Spare the rod and spoil the child

With earnings season here, it looks as if the market is limbering up and stretching its shoulders in anticipation of another round of throwing its toys out of the pram.  Early returns have not been encouraging, and companies have retreated behind the excuse of the strong dollar to justify their poor performance.   Indeed, of the first 25 s&p 500 companies to report, 60% had a moan about the strong dollar.


Really?  While the DXY closed Wednesday at it highest level in seven months, it's hardly at unprecedented levels.   Indeed, the quarterly change in the Fed's broad dollar TWI was less a percent- quite a bit smaller than Q2's decline.  Obviously those with sterling receivables have been in a spot of bother, but come on: has no one heard of hedging?


While the dollar has of course generated substantial gains over the past couple of years, the vast bulk of that was a 2015 story.  Indeed, on a y/y basis the TWI was only up 2.4% in Q3...more or less the same magnitude of the forecast decline in earnings.   It's kind of hard to blame all that on the dollar, guys.


In a stunning coincidence, of course, productivity growth remains lousy on a macro level, which certainly isn't supportive of earnings growth on a micro level.   In 1990's Japan, yen strength forced exporters to think in terms of being a "100 yen company", i.e. a firm that was productive enough to remain profitable with USD/JPY at 100.   Instead of bleating about the dollar, perhaps US corporates should do more to focus on being 100 DXY companies by investing to enhance productivity.

Instead, what have we seen?   Huge investment in financial engineering and balance sheet leverage as firms issue debt to buy back stock.   If we look at the ratio of credit market liabilities of the nonfinancial corporate sector to fixed investment in equipment, we can see that we're at the highest level ever outside of a recession.  Indeed, the recent rise in this ratio over the last couple of quarters should be of concern to policymakers, because it implies a rise in leverage that often heralds and/or exacerbates a recession.

In this cycle, naturally, the ratio has been goosed by the enablers of the Fed itself and its ZIRP monetary policy.  The upshot has been an apparently inexorable decline in the ratio of wages to profits since the turn of the millennium.


Now that the reality of an impending rate hike and its implications are staring companies and the market in the face, the chances seem reasonable of a full on tantrum to discourage the Fed from doing a bit of prudent parenting.  However, as the old saying goes if you spare the rod you spoil the child; if a modest policy tightening forces companies to do the hard work of trying to improve productivity instead of screwing around with their balance sheets, well that's no bad thing now, is it.

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Anonymous
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October 14, 2016 at 10:29 AM ×

"an impending rate hike"?!
Betcha a hundred ego points there isn't one.

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12yo HFM
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October 14, 2016 at 11:18 AM ×

Apologies for the limited updates yesterday, I was busy covering our energy desk ;)

Yday, oil and the sp500 reversed strongly 'off the lows' as 12yo energy traders delighted in the biggest build in 6mths & corporations salivated over rising fuel costs. As we told CNBC: 'PnL support lines' and a 'W shape' in front-month CL were also strong contributing factors.

Today, EU equity indexes have largely reversed the last 3 days' fall, proving the worth of hedging temporary sp500 losses via buying FDAX dips with extreme leverage (or as we say to our clients, "value investing").

In summary, we trust you're all making bank in these benign market conditions & wish you a pleasant w/e. Peace out.


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Anonymous
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October 14, 2016 at 12:23 PM ×

12yo HFM.... I am a 9yo PHD looking to apply my quant skills to the markets and daddy suggested i look you up. Normally i dismiss his suggestions as mutterings of a gen Z geriatric, but have seen the astuteness of your technical analysis ( support lines under indices ) and swapping P&L into profitable currencies. Is your firm hiring?

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Polemic
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October 14, 2016 at 12:30 PM ×

Great post. fully agree

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Anonymous
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October 14, 2016 at 12:38 PM ×

Btw, i am all over delta and how selling lots of cheap otm puts and buying otm calls leverages the limited downside of options. Gamma lolz.

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12yo HFM
admin
October 14, 2016 at 12:58 PM ×

@Anon 12:23 Thx for ur interest. Regretfully we feel that you are:
a) somewhat overqualified for the role and,
b) see a limited future for our workforce (we intend to IPO next yr after which I will fire the entire workforce and engage in share buybacks for the next 5 yrs before retiring aged 17).

PS It is 'support lines under PnL' $STUDY ;)

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checkmate
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October 14, 2016 at 1:11 PM ×

"Is your firm hiring?"
In my day ( Gen Dino's) it usually went 'Can I be in your gang?)

Keep it up, it's actually a very amusing , inoffensive way to fill the quiet spots.

Just to throw a rumble though because it can be too quiet , I give you ;
"Hard Brexit" is the only offer on the table, European Council president Donald Tusk has warned, unless the UK changes its mind and decides to stay in the EU. "
I like it when idiots like Tusk want to play games of mutually assured destruction. Makes making money out of volatility a lot easier for one thing.

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washedup
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October 14, 2016 at 1:37 PM ×

Wow MM - are you considering a joint venture with zero hedge? I had to do a double take when I read the article.

All true, of course - corporate america has indeed, not just eaten its seed corn, but razed seed corm factories, eliminated seed corm producers, and banned seed corn out of any future consideration.

It was baked in the cake though - if the politicians/Fed are at the corporate sector's mercy to create jobs which will keep them in power, and the corporate sector is in turn at the mercy of institutional shareholders that couldn't care less for old fashioned profit growth (as opposed to financially engineered ones, that is) , guess whose been really running the world?

Ultimately populist backlashes and further declines in productivity will bring wage inflation back, increase yields, and reduce buyback incentives - till then, JBTFD it is.

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Anonymous
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October 14, 2016 at 2:50 PM ×

This is the elephant in the room. Some people see it, most ignore it. The central bankers and politicians tell us they have it all under control.

via Salient Partners:

"Here’s the most impactful chart I know. It can’t be fudged. It’s a measure of US household net worth over time, compared to US nominal GDP. Is it possible for the growth of household wealth to outstrip the growth of our entire economy? In short bursts or to a limited extent, sure. But it can’t diverge by a lot and for a long time. We can’t be a lot richer than our economy can grow."

http://imgur.com/a/kBhFK

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Flowthrough
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October 14, 2016 at 2:55 PM ×

With all due respects, I disagree with your comment MM. First, not sure US companies should copy anything Japan does. Did not work out so well for them. I think your prior post that low interest rates keep zombie companies alive and excess capacity around as much more likely to be one cause of lack of productivity growth. And you comments re buybacks instead of building new capacity is 180 degrees of your previous comment I agree with.
Of course, I would add increase in the regulatory burden as another likely cause.
As to markets, having a very good year being long energy. Midstreams place to be.

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EuropeanBull
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October 14, 2016 at 3:35 PM ×

@Flowthrough:
agreed. The US listed(!) corporate sector is one of the few economic actors on the planet, who listened to what central banks were telling them to do.
They levered up through debt-financed M&A and buybacks.

That is what happens in capitalism. People react to incentives and maximize their goals.
Companies will not spend capex to contribute their share to make some economist's chart look more friendly.
That is what CBs got wrong and also the key difference to Japan, were the economy works different. (on a side note: the third arrow of Abenomics is the slowest but also the most powerful, which is why I am massively bullish on japanese stocks which reorganized their governance)

switching topics:
to me the most important piece of news today is Rosengren hinting about re-twisting the balance sheet. Looks as if more and more people are discovering that negative term-premia are madness....


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12yo HFM
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October 14, 2016 at 4:12 PM ×

@EuropeanBull - I agree with the importance of Rosengren's comments; particularly his quote, "we may have to raise rates or not" ;) #forward_guidance $STUDY

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wcw
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October 14, 2016 at 4:33 PM ×

@Anon14:50, that chart is six kinds of dumb, but here is the dumbest: it does not adjust for government share of GDP. Second dumbest: it does not adjust for long rates. Instead, try non-government GDP as fraction of household/nonprofit net worth, kinda like a gross revenue yield if you squint, less the 10-year, since 1986: https://fred.stlouisfed.org/graph/?g=7J8b

Whoever Salient Partners are, I feel the sudden urge to short their entire book. Now I get to look at some filings, always fun, so thank you, I suppose.

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Anonymous
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October 14, 2016 at 4:53 PM ×

wcw:
Actually, that is a Bloomberg Chart

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Anonymous
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October 14, 2016 at 5:01 PM ×

banks quite soggy this week - ???

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wcw
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October 14, 2016 at 5:04 PM ×

Looking again; it says 'source: bloomberg, tcw' so it looks like a TCW chart with BB data. A Google search confirms. There are few things less interesting than a bond manager talking up bonds and down equities. Sometimes right, sometimes wrong, a dishwater evergreen.

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Anonymous
admin
October 14, 2016 at 5:10 PM ×

wcw:
I emailed the articles author( he is the Salient Partners' Risk Manager) with you first observation. I'll let you know his response..

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checkmate
admin
October 14, 2016 at 5:20 PM ×

Never did get the breakout entry for a 2nd tranch on the USD/CAN$ trade. Whilst the GBP hedge paid off a few % the core trade looks 'soft' so I exited this morning. Keep a watch eye on it , but no breakout no trade.

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Skr
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October 14, 2016 at 5:25 PM ×

Where are The JBTFD'ers? come on guys one more time for old times sake... Nearly fully loaded on short S&P and want to max this sucker out.

Greed is good ;)

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Mr. T
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October 14, 2016 at 6:39 PM ×

When is the whole "were going to run the economy hot" theme going to just die. There is an implicit assumption there - that the FOMC is controlling anything - that is just wrong. They have been trying to "run it hot" for almost a decade now. The only thing thats running hot is spoos and credit.

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Mr. T
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October 14, 2016 at 7:01 PM ×

"Yellen raises question about personal savings rate and why it has been elevated, and whether it could return to a more normal level after households repair their balance sheets:" - I cant believe this is still something that causes head scratching by this room full of brains. When rates are lower and expected returns are lower you have to save more money to not starve to death in the future, or send your kid to college. Discretionary spending comes into the budget after accounting for future liabilities!

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washedup
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October 14, 2016 at 7:01 PM ×

T - didn't you catch the presser after the last meeting - in response to a question about why yellen simply said 'we don't want to be blamed for a recession if there is one'. These guys are too smart to not have figured out the trajectory of the real economy 9and inflation) is outside their control now - its just that they don't want to be blamed if anything bad happens - everything in the last 3 months, speeches, dissents, promises of more asset purchases in the need arises, should be viewed with the prism of CYA tactics, individual and collective - there are 3 elements to it - 1) keep rate hikes in the future alive because it keeps an optimistic face lest their caution becomes self fulfillingly negative, 2) not actually hike because the idea that anything outside of assets and real estate may be overheating globally is simply laughable, and 3) keep pressing the case for fiscal action so there is more than one scapegoat if the s#4t hits the fan.
I actually think its a very rational approach as befits MIT PhDs - we will see if it works.

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checkmate
admin
October 14, 2016 at 7:37 PM ×

Mr T
Please go to the head of the class , do not pass by the FED and collect your token for utter stupidity. Like you I wonder where these idiots are recruited from ? They appear to understand so little I can only summise any real intellect was ground out of them by the educational system. Repeat after me , rote thinking is not what education is supposed to produce.

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Leftback
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October 14, 2016 at 8:26 PM ×

Dame Janet likes it hot.... we have all observed this here many times. Yes, maybe so, but that doesn't mean she's going to be able to elevate America's economic temperature one bit. Wages are only going to grow very very slowly.

Demographic factors are in play that will keep aggregate demand low. Joe Sixpack is going to be saving. Why? Because by and large the Boomers already have the house, furniture, washing machine and plastic crap made in China that they are going to need, and what many don't have is any savings. So they are going to work part-time and they are going to save - no matter where interest rates are, as was seen during Japan's long decline. Meanwhile, Gen-X are trapped in their houses and mortgages, and much of Gen-Y and the millennials are resigned to the fact that they are never going to buy a house in their entire lifetime. As a result, a second wave of property price declines will overtake the US at some point.

Enjoyed the thoughts on the stronger USD, from MM and others. We were out there early with that trade idea and have been taking profits this week. Still short crude, but flat the CAD at the moment. One of the things we think maybe perhaps happening next is a stronger JPY, with all of its attendant risk-off consequences, but right now we are on the sidelines - or back in the hammock, as you prefer. A few small bets - and a sizable one on lower crude oil, post-election.

I wasn't alone in noting Rosengren's comments on the long end. He is one of the more independent of the Fed thinkers, and very clearly sees a bubble in CRE on which he has commented in public numerous times. Ignore this at your peril, REIT investors, because a "reverse twist" would hurt the value of the portfolio in a business that lives (and dies) by its leverage. The Fed could sell long-dated MBS or Treasuries and buy equivalent short-dated paper, thereby steepening the curve. If this happens, long banks and short REITs?

Thanks for showing the long bond chart so often MM, it still looks nasty. The patience required to stay away from equities and fixed income at the same time is considerable, but I believe this prudence will ultimately be rewarded. Many have written about the [all asset] correlation, to the point that is becoming a cliché, but when risk parity blows up yet again in a big way, punters are really going to understand the meaning of reflexivity. I just don't know how the media will spin it. Maybe the next crash will be blamed on MM's comment thread, or some guy trading in a garage in Hounslow. Who knows?

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October 14, 2016 at 10:36 PM ×

Investment spending is more variable than GDP, so that chart you printed doesn't say what you think it says.

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Macro Man
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October 14, 2016 at 11:00 PM ×

Well, I specifically cited that the peaks are coincident with recessions. More generally, the long term trend is clearly higher, meaning that firms are investing less in equipment for ever dollar that they borrow, so yes it says exactly what I think it says.

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12yo HFM
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October 15, 2016 at 9:00 AM ×

MM is exactly right (above). Just yday, I fired 2 capable employees from my fund, and cancelled an order for a new data mining IT system. My view is essentially this: why invest in people & technology, when I can just load up on debt & leverage the f*ck out of my business with CBs waiting to bail me out if I'm wrong? DB & HP must have got wind of my announcement, as they laid off 10k & 4k employees respectively, resulting in a 3.8% gain on our DB stock purchase within 48hrs (easy money right?)

By way of update, we also unloaded half our US equities position on the cash open; preferring to keep our equity exposure more focused on EU/JP nearer term. Underlying strength in US economic data, a rising USD, and the Fed's hesitation in starting QE4 makes me less bullish US. Much as I'd love to buy more of this dip, I have to face facts: Janet Yellen is a hawk. Peace.

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checkmate
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October 15, 2016 at 9:28 AM ×

Question. I have some sperm gestating. Is it too early to send it to you for training.

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12yo HFM
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October 15, 2016 at 11:55 AM ×

@checkmate: We're always open to cross-fertilization.

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Anonymous
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October 15, 2016 at 4:29 PM ×

MM what do think of Flash crash trader Nav Sarao being extradited to the U.S.

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Anonymous
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October 15, 2016 at 5:04 PM ×

@Anon: 4:29
Here's analysis showing he stopped spoofing before the crash:
https://twitter.com/nanexllc/status/591320903041961984

(Btw, the publisher of this analysis is an expert on market internals and has been used as an expert witness by the SEC).

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Anonymous
admin
October 15, 2016 at 10:14 PM ×

The ground being set for moving the goal posts.

"Increased business sales would almost certainly raise the productive capacity of the economy by encouraging additional capital spending, especially if accompanied by reduced uncertainty about future prospects," Yellen said. <---- from where are the increased business sales going to come from for US companies if not from cannibalizing trade deals with the EU? "More capital spending" presumably means buy backs?

http://www.businessinsider.com/janet-yellen-speech-october-14-2016-2016-10?r=US&IR=T&IR=T

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abee crombie
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October 16, 2016 at 1:33 AM ×

Weekly chart of 10 year looks interesting. While many on this blog lean hawkish, I think a lot of part time investors would be shocked to see interest rates rise. And yet here we are now with the chart setting up nicely.. double bottom and now above many moving averages. Wonder how long b4 CTA models jump in

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12yo HFM
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October 16, 2016 at 10:58 AM ×

Another interesting read:
http://bawerk.net/2016/10/15/usd-ready-for-a-second-leg-higher-then-what/

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Celeriac1972
admin
October 16, 2016 at 11:34 PM ×

Until the last para where the writer gets a little carried away.....

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Anonymous
admin
October 16, 2016 at 11:44 PM ×

@5:04

Thanks for the link.

But why then he lost extradition hearing?

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