Wednesday, January 30, 2013
TMM were recently comparing notes with friends around the market (and indeed some not in the market but in other large institutions) over the pleasures of online compliance, ethics, anti-bribery and anti-money laundering training. Of course these courses are designed to pass the onus of responsibility from the company to the individual and prevent said company enduring prosecution for the actions of its employees, but the courses themselves often appear to be written by the same people that design tax returns, benefit forms or immigration documents. The clue is the way they veer wildly from mind numbing tedium that is little more than "can you manage to point the mouse where we tell you and copy theses letters" to the bizarrely perverse obscurity of which day of the week you are allowed to accept a $10, not $20, gift token from your grandmother and not declare it in a very large book kept in a safe three buildings away and in which colour pen.
The multiple choice questions that always end the "how fast can I click through this" course are also of a very predictable form. Three options are along the lines of "don't tell anyone unless it's inside information in which case leave it on the photocopier" and a fourth, the correct one, which contains the words "inform your Money Laundering Reporting Officer (MLRO) or line manager".
So bearing those prerequisites to a successful compliance assessment in mind Team Macro Man offer you their own version. As usual you have three attempts to achieve the 80% needed to attain a pass before you will be reported to compliance.
1) A man arrives in reception with a striped top on, a balaclava and leather gloves, says he has £75m he needs to deposit tom/next. He has no KYC docs, but plenty of KFC. Do you
a) Take the bargain bucket and the money
b) Take the bargain bucket only
c) Offer the Money Laundering Reporting Officer (MLRO) two pieces of chicken and a week in the KFC City branch all expenses paid.
2) As you enter your building you notice a senior member of management "slipstream" you through the security gate without using an ID card. Do you
a) Ignore it and carry on as it isn't worth the aggro.
b) Escort him back to reception and make sure he proves his identity before attempting to re-enter.
c) Rugby tackle him to the ground, then smash his forehead repeatedly into the genuine Italian marble flooring whilst whispering into his ear "This is for last year's bonus, arsehole" and screaming loudly "HELP HELP INTRUDER !!!!"
3) Ethel and Leonard Dalrymple , who normally trade their account once a year, call to say they have won €250mm on the Costa Del Sol Lottery and begin trading clips of €10mm a time on March 2013 delivery Lard futures , do you
a) Tell them it's normal for the bid /offer spread to be 20% of the cash price and deal anyway
b) Offer them a £500 a night, all expenses paid trip to Butlin's Bognor Regis holiday camp , with unlimited cava and Pringles in return for a sole new issue order.
c) Offer the MLRO a magnum of cava and a week in Marbella to let you open a safe custody account in your name.
4) You are in a nightclub whilst on a ski holiday in Zettmypantsonfeuer with friends and are approached by a svelte 22 year old blonde proffering Hedonist-A-Go-Go shares at a huge discount. A firm in which you have a controlling interest as a founding member: Do you
a) Accept the special offer and commission rebate without saying anything
b) Ask, slightly aghast, "do you know who I am?" whilst revealing your faux chamois leather thong and walk away from the deal
c) Offer the young Frau some "special advice" only available from your suite , and also partially do a) and b)
d) Report the incident to your MLRO on your return to the UK three days and three stone later
5) Your colleague Steve is shaking and sweating violently, his pupils are dilated and he has clear needle marks on his forearms. You notice him levering open the cash till and ask him if he is alright. He appears shocked by your approach and pleads with you to open the till or he's a dead man. Do you
a) Open the till for him and suggest he switches dealer to Pedro who isn't so violent.
b) Lock the door, pull out a reefer to share and tell him to just chill man, it'll all be ok.
c) Report the event to your line manager or MLRO as your colleague's behaviour is suspicious and out of character.
d) Action (c) but then ring them back amending your report as you realise that Steve's actions are actually in character as this happens most Monday mornings.
6) You have been appointed CEO for life of Hedonist-A-G-Go Plc after a long and bitter takeover battle which involved taking a poison pill to despoil your erstwhile hostile partners by over paying vastly for Wendy's Tasteful Flowers PLC (WTF). You have been approached by Appleby Inc(AI) who inform you off the record of a cancer gene being discovered in the petals of the blue Delphinium ( Bolluxia Sapphic Deum) and he knows you have a pending bid by a deranged asset stripper for WTF. Do you
a) Offload WTF as best you can to the asset stripper and pray AI s info turns out correct
b) Buy a majority stake in AI Inc asap and claim it was in house research
c) Send a huge bouquet of Blue Delphiniums to Bashar al-Assad signed "hugs from Mahmoud".
d) Report your quandary to your 23 year old Angelina Jolie lookalike MLRO.
7) Fidel Castro walks into your branch and despite his false nose, Kim Il Jun suit and Sudanese passport you have a suspicion that he is not who he appears. On checking his signature against the one you have on file you find that the "tittle" dotting the final j in Mahmoud Ahmadinejad is a full millimetre out of place. Do you
a) Ask him to have another go at the signature pointing out where the discrepancy lies
b) It's close enough, so you willing cash his cheque from from "Embargoed Oil" and make the payment to "Nukes 'R' Us".
c) You see a cross sell opportunity and introduce him to your Wealth Management department.
d) Inform your MLRO office and line manager as you have spotted a Syrian stamp in his passport, Syria being a sanctioned country.
8) An old friend pops in to see you after a very long lunch at the City Club reeking of port and cigars and sporting classic red wine lips. In his battered brief case he has several large wads of grubby £50 notes. Swearing you to secrecy, he tells you there is about two million quid that he has been given as "Thank yous" over the years for various deals he did with friendly overseas defence ministries. Do you
a) Wheel him back to the City Club and blow as much of the contents of the case as you can on the oldest vintages on the list.
b) Suggest he invest it in a Jersey based OEIC because they don't check too carefully.
c) Remind him that you are an institutional Fund Manager and that effectively you don't get out of bed for less than £100million these days.
d) Ask your MLRO what is the most effective wash cycle for dirty £50 notes.
9) You are abducted unexpectedly from a strip club in Mayfair by Martians who inform you that in fact Rasputin/Beria/Stalin/Hitler/Mussolini/Pol Pot /Genghis Khan and Piers Morgan were all in fact closet bankers . You had just invested heavily in a charity, Bankers Easily Lie Lots, Endeavour Never Fails (BELL END) and had persuaded Great Ormond Street Hospital( GOSH) to invest all their monies with you before this was made available to the rest of the Human Race. Do you
a) Let GOSH go ahead anyway and hope that no one believes your story about the Martian Abduction was correct.
b) Persuade their leader, Vince Cable , that backing BELL END would be unwise as all the wrong 'uns in the known universe have always been bankers.
c) Over supper with the 22 year old ex Miss World MLRO let slip that you have a story unlike any before but that no one would believe you and did she have any contacts at The Daily Mail who might be able to help give the story some real clout
d) Ask for your LIBOR rate to be artificially ramped for sufficiently long enough to get away the option exposure on your Cliff Richard Ain't Perfect (CRAP) EBT
10) You are fiddling with the screen on your smartphone trying to text the details of the next M+A deal to your mates but accidentally switch on the camera mode as your other hand is opening the door to the stationary cupboard. On entry you trip over some discarded clothing which causes you to hit the shutter button. The flash in the darkened cupboard temporarily blinds you so you stumble back out and close the door. Back at your desk you realise that the resulting photo depicts your MLRO and line manager in a very compromising position. Do you
a) Delete the photograph as it is in clear contravention of your institution's obscene publication rules.
b) Report it to your MLRO and line manager.
c) Suggest a payrise and blind eye policy towards your future conduct would be a good idea.
d) Post it on a social networking site.
e) Suggest a threesome.
Please now complete the following survey
Was this course easy to understand?
Did you find the assessment in line with our diversity agenda?
Was this course socially inclusive?
Were you happy that your human rights were not impugned?
Please consider the environment when completing this survey.
Finally, to complete the course, please sign the following declaration-
"I agree that should anything occur to encumber this institution with either reputational or financial costs due to lack of senior management oversight or failing policy, I will take sole responsibility and will willing be banged up for 20 years and used as the scapegoat leaving said senior management to continue with their self-aggrandisement".
Tuesday, January 29, 2013
Sorry for the lack of posts, TMM have been sliding down hills in Austria and very nice it was too. Germany and Austria were as clean and efficient as ever and that includes the "Après ski" where the Austrians are still (in our eyes, so please pipe down any Canadian readers) the masters of "Après".
So back to the markets. The last couple of weeks have been of no great surprise to TMM as the stresses of 2012 unwind and positioning tries to revert to a more normal balance. FX land has seen the safe havens unwind and it is interesting to hear the background excuses that cite local yet really its all part of the same great relief trade. For example GBP's tanking is, in TMM' s eyes, just as much about money going home as it is to the new focus on potential "Carney cuts" or recession part 3 (Which makes us wonder what will happen to the top end London property market. Time to play the Chelsea/Chester regional house spread -not that we can)?
Equities have done us proud over the past months but we are getting a bit wary. Not so much towards equities themselves, but the global mood backdrop as expectations have pretty much converged on -
- US recovery - Agree, but looking at the Citi surprise index for US data sitting on zero we would suggest that s in the price.
- The Bernank prostituting money supply like a 5 buck hooker
- Europe will not die today. ( even Greece today announcing the worst is over)
- Asia is just fine.
- Japan will Bernanke the Bernank out of the Bernank.
- Yields will all rise.
- Equities are the no brainer. - Well we would agree that they WERE a no brainer, but as per above, we now have doubt.
Lovely - so what could possibly go wrong? Even our friends at Hero Zedge appear to be scraping the bottom of the barrel for new negatives. (US lost the German's gold? Purleeese!). But the debate within TMM is how isolated different assets can remain if or when we start to see pressures build in other areas. For example, EM credit structures where rising US reference yields are making things pop and squeeze. Add to that the weight of positioning in that field that has been chasing the last bp in TMM's eyes EM High Yield credit is looking shaky. Recent moves in EM FX are predominantly being blamed on potential FX wars in Asia but we think there may be more behind this.
But how infectious would a credit sell off be? The pressures of "Risk on Risk off" have appeared to diminish and the fast flowing Roro river has hit the low planes allowing it form a delta with different asset classes feeling they are no longer influenced by other flows. Backwater micro analysis proliferating in the absence of daily changing macro news. Already the debate has opened up as to whether 2013 is a brave new world, a new paradigm in contrast to the paradigm rule book of 2008-12. This is almost as good an indicator in its own right. As soon as we hear the words "Paradigm shift" we worry.
So if we are already seeing positions being justified on the "No, this time is different", we are ready for the next "Oh that shouldn't have happened" event to occur to remind everyone of Mark Twain's quote about rhyming history. We don't believe that we can have a panicky sell off in one market without it starting to infect others, (Pink Flamingo rule 1) so despite equities being our "least worst" long option compared to bonds and commodities, we are putting our P+L where our thoughts are and have unloaded all our equity index longs in anticipation of the next unseen unseen. We would go further and suggest that that unseen is going to come from Emerging Market Credit.
What else? Well if we are looking for an EM wobble then the least we can do is look at the high yielding NAFTA favourite the MXN. Everyone's darling but if we get a big enough wobble we could see USDMXN easily pushing through 13.0000. While we are surmising a turn perhaps we ought to even look at GBP turning back up for all the opposite reasons that world has sold it. So let's go mad and buy GBP/MXN.
Friday, January 18, 2013
TMM have often commented on the PIN (Price is News) function of markets and over the past year that has normally been applied to the self-feeding frenzies of downside moves, where the likes of Portuguese 10yr went to 12% and Spain went on its hikes up 7% mountain. Today we are thinking that the ratio of real news to Price is News on some of the more popular bullish trends is showing similar traits. "Not seen since the last time" comments abound and we feel that it is probably best to stand back, leave our short dated downside hedges in place and go with the flow.
Euribor has been a pain but with Lagarde reminding the market that the European economy isn't out of the woods yet and advising easy ECB policy, we are holding tight (though we can feel the knife steel through the Kevlar of our gloves).Spooz appears to be hung up on 1475 expiries today and each asset market appears to be coping with its own flock of screaming pink flamingo chicks , as core asset reallocations take place swamping micro news. Data really appears to be taking a back seat to portfolio flows.
So on with the Non-Predictions. After charts, graphs and automobiles its time for a more light-hearted look forward, so where better to start than with our annual favourite as its always a sure-fire winner -
5) The BBC will NOT stop linking any injustice anywhere in the world to the UK Government spending cuts and will NOT stop generalising anyone working in a bank as evil but will manage NOT to generalise all journalists as phone tapping, family destroying, moral bankrupts.
6) David Cameron's call for an EU referendum will NOT stop UKIP from pushing the Tories into 3rd place in the European Elections. TMM don't believe that the "long awaited / eagerly anticipated /most important" Cameron speech on EU membership will be enough to swing the "disgusted's of Tunbridge Wells" and the other angry old men of the Tory party who are defecting in "Tea party" style. Perhaps the Tories are missing the point as polls suggest UKIP is winning on immigration policy rather than abject anti-EUness.
7) "Blogger" will NOT cease to irritate TMM by screwing up the formatting whenever they try and post something. In fact we might expand that to - The huge technological giant Google will NOT fail to surprise TMM in the shabby, unthoughtout and user unfriendliness of all of their recent products. (e.g. - Google circles, blogger, impossibility to link Android apps to new Gmail accounts).
8) Vanadium redox batteries, despite their clear technological advantages will NOT catch on as a viable energy storage system. A simple call as TMM have had investment in them for many years and have seen squat return so far so TMM really can't see why things should change this year. Though they should.
9) William and Katherine's baby will not have the same first name as a global leader or leader of a UK political party. Or James (Jimmy).
10) It will NOT rain on St Swithun's day in the UK. It's only 9 months ago that the UK was in the grip of hosepipe bans and dire warnings of the most dreadful drought. Back in March TMM remarked that the introduction of the ban was fantastic news as hosepipe ban announcements usually saw the onset of biblical deluges. And so it was. The UK has racked up its wettest year since some other wet year and we are drowning in forecasts of more to come. Knowing how the Press and of course the markets, love to extrapolate (we can remember the predictions ten years ago of "no more snow in the alps" and "plant your English gardens with cacti" articles with wry pleasure) TMM will instead apply their strong belief in mean reversion and will predict a lovely UK summer this year.
11) This year's New Year diet plan will NOT succeed and, which ever new fad it is, will be quickly usurped by another "foolproof" diet which insists on highly expensive books, ingredients, apps and plans. TMM don't know why if people can't grasp the simple concept of "calories in versus calories out" they think they can manage anything more complicated.
12) The UK press will NOT fail to publish a picture of a prat on skis trying to get to work everytime it snows.
Monday, January 14, 2013
Europe - Well TMM read that one wrong and regret our move against our big trend thoughts in trying to finesse the thinking that the market had got a little ahead of itself on its path back to a new normal from one of abject doom. Nevertheless, for those with ammo, adding to existing Euribor longs (or if lucky enough not to already have them, adding one) doesn't seem like a terrible idea. Either way, it appears that together with the market, we a can add someone else to the "getting a bit cocky" box. Dr. Aghi's performance was verging on the valedictory and though we detested the blinkered old bureaucracy that was the Trichet/Duisenberg ECB, the cult of personality appears to be infecting Mario. First symptom? Casting opinion on matters that aren't his to cast opinion on. Don't go all Greenspan on us now Dottore!
TMM like to think that we have seen a 3 stage capitulation on short risk positions over the last couple of weeks. First came the improving Chinese data (though many are again questioning its validity), then came the ironing out of the cliff to a hump and finally Draghi announces Europe cured (well not quite, but that appears to be the market response). With such a huge collective sigh of relief and resurgence of media coverage of upside even TMM (with their view of recovery) are wondering if in the short term things are a little ahead of themselves to the point of having bought puts in SPX on Friday looking for a turn lower in direction and higher in VIX. Much like our languishing USD/JPY puts, this is a shorter term hedge against our longer term trend expectations.
But on to more pressing things - TMM's third Non-Prediction of 2013:
3) EM equities will NOT be able to resist the improving domestic growth & inflation mix as well as the lift in the global manufacturing cycle and should handily outperform their DM counterparts.
Continuing the theme of the past few months, TMM reckon EM Equities have a lot further to go, based upon a combination of:
1. The turn in the global manufacturing cycle driven by a combination of the US consumer & pent-up CapEx-related demand from corporates.
2. Monetary & fiscal stimulus in China.
3. Reduced drag from Europe after the recent stabilisation of the PMIs (last month's dire IP numbers notwithstanding).
4. Food inflation risks overstated, particularly given upcoming reweighting in the Chinese CPI basket, meaning that the easing cycle of the past 12-18months should still be supportive of both liquidity conditions & growth.
5. A return of capital flows into EM (and Asia in particular) as real money underweights enacted in early/mid-2011 on the back of EMU-break up fears are reversed.
The below chart shows the YoY change in MSCI EM vs. DM vs. a proxy for the growth & inflation mix based upon a bunch of PMIs, export figures, money supply & inflation prints and is showing a reasonable divergence right now. TMM would argue that the divergence in 2006-8 can be explained by the BRIC-lovefest which subsequently unwound, and that of 2009 by non-linearities uncaptured by the model. The current gap looks to be around 15-17%, and as discussed above, likely a function of the very strong risk aversion of summer/autumn 2011.
Real exports from the big-3 in Asia (ex-China, ex-Japan) have picked up momentum over the past few months, driven presumably by robust US consumer demand. Post the fiscal cliff agreement, the CapEx rebound TMM have been talking about for a while should provide further gains here as pent up demand is released (though, admittedly, the debt ceiling deadline next month may postpone some of this).
Since late summer, fund flows (see below chart, courtesy of TMM's mates at Nomura) have picked up significantly, powered by the turn in exports, a resumption of appreciation pressures on the CNY - partially due to the PBoC calming market fears of capital outflows & partly due to China's soft landing. Given the real money underweight, above valuation & signs of fundamental strength these should continue to pick up pace.
Given the policy stimulus in China, TMM believe the best place to be is Asia, and within that region, their favourite pick is Korea (but also have the usual MSCI EM vs. DM). Obviously, the recent move in Samsung vs. Apple has been large, but more broadly, Korea seems best place in Asia to pick up inflows (given the currency has become dominated by sticky bond flow it is now far less volatile and thus less risky for equity investors). Moreover, its strong manufacturing & electronics bias make it the perfect candidate for the turn in the manufacturing/services cycle and the coming CapEx ramp up in the US. The one fly in the ointment is, of course, KRW/JPY which has had quite a large move. But as per TMM's first Non-Prediction, we reckon that Japan has permanently lost market share, so 15% on the exchange rate is certainly not going to help them (or hurt Korea) too much - at least not in the coming year.
Trading at just 9.6x 2013's earnings, it is amongst the cheapest of the liquid EM markets (H-Shares only beating it at 9x). In terms of price targets, TMM think the trade has about 15%-20% in it, which corresponds to the overall EM/DM mismatch in the first model chart & the underperformance vs. the S&P 500 since summer 2011:
We will be following up soon with a couple more predictions but for now we really have to add Non-Prediction No.4:
4) The UK media will NOT recognise the difference between Captain Oates' famous walk to oblivion in the South Pole and the minor inconvenience of having to commute to work in a light dusting of snow.
Tuesday, January 08, 2013
After the hectic start to the year seen last week, this week so far has been somewhat of a damp squib. This leaves short term overbought or sold signals a bit of time to come back from extremes, for USD/JPY in particular. But given TMM are long relatively short-dated USD/JPY puts, they would rather see this correction pick up a bit of panickyness, as opposed to what can so far be considered by bulls to merely be a "healthy consolidation" before a further move higher.
Another notable twist in market dynamics is how the complete lack of shouty news has left the market chasing flow. Moves being blamed on any old news headlines have rapidly morphed into low level debate over who has done or may do what. Yawn. Basically its suddenly gone pretty quiet. So we press on with our Non-Predictions.
2) The Polish Zloty will NOT underperform the Czeck Koruna even if the NBP cut rates aggressively.
Let's start with Poland. Although CPI has surprised to the downside over the past few months, this will not last. The National Bank of Poland often stress that they want real interest rates to remain positive. The model suggests that CPI should remain above 3% for the coming year, which implies a floor for rates. And even if they do cut rates aggressively, TMM reckon that it will not be long before they are once again tightening.
But with the recent NBP minutes suggesting more members dissenting in favour of a 50bp cut in December, the curve prices around 150bps in the coming year, and well below the real rate floor implied above. TMM don't disagree that the cutting cycle may continue over the next few months, we just don't think they will be as aggressive given the inflation outlook and also the coming improvement in the activity outlook (more below).
By contrast, the Czech Nationalbank are faced with the zero bound on rates and have become increasingly vocal on currency strength, the relative real rate spread vs. Poland has moved sharply higher in favour of the Zloty. Of course, the EMU crisis has hit Poland hard as it runs a reasonably large current account deficit (in contrast to the Czech Republic's surplus) and coupled with the risk aversion of the past two years has resulted in significant underperformance of the Zloty vs. the Koruna.
But TMM reckon there are reasons to believe that this is coming to an end now as there has been a dramatic improvement in the Current Account over the past year...
...and while both IP & retail sales have been weakening in Poland, they have not decelerated as much as in the Czech Republic, and look set to bounce in the coming months as the Eurozone begins to exit recession. Poland should be in a good place to be as the data in Europe improve.
The Czech Koruna, however, just looks like a crap Euro to TMM as at the end of the day, it is an EM currency (no matter how credible the central bank...) with zero yield with the possibility of currency intervention to weaken it on the horizon.
Putting those together, TMM like both being long PLN/CZK but also paying the 9x12 FRA in Poland.
Saturday, January 05, 2013
Before moving onto our first Non-Prediction of 2013, TMM thought they probably should at least comment upon last week's moves in fixed income markets which appear to have caught a lot of people off guard. The FOMC minutes suggesting that QE3 could end by the close of this year evidently surprised a lot of people. TMM were lucky enough to have been short various rate markets, but covered these on Friday morning ahead of Non-Farm Payrolls. The spike higher in yields has been very rapid and reasonably large - justified to some extent by the passing of the fiscal cliff deal and generally stronger data, but things do not move in straight lines.
There are some strong underlying currents developing at the moment with govvies looking as though they have minimal upside globally, equities showing their strength as alternatives to highly complex and margin tight credit products and reflation trades in general showing their mettle (pun intended) and the post FOMC reaction was like a small "no more QE" earthquake shaking them. Bonds were swiftly shaken lower, equities got shaken down against trend and USD/JPY was accelerated on its path. TMM would normally look for opportunity to buy things that have been shaken back against trend in such events (equities in this case), but some things have moved so far forward of where they should be right now we are looking to go countertrend.
The fact that things like Schatz & Euribor have also sold off to the extent that barely any chance of a further deposit rate cut is priced in has TMM reckoning that buying things like ERZ3 or ERM4 ahead of the ECB meeting represents compelling risk/reward. Additionally, seemingly in contrast to the theme of our first 2013 Non-Prediction, TMM purchased some 1 month 86-strike USDJPY puts on Friday, for a cheap-looking 33bps. Given the parabolic nature of the recent move and weekly RSIs being as overbought as they have been since 1997, the setup for a countertrend move early next week looks good. We also appreciated the market reaction to an "as expected" NFP which gave strong clues that expectations vs. reality are ahead of themselves in the very short term.
And finally... on to our first Non-Prediction of 2013:
1) Japan will NOT escape deflation this year, but reflation trades will NOT disappoint.
TMM have generally been skeptical of these kinds of trades, given that people have been trying them for the best part of 15 years, and especially over the past couple of years, with little or no luck. But, as regular readers will know, TMM changed their minds in recent months (sadly missing the most recent moves from mid/late-December, but booking a tidy profit so we shouldn't complain) for two main reasons:
First, the Basic Balance of Payments (see chart below from GS) has failed to recover from its post-Tohuko earthquake deterioration, instead remaining mired in deficit. On the trade side, the nuclear plants haven’t been switched back on (much to TMM's surprise - though the poor showing of the anti-nuclear parties in December's election & subsequent TEPCO rally as the Keidanren are de facto calling the shots now probably means some reversal of this position), territorial tensions with China have hit (especially) auto sales and Japan Inc. is being hollowed out by Korea (TMM bought a new laptop in the sales, with an equivalent Samsung spec being as much as £400 cheaper than their hitherto trusty Sony Vaios - it wasn't a hard choice...). The experience of the UK over the past 10 years suggests that once lost, it is very difficult to regain market share, even after FX depreciation.
The other main component of Japan’s Current Account is the Income Balance, which sits in hefty surplus. The problem here is that maturing bonds are being reinvested at poor yields, which threatens to structurally weaken this component going forward (even after considering Mrs. Watanabe’s recent flirtation with the Turkish Lira). It appears that the deterioration in the BoP has become structural.
Second, there has been a dramatic change in macroeconomic policymaking within Japan over the past year. The BoJ adopted a 1% inflation target and began expanding its balance sheet at a pace it has historically resisted. But it has still opposed being as aggressive as the Fed, with Governor Shirakawa repeatedly arguing that monetary policy cannot do anything to get out of deflation. The recent election, however, with a super-major for the LDP-led coalition, changes all of this given that the central theme of election campaign was the call to institutionalise a 2% inflation target for the BoJ and to embark upon aggressive policy easing (both monetary & fiscal). TMM cannot imagine an election in the UK or US being centred on such a specific monetary policy framework - the closest parallel really being the UK's 1979 election & the embrace of monetarism. TMM cannot remember political pressure upon the BoJ ever being so great, with explicit threats to change the BoJ Law if they don’t play ball. This is doubly important given Shirakawa’s term expires in March and it seems likely that the academic Iwata san, who is known to favour aggressive easing. Press reports suggest the BoJ have accepted the government's will.
Of course, the Nikkei & Yen have moved quite a lot already, but they can certainly move a lot more. When the deleveraging cycle in Japan ended in 2005 (see chart below) we were given a hint of the potential for reflation trades, as the Nikkei rallied 60%, the belly of the curve sold off 100bps and USDJPY rose 15%. And exit from deflation still looked years away. Then, as they often are prone to do, the BoJ torpedoed everything by ending QE and then moving to hike rates. If policymakers are pushing in the right direction and the BoJ don’t about turn and crush the reflation, things can go a lot a further.
Can policymakers raise Japanese inflation expectations towards 2%? Well, it’s a tough shot, but the evidence from the US & UK is that if central banks are aggressive enough, they can move inflation expectations to where they want them (while nominal yields have fallen over the past few years, whenever forward breakevens have moved too low, monetary easing has followed). TMM are in the camp that believe the BoJ have just not tried hard enough before.
As far as USD/JPY goes, we all know the Yen is overvalued as far as PPP/REER metrics go, but the bulk of the reason for the move of the past 5 years is the dramatic fall in real rates in the US, which for the 10yr is now something like -65bps (up from around -90bps in mid-December). Stitching together linkers & inflation swaps (not perfect, but good enough for this back of the envelope exercise), Japan has been stuck with 10 year real rates in the 1-2% range in the face of the Fed moving those in the US down from 2.5% to -0.9%. The flip side of real rates being so relatively high (despite low nominal JGB yields) is that inflation expectations in Japan sit at just 0.50% for 10 years. Still, since introducing their 1% inflation target earlier this year, the BoJ have at least managed to get these positive (having been showing continued expectations of deflation beforehand) and also to move long-term real rates to the lowest they have been since at least 2005 (see below chart).
The chart below shows the 10 year real rate spread between the US & Japan (blue line) vs. USD/JPY (red line). It also shows a few scenarios for what could happen (assuming that US inflation expectations remain unchanged at current levels). The bear case (light blue line) shows a projection of the spread if 10 year Treasuries are largely unchanged from their end-2012 levels (1.75%) by the end of December 2014 and the BoJ is unsuccessful in moving inflation expectations higher than current levels. In this case, USD/JPY is likely to move back towards 82, not a disaster. The Stable Bonds case (purple line) assumes that the BoJ are able to move these as high as 1%, but overall bond yields do not change (presumably the function of continued aggressive easing and tepid growth globally). A gradual move towards 90 for USD/JPY can be expected in this outturn. TMM's base case is that US growth reaccelerates as Euro-contagion becomes less of a driver of markets & the CapEx cycle ramps up, sending 10yr yields towards 3% by the end of 2014 (driven by a 125bps move higher in real rates). In this case, the BoJ are partially successful, getting inflation expectations up to 1% and targets USD/JPY at around 110. Finally, the bull case is both a re-acceleration of the US resulting in 10 year yields pushing 3% by end-2014 *and* the BoJ are successful in moving inflation expectations up to 2%. This would send USD/JPY back to levels not seen since 2007.
However, the rapid acceleration to the topside in USDJPY (outperforming the real rate move so far) since mid-December has TMM hoping for a pull back before dipping back in again (it's kind of hard to buy something when the 14 weekly RSI sits at its highest level since February 1997...).
What about JGBs?
Well there’s not really much to be said other than shorting JGBs has been a graveyard trade. But should the BoJ manage to reflate the economy then it is not too much of a stretch to imagine with 1% growth + 2% inflation that medium/long-dated forwards should be trading around 3%. The long end (10Y10Y and 10Y20Y) have already moved towards this level – but then, they have traded these levels before when reflation hardly looked imminent. Should the BoJ gain traction, the 10yr sat at just 0.7% looks very vulnerable and there is plenty of room for the 5Y5Y forward to move higher. The risk reward to shorts here, with so much BoJ easing priced in to the curve strongly favours selling JGBs, though TMM reckon after the move lower in fixed income globally the past week, we get better entry levels. After all, if the BoJ are successful, yields will move sharply higher, if they are not, the negative carry is only around 18bps/year with a move to the 2003 deflationary panic lows of 41bps (which seems exceptionally unlikely given the BoJ are easing aggressively and there is no NPL/Resona bank shock right now) wiping out a further 30bps.
And the Nikkei/Topix?
Well, with the recent rally, the forward P/E has already expanded from around 12.5x to 15x, which isn't exactly cheap, so buying upside here has to be a function of EPS growth. Which means it is going to be a function of how much the Yen weakens (as far as exporters go), but also the extent to which raising inflation expectations spurs domestic demand. The below chart shows a model of the one year ahead EPS of the MSCI Japan based upon the Yen, the Tankan, ISM, Core CPI & M2. Using relatively conservative assumptions for these variables produces an EPS number of around 44.9. With the index trading 549, this produces an earnings yield of around 8.2% (or 12.2x 2013 earnings). That looks cheap enough to want to own some, but again, given the recent moves, TMM are hoping for some retracement to allow them to get back in.
So that's the theory behind the first of TMM 2013's first Non-Prediction. A little more drawn out than in past years, but the Yen theme needed a more detailed post as we haven't done it justice since it hit No. 1 in the "Trade Parade" over the past few weeks. More non-predictions to follow in the next few days.
Thursday, January 03, 2013
Happy New Year!
Well, once again it's that time of the year where TMM mark to market their non-predictions for the prior year and foolishly attempt to make new ones about the coming year. As JK Galbraith said, economists forecast not because they know, but because they are asked. Wise words to bear in mind indeed. P&L wise, for TMM 2012 was a reasonably good but not stellar year, finishing a smidge better than their peer group, which they'll take, but like 2011 before it, they hoped to see a bit more reward for the effort put in, particularly in their rates trading. Anyway, enough with the moaning and on to the laughing at the ludicrous things we didn't predict...
1) 10yr Gilt yields will NOT finish 2012 below 3%.
BIG MISS. Well that was completely wrong as their macro model for Gilts diverged even further from the market (it actually currently points to a "fair value" of around 3.70%!) as QE and the flight from European bonds into safe havens as a fear of EUR-redenomination/Grexit overwhelmed any sense of value, particularly from our friends in Japan & Switzerland. TMM are still searching for a catalyst to reverse this hideous overvaluation of Her Majesty's Gilt-Edged securities.
2) 3yr CNY Shibor swaps will NOT close 2012 lower on the year.
HIT. The much mooted "hard-landing" for China didn't materialise and as activity & exports began to rebound in the autumn and the market begins to focus on the potential for tightening in response to a rise in food inflation by mid-2013 these closed the year not far off their highs.
3) 5y5y forward UST will NOT finish the year below 4%.
MISS. A similar story to Gilts. While ISM did indeed move towards 55 in line with TMM's model forecast, economist GDP forecasts and the overall number for 2012 GDP looks to have been around the 2.2% (close to trend) growth TMM expected, bonds were primarily driven by Grexit fears and then expectations of (eventually delivered on) of further QE. A case of getting the macro "right" but the market response to it "wrong".
4) The RBA will NOT cut more than 25bps and the Cash Rate will also NOT finish 2012 below its current level of 4.25%.
BIG MISS. Well somehow, TMM managed to break even on this theme by a combination of playing the range, but more importantly, luck (we all need a bit of that!). Along the lines of our belief in a soft landing for China (which proved correct), that the labour market would not weaken anything like the dire predictions of an unemployment rate north of 6% (which also proved correct, as the unemployment rate sits at a mere 5.23%), growth would be robust (which was also correct, looking like an above trend 3.5% for 2012) and that core inflation measures would remain in the middle of the band (which proved incorrect, as the RBA's trimmed mean measure moved down to 2%) would mean higher, rather than lower rates would be required. Unfortunately, the fall in inflation and overvalued (though not grossly so) Aussie Dollar led the RBA to capitulate on its view of China (and the mining sector) and also on the domestic sector, cutting rates. TMM reckon that policy is now far too loose in Australia and the risk of an about turn in policy is very real and they resold the front-end into December's rally.
5) Platinum will NOT under-perform Silver.
HIT. Not really much movement here over the year to be honest, but this is still a trade TMM like.
6) Copper is NOT going anywhere.
HIT. While finishing up around 8% on the year, volatility realised around 22%, meaning selling Copper vol at 40% produced a tidy profit.
7) Oil vol will NOT disappoint.
HIT. Well, only just... realised vol of 26% only just beat the 23% implied.
8) EM Equities will NOT repeat 2011's under-performance of DM Equities.
HIT. Again, only just, eking out just shy of a 2% outperformance. This is a theme TMM expect to continue this year, but more on this in our 2013 Non-Predictions.
9) Equity Bears will NOT stop trying to argue that earnings will fall as a result of margins contracting from multi-year peaks, but S&P earnings growth will NOT disappoint the consensus of 5.5%.
MISS. Equity Bears did indeed spend a good deal of the year arguing that earnings will fall as a result of margins contracting, but for all the hyperbole, margins only fell by 10bps which is neither here nor there. And earnings still look like they will have risen by just below 3% YoY, but that is shy of TMM's 5.5% threshold and so this is a "miss". However, TMM still walk away with an intellectual victory in that margins neither collapsed, and nor did earnings, something they consistently point out only happens during a recession (something the Herozedgers never cease to predict...!).
10) The ASX200 will NOT reverse its poor relative performance and will remain a laggard of global equity markets.
MISS. While the ASX200 was no stellar performer, it was also not a laggard, finishing in the middle of the pack, as RBA easing offset the high Aussie Dollar. Getting this one wrong is a corollary of getting the RBA call wrong.
11) Ed Miliband will NOT be the leader of the UK Labour party by the end of the year.
MISS. What a difference a year makes with him sitting 8% ahead in the polls. TMM desperately hope that Cameron & Co. can pull a rabbit out of the hat by 2015 as otherwise the UK will be faced with a the most left wing government seen since the dark days of the 1970s. Shudder.
12) The BBC will NOT stop linking any justice anywhere in the world to the UK Government spending cuts and will NOT stop generalising anyone working in a bank as evil but will manage NOT to generalise all journalists as phone tapping, family destroying, moral bankrupts.
HIT. Well... that *was* an easy one wasn't it...?
13) Consultants will NOT find life easy. Shareholder backlash to senior management pay will NOT leave middle management untouched. A crackdown in inefficiency will lead to more focus on the production of the final product and less spent on the luxuries of "corporate awareness" and all the associated "consultants". However, IT & HR departments will NOT lose any of the control they have over the business lines they are meant to serve.
MISS. While the latter part of this non-prediction proved correct, TMM really must've been off with the fairies when they came up with the former part.
14) The Olympics in London will NOT be the disaster many expect, yet during them, manned flight to Mars will NOT be harder than getting to Canary Wharf. However, the Olympic tradition of the host nation losing money on the whole even will NOT be broken.
HIT. TMM don't know anyone who attempted to get to Canary Wharf so we'll have to leave that part unanswered. However, the Olympics proved a roaring success. And while the final financials will not be known for many years, TMM hope their dear readers will allow them the luxury of awarding this point. TMM really will eat their hats if LOCOG manage to break even on the deal.
15) Greece will NOT stop taking the piss with pricing in tourist restaurants. As shown by their inability to change their macro economy, there is little chance of micro Greek economic theory changing.
HIT. TMM's contacts recently in Greece assure them that a coffee still costs 4-5 Euros. What a rip off.
16) Kate Middleton, Duchess of Cambridge will NOT announce that she is expecting a baby.
BIG MISS. Whoops...! Well... it could've been worse, we could've been the Daily Mail who must've splashed that she was pregnant about three times over the past year.
17) The Mayan predicted end of the world will NOT occur in 2012. TMM are offering believers immediate delivery of ayuverdic tea and Himalayan pink salt lamps against Dec 22nd delivery of all their worldly goods (excepting their tea, lamps, wind chimes, tin foil beanies and Peruvian wooly hats).
HIT. Well, that was also an easy one. Sadly no-one took TMM up on their offer.
So, to chalk that up 9/17 or 53% which though marginally better than evens is nothing to shout about, and unfortunately down on last year's 62%. TMM hope to do better this year and will follow up with some of their 2013 Non-Predictions over the coming days.
Wishing all our readers a fun and profitable 2013. Good luck.