiny digital, inevitable. It’s possible Elon hasn’t yet bought his bitcoin, and pre-announced the intention, lifting the price ahead of his purchases. But sane people don’t do such things. Only central bankers do. They tell us what they’ll buy, in what quantities, and at what time, knowing that those with capital front run their purchases. For decades this helped bankers distort the price of money, accessibility to credit, and asset valuations. In retrospect, it was inevitable that those with the means to front run the Fed’s manipulations would amass far more wealth than those without. In retrospect, it was inevitable that those without those means would come to resent those with. And it was thus inevitable, in retrospect, that in the absence of sensible policies to restore balance to the system, those who benefitted from Fed policies would come into increasing conflict with those who did not. Naturally, the latter would vastly outnumber the former and they would thus ultimately prevail in a full-blown conflict. So in retrospect it was inevitable that those with the means to front run the Fed would find ways to have their politicians give just enough money to those without to forestall such a clash. And as they argued over whether to approve $1,400 checks, it was also inevitable that those without would rise-up in unexpected ways, to assault the institutions they blamed for the injustices they suffered. Storming our Capitols. Short-squeezing our Citadels. It was also inevitable, that such conflicts were just the prelude to a tumultuous decade. And of course, it will be inevitable, in retrospect, that while the central bankers and politicians grew increasingly desperate to fill the growing cracks of their own creation, with printed paper, sane people sought refuge from such things.

Week-in-Review (expressed in YoY terms): Mon: California lifts stay at home order, Biden reimposes certain travel bans, China sends warplanes into Taiwanese airspace, Portugal’s center right president reelected, Mexican president AMLO tests positive for COVID, Schumer indicates may take 4-6w for next round of stimulus, Moderna vaccine effective against UK & S. Africa COVID strains, Taiwan IP 9.9% (6% exp), German IFO 90.1 (91.4 exp), S&P +0.4% Tue: Italian PM Conte resigns and is expected to form a new gov’t, EU threatens to block exports vaccines produced in the Union as the bloc’s vaccination program lags others, Yellen confirmed as Treasury Secretary, R/Wallstreetbets continue to pressure stocks with high short interest (GME +95% on the day), Global COVID cases top 100m, Biden says US buying add’l 200m vaccines and US will have enough for entire US by end of summer, UK unemp 5% (5.1% exp), US Home Prices 9.08% (8.7% exp), US cons conf 89.3 (89 exp), S&P -0.2%; Wed: ECB’s Knot says there is room for a rate cut, Russia to restrict crude exports due to high domestic fuel prices, GME and other R/wsb focused short stocks drive a general degrossing in global equities, FOMC unch as exp, Australia CPI 0.9% (0.7% exp), German cons conf -15.6 (-7.9 exp), US durable goods 0.2% MoM (1% exp), S&P -2.6%; Thur: EU pressures AZ to divert vaccines made in UK to EU after AZ announced it will fall short of supply promises to EU, Novavax vaccine 89% effective (60% against S. Africa strain), Russian police raid Navalny home and offices, China warned Taiwan that “independence means war”, brokerage houses restrict trading activity in extremely volatile names (mainly r/wsb targets), Japan retail sales -0.3% (-0.5% exp), Swedish unemp 8.2% (7.7% prev), German CPI 1.6% (0.5% exp), US init claims 847k (875k exp), US 4Q ann’l GDP 4% (4.2% exp), S&P +1.0%; Fri: Germany recommended that the AZ vaccine not used in the 65+ group, S. Africa variant detected in US for first time, researchers find patients infected with two strains of COVID at same time, J&J single dose vaccine 66% effective, Musk sends BTC +20% when he adds #bitcoin to his twitter profile (gives up most of the gains), SEC says will investigate curbs on trading by brokerage firms after backlash, GM announces fully electric fleet by 2035, Taiwan 2020 GDP 2.98% (2.55% exp), Spain CPI 0.6% (-0.6% exp), German unemp 6% (6.1% exp), US PCE 1.5% (1.3% exp), UofM sentiment 79 (79.4 exp), S&P -1.9%.

Weekly Close: S&P 500 -3.3% and VIX +11.18 at +33.09. Nikkei -3.4%, Shanghai -3.4%, Euro Stoxx -3.1%, Bovespa -2.0%, MSCI World -3.4%, and MSCI Emerging -4.5%. USD rose +3.0% vs Mexico, +0.9% vs Australia, +0.9% vs Yen, +0.8% vs Sweden, +0.8% vs Russia, +0.6% vs Chile, +0.3% vs Canada, +0.3% vs Euro, +0.1% vs South Africa, and flat vs Brazil. USD fell -12.6% vs Bitcoin, -12.0% vs Ethereum, -1.5% vs Turkey, -0.8% vs China, -0.2% vs Sterling, flat vs Indonesia, and flat vs India. Gold -0.5%, Silver +5.8%, Oil +0.3%, Copper -2.2%, Iron Ore +0.7%, Corn +9.4%. 5y5y inflation swaps (EU flat at 1.31%, US +2bps at 2.38%, JP -8bps at 0.18%, and UK +6bps at 3.58%). 2yr Notes -1bp at 0.11% and 10yr Notes -2bps at 1.07%.

Jan Mthly Close: S&P 500 -1.1% and VIX +10.34 at +33.09. Nikkei +0.8%, Shanghai +0.3%, Euro Stoxx -0.8%, Bovespa -3.3%, MSCI World -1.1%, and MSCI Emerging +3.0%. USD rose +5.4% vs Brazil, +3.3% vs Mexico, +3.2% vs South Africa, +3.1% vs Chile, +2.5% vs Russia, +1.7% vs Sweden, +1.4% vs Yen, +0.7% vs Euro, +0.7% vs Australia, and +0.4% vs Canada. USD fell -47.5% vs Ethereum, -23.0% vs Bitcoin, -1.8% vs Turkey, -1.5% vs China, -0.3% vs Sterling, -0.2% vs India, and -0.1% vs Indonesia. Gold -2.9%, Silver +2.0%, Oil +7.4%, Copper +0.6%, Iron Ore +10.1%, Corn +12.7%. 5y5y inflation swaps (EU +5bps at 1.31%, US +8bps at 2.38%, JP +5bps at 0.18%, and UK +7bps at 3.58%). 2yr Notes -1bp at 0.11% and 10yr Notes +15bps at 1.07%.

YTD Equity Indexes (high-to-low): UAE +11.8% priced in US dollars (+11.8% priced in dirham), Russell +5% priced in US dollars, Hungary +4.4% priced in dollars (+3.5% in forint), HK +3.9% (+3.9%), Taiwan +3% (+2.8%), Israel +2.9% (+5.1%), Austria +2.5% (+3.9%), Sweden +1.9% (+4%), China +1.8% (+0.3%), South Africa +1.7% (+5.4%), Singapore +1.5% (+2.1%), NASDAQ +1.4%, Thailand +1.4% (+1.2%), Saudi Arabia +1.4% (+1.4%), Turkey +1.3% (-0.2%), Netherlands +1.2% (+2%), Korea +1% (+3.6%), Finland +0.8% (+2.1%), Norway +0.7% (+0.5%), New Zealand +0.2% (+0.3%), Poland -0.2% (-0.1%), Chile -0.3% (+2.7%), Australia -0.4% (+0.3%), UK -0.4% (-0.8%), Japan -0.6% (+0.8%), Belgium -0.7% (+0.1%), Canada -0.8% (-0.6%), S&P 500 -1.1%, Czech Republic -1.5% (-1%), Switzerland -1.9% (-1.1%), Indonesia -1.9% (-2%), Russia -2.1% (-0.4%), India -2.3% (-2.5%), Portugal -2.3% (-1.5%), Euro Stoxx 50 -2.7% (-2%), Germany -3.3% (-2.1%), France -3.5% (-2.7%), Malaysia -4.2% (-3.7%), Italy -4.2% (-3%), Denmark -4.3% (-3.1%), Mexico -4.5% (-2.5%), Spain -4.6% (-3.9%), Ireland -5.2% (-4.5%), Philippines -7.5% (-7.4%), Greece -8.1% (-7.4%), Brazil -8.6% (-3.3%), Argentina -9.2% (-5.8%), Venezuela -9.6% (+44.5%), and Colombia -10% (-6.2%).

Temple of Doom: “We waited to hear what Powell thinks about asset bubbles,” said Indiana Jones, our industry’s leading archeologist, explorer. “He admitted markets may be ahead of themselves.” Echoes of irrational exuberance reverberated through the ages. “But he said interest rates aren’t the right weapon for whipping asset bubbles,” he explained. “This then frames the issue as a regulatory matter,” he said. “But they never really define matters of financial stability. Powell passed the problem to Yellen without a clear mechanism for the Treasury or the SEC to respond.”

Temple of Doom II: “So what does Yellen think about financial stability?” asked Indiana. “She doesn’t,” he said, exploring her archives. “In her final Jackson Hole speech, she emphasized the Fed had been on a mission to make banks safe, and they were, so market risks were in the hands of private investors who understood what they were doing.” The Fed obviously changed their minds in March 2020, saving overleveraged investors from themselves. “So Powell just punted issues of macro stability to Treasury, where Yellen will bury them. And we’re left right back where we started.”

Crazy Ivan: “Monday, Short-Interest factor had a 3 standard deviation move higher. Hedge Fund factor fell -1.3 standard deviations,” said CO2, gasping for air. “Tuesday, Short Interest factor jumped 5.9 STD. HF ownership fell 2.4 STD,” he added. “Wednesday, Short Interest jumped 7.6 STD. HF ownership fell 4.5 STD.” Risk managers swung the scythe. “Thursday, Short Interest fell 2.5 STD. HF ownership was up 2.3 STD. That’s when Robinhood restricted trading,” said CO2. “Then Friday felt like any other day, despite the S&P 500 puking 1.9%.”

Crazy Ivan II: “Our biggest prime broker said this week was one of the largest gross downs they’ve ever seen,” continued CO2, his position tiddy. “No one stress tests their books for a 7.6 standard deviation move.” Last time things went wrong was when the momentum factor turned abruptly. This time some minuscule retail stock sparked the short squeeze. “Obviously there are too many funds running highly-leveraged factor-neutral books,” said CO2. “The breadth of the blowups is widening, the depth of pain deepening. But will anything change? Nope.”

Anecdote: Got a soft spot for the short side. Less crowded. Usually. Solitude speaks to my soul. But our institutions conspire to squeeze shorts - make too much money, they change the rules. And central banks strive to lift the price of absolutely everything by debasing our currencies. 2% each year. In perpetuity. So, to survive as a short, you’ve got to be selective, timely. Follow key principles. Avoid shorting things highly convex to the upside. Discontinuous. If you do, trade with a tight stop, honor it, religiously. Know your liquidity. Spend more time imagining what could go wrong than what might go right. Lest you get GameStopped. BlackBurried. And like everything you ever do in markets, know who takes the other side of your trade. Understand what they think they know, why they believe you’re wrong. Articulate what you think you know that they don’t. Visualize how you’ll react when your conviction gets tested. Every trade worth its weight will torture you. Embrace it. The universe doesn’t reward pleasure, it pays you for pain. And after you’ve done that for years, lived the torment, look for trades where others think they’re long without realizing they’re short. Most people bet that tomorrow will look like today – that wager rarely goes wrong. So they build status quo longs, without quite realizing they’re short change. Long bonds? You’re short inflation, everyone knows that. Long stocks? You’re short inflation too. You see, owning equities at these valuations requires one to believe the Fed will ease aggressively on any selloff. But the Fed can’t responsibly do so unless inflation remains muted. If our fully politicized Fed chose to support stocks and ignore rising inflation the world’s ubiquitous dollar longs would lose confidence, the greenback’s value would get destroyed. Which means dollar longs are now short Fed courage, independence. And a dollar decline is inflationary, which would amplify the conditions that precipitated its decline. Such a reflexive dynamic is something we haven’t experienced for many decades. And this reflexivity is the market’s most underappreciated short.

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.