Musings On Mexico's Presidential Election--A Market Waiting for Tomorrow

This July, these five characters will be vying to be the next president of Mexico. The one on the far left--in the picture and the political spectrum--is Andres Manuel Lopez Obrador, or AMLO.  He leads most polls, but the campaign is still in the early stages.


From left to right: AMLO (Morena), El Gato en Saco (PRI), Flaca (Ind), El Joven (PAN), and mi guarura (Ind)
Thanks to his two runner-up showings in 2006 and 2012, the market has convinced itself AMLO’s populist campaign won’t sustain itself and one of the other candidates will emerge victorious by uniting mainstream voters.  I believe political undercurrents and the polling data indicates otherwise, and current market optimism presents an attractive opportunity to sell MXN or buy MXN vol.
First, a quick primer on Mexican politics. The current president is Enrique Peña Nieto, or EPN. He is a member of PRI, a party that has run the government for most of the past eighty years. His presidency has been a disaster. Growth and wages have stagnated, inflation has spiked higher, and the peso has been decimated. People are frustrated with high rates of crime, and dramatically higher energy prices, despite the promises cheaper gasoline and propane following the passage of reforms in 2014.


Corruption has been a big issue too, as allegations have dogged the administration since its early days, as well as PRI governors throughout the country. This has left behind the stench of systematic sleeze, both within PRI and throughout all of the nation’s political parties. Do you really believe Mexico was the only big Latin country to be spared the public works bribe-fest led by Odebrecht? Maybe…..But it seems like a bit of a long shot.  People aren’t buying it.


EPN and PRI have led his administration to unheard of levels of unpopularity in Mexico; only 26% of people approve of EPN’s government. Here is a chart of the approval ratings for this stage in time of last five administrations...none of them come even close to the vitriol generated by the current government.


And lest you think this is a “class warfare” thing, look at this chart.


EPN approval rating by group:


This chart says….men, women, rich, poor, uneducated, educated, young, old….they are all united by one thing: a hate EPN.

Well, a hate for two things. EPN and Trump.


People are fed up. All of ‘em. This isn’t 2006. It is going to be a “throw the bums out” type of election.


No doubt about it, AMLO is a divisive name. He is your standard-issue leftist, and talks about import substitution, national pride, how to revive rural economies, and promises to roll back market-friendly energy reforms, amid a broad “power to the people” theme. Financial markets panicked in 2006 when it looked like he might win, and there has been no signs that his rhetoric has softened in the intervening twelve years.


AMLO will run against PRI’s Jose Antonio Meade, and Ricardo Anaya, the leader of the center-right PAN, as well as a couple of independent candidates who have yet to show any signs of life.


Meade is perhaps one of the weirdest candidates I have seen from an establishment party in any country. He’s not even a member of the party. He’s a life long bureaucrat, with high marks for basic competency, but has never run for office at any level. In contrast to any other PRI politician, he’s clean as a whistle--but has the all the election campaign charisma of an old house cat.  


AMLO leads early polls by between 3 and 12 points. But financial markets are desperate to believe Meade will somehow find a way. A brilliant illustration of this fact came last week, when I stumbled across this gem in a tweet by Bloomberg journalist Eric Martin:




Now, let’s take a look at a recent poll for a national newspaper by polling firm Buendia & Laredo:


Regardless of the candidate you are planning to vote for, with what you know or have heard, who is the candidate most likely to win the election of President of the Republic?


Put another way, actual voters believe AMLO will win by a near 2-to-1 margin. There’s a 46% gap between the proportion of actual voters that believe Meade will win, and the business elites in the Santander poll.


Before we look at how that may manifest itself in a trade, let’s look deeper into the polling numbers.


Presidential preference--AMLO leads PAN’s Anaya by 6 points, but a whopping 16 points over Meade.


Alright you say, but as the election approaches, will  center and right-wing voters unite under an “Anyone but AMLO” flag?  That appears unlikely. First, both Meade and Anaya will have their own problems uniting their constituencies. More importantly,  AMLO is way more popular among supporters of the other two main candidates than they are among his supporters.


In a hypothetical two-way race between AMLO and Anaya, AMLO’s support rises from 32% to 46%, while Anaya’s rises from 26% to 38%.





The outlook in a two-way race against PRI’s Meade is even more in AMLO’s favor. AMLO’s support goes from 32% to an outright majority--55%. While Meade’s support rises from 16% to a pathetic 26%.


Another prevailing belief about AMLO is that he has a “toxic brand” among centrist voters, owing to his long history of leftist politics and his decision to dispute the results of the 2006 election. But again this ignores the data--AMLO is BY FAR the most popular politician in the race!


What is your opinion of...


Maybe there is some chance that Meade can unite the party and take advantage of the PRI “machine” to bring in the middle class and get out the vote in the rural south and northeast. But it is tough to see how, given his personal unpopularity and these numbers:




59% of people say they would never vote for PRI--a number that has risen materially since Meade’s nomination in November.  With these numbers, Meade might struggle to beat The Donald in a head-to-head race.


Can Anaya and the Frente por Mexico left/right alliance cobble together a coalition to defeat AMLO? Sure, it could happen, especially as the campaign picks up speed and gets into debates where he could excel. As of now, the metrics aren’t suggesting Anaya is gaining any traction, and the machiavellian break between him the Calderonistas led by former PAN first lady Margarita Zavala will continue haunt him so long as she continues her independent bid. By refusing to make peace with Zavala, Anaya signaled to many voters he is just another career politician, exactly the type of figure that many Mexicans claim they are sick and tired of.


Given there is no runoff, Anaya could cobble together 30-35% of the vote between independents, PAN, PRD and dissident PRI voters and hope Morena’s lack of financial resources, campaign experience and “GOTV” machinery dilute AMLO’s electoral performance despite his broad appeal. Even if that happens, it won’t be pretty, and there will be plenty of volatility along the way.   
   
Putting it all together:
  • The Anti-PRI/anti-corruption vote is going to be significant
  • AMLO is popular, and a likely second choice candidate by many non-supporters
  • Meade will have enough trouble uniting PRI, say nothing of the country, behind his campaign,
  • Anaya, same thing, but with marginally better chances
  • There is little chance of any change in sentiment towards PRI, or a material change in economic fortunes to favor establishment candidates at this stage of the race
  • The base case should look for an AMLO victory in July. 


So what’s the trade?


First, politics matter. Another undercurrent in this fantastical EMFX market may be the belief that this is a “kinder, gentler” AMLO and EM investors aren’t that worried about him blowing up the market-friendly system. But just looking at recent history in Argentina, Brazil, South Africa, or even Chile, where equity and FX markets rallied hard after Piñera’s victory in December, and you can’t ignore the power of politics in EM. The result of this election will move the market.


The easy answer is just to buy USD/MXN and be done with it. You won’t get much argument from me on that one, especially after MXN was swept along with the USD fire sale over the past three months. Nobody is making big country-level decisions (ARS and ZAR being notable exceptions). All macro, all the time. Flows.


Source: JP Morgan


Now, over the past week as US equity markets cracked, volaitlity spiked, and short-gamma funds started washing up dead on the beach, high-beta EMFX has been quiet….a little too quiet. You could do a lot worse than to overlay a short MXN position in a risky portfolio.
If you’re too squeamish--or too bullish on EM, I guess-- to buy USD/MXN outright, the currencies in the chart above would be high-carry candidates from the long side.


FX volatility presents an opportunity as well. This is the chart for 3m atm volatility in USD/MXN and USD/BRL--which I included as a “control”--going back to the stone ages in 2010. Today’s level around 12% isn’t too bad at all historically--and certainly seems cheap flat to BRL.  
Source: JP Morgan


Similarly, 3m riskies are flat to BRL and not looking expensive at all. Keep in mind both of these trades give you protection against a global short-gamma freakout or Trump drone-striking NAFTA too.


Source: JP Morgan


Indeed, the 3mo option expiries only give you protection until early May. If you prefer a full six months of protection to get past the election on July 1, those levels look pretty spicy. The 3mo, 3mo fwd atm vol is 17%, which you see in the chart above is higher than most any non-crisis data point. Similarly, the 3mo, 3mo fwd 25d RR is 5.3%, which is higher than anything this decade outside the European debt crisis.


Those levels may pay off, but look overdone relative to spot 3mo volatility. Moreover, while the 3mo vols only take you into early May, the fireworks will likely already be in the air by that time, especially if AMLO has consolidated a significant lead and his rivals appear incapable of staging a comeback. This chart from a Barclays piece last week shows how MXN started to depreciate around this time in the 2006 cycle, when AMLO-risk was particularly acute:
Source: Bloomberg, Barclays


And while that underperformance in MXN in 2006 was triggered by AMLO jumping to the lead in the polls, the peso continued to weaken throughout the campaign, even though it was a tight race right to the end.

Source: Wikipedia, Barclays


Fast-forward back to 2018, and the spec market is still stubbornly long MXN--expect that to change, soon.


Bottom line, three factors set up an attractive trade here:
  • A big disconnect between political expectations in financial markets and reality
  • Strong signs the market is remembering the divisive, undisciplined AMLO of 2006, and ignoring his broad popularity combined with the utter disgust for the establishment, 
  • A currency that has been pushed along by a macro tailwind, ignoring the local scene,
  • A vol market that is mis-pricing the timing for a panic--or at least giving you good odds to bet on a shock sooner rather than later. 

So take your pick--buy USD/MXN outright if you think the USD selloff is overwrought, sell MXN vs. an EMFX for a market neutral position, or buy vol to provide some upside for a relatively quick realization that AMLO is likely to be the next president of Mexico. 
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22 comments

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johno
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February 9, 2018 at 5:47 PM ×

Welcome to the Jungle, Buy Stocks.

https://www.youtube.com/watch?v=o1tj2zJ2Wvg

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Shawn
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February 9, 2018 at 6:08 PM ×

"if you got the money honey, we got your disease." Pretty sure I saw that in a slide deck somewhere.

Axl, a gentleman and a poet.

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Shawn
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February 9, 2018 at 6:11 PM ×

I'm a big GNR guy, but this market calls for the Clash, no? first twenty seconds.

https://www.youtube.com/watch?v=u-qcy0-7ngw

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checkmate
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February 9, 2018 at 6:25 PM ×

"Welcome to the Jungle, Buy Stocks."
As if, seriously didn't you know he's triple leverage short by now , measuring is new yacht to see if it will fit in the berth @ Port De Monaco

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Nico G
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February 9, 2018 at 6:47 PM ×

if you ask me the Comatones packed 3x the energy of GnR but their singer Vitanza did not look white enough (he looked Mexican which gives you an idea of 1980s racism in LA). This genius died in complete oblivion.

and then there is Gun Club and even better Texacala Jones. 1980s LA punk scene deserves a movie and Tom Hardy should kill it !

to remain in the theme this ballad is dedicated to Buy Stocks

https://www.youtube.com/watch?v=IsuNAJGunV4

haunting beauty JL Pierce is the most underrated songwriter in rock history

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johno
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February 9, 2018 at 8:59 PM ×

Oh, and Buy Stocks, I did buy near the lows and sold near the high and it really didn't require much of this "talent" of which you brag.

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Whammer
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February 9, 2018 at 11:45 PM ×

Thanks for that Gun Club video, Nico. I don't remember them, something to check out more...

- Whammer

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IPA
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February 10, 2018 at 1:40 AM ×

Head clearing done, second session of being flat as a pancake, watching equities with much interest in a pattern I like developing. Wanna go long, and not just for a day. If you are not into charts, I understand. I don't even mind being called stupid as long as you tell me why you are smart.

Anyway, let's look at the picture with the eyes of the one who is neutral and flat. I mean it only matters to those who are not biased and would like to trade two ways here, which I agree with @Skr may be the best strat. But the thing is not to get caught here and get chopped, ahem... pouring myself a drink (WTI snafu, all targets hit w/out me, what a shame).

Some cliches first: after they shoot the generals they proceed to behead the king. Another one: animals have tails, chart candles have them too, and tails get filled. And the last one: markets rarely bottom on Friday. With that in mind...

Generals = FANG. FB, AAPL, AMZN, NFLX, GOOG. Like I said before, cults die slowly and this one is far from that. So the weakest one is AAPL. The strongest ones are NFLX and AMZN. You care to look at charts? Let the minor puke levels play out (as early as Monday). Everyone here has charts so I will not go there. I'll just point out that GOOG was breifly a three digit stock today and NFLX has a gap to fill (half gap fill was in today). Look at NFLX daily from mid 2015, that's all it does, fills the earnings gap and goes higher. Need to reverse that to kill the cult. AMZN is warming up to get to some minor pain levels, nothnig yet, peanuts really, but volume is perky so I gather they are gonna puke it. Major pain is needed before this group is done. BUT, the buyers are waiting on the other side too. Let them wash out a bit, if not, it's up and away from here. CULT!

King(s) = NVDA and SOX in general. SOX finally made a double top going all the way back to 2000. I posted here that NQ is ready to sell off and SOX is leading the pack. But one does not know if this is a bear, not yet. What's missing? Pull SOX up - the right shoulder is not there yet. That's the retrace I am looking for, tradeable bottom somewhere here and a rip or gradual upclimb (better for shoulder building) and a retest of the left shoulder top. The KING has to be killed before the bear begins. Looking at NVDA specifically, there is little here to base the opinion that the party is over for good. All trendlines are intact, major support levels are too, and the panic has not set in at all. Remember, this is a crap-to-currency play as well. This being said, more time is needed and should the uptrend channel on SOX break along with horizontal supports, then we may have a signal. These things do take time, SOX is a major cyclical index and it's up eight-fold since the bottom in 2008. You can't kill this one until you shoot the generals, and you have not even begun to do that yet (except AAPL is starting to look like it's getting there). A word of caution, royals are good at deception, SOX fakes like none other. 2014 is a good example, broke the uptrend channel for seven trading sessions, reversed and annihilated all bears after that.

Quickly on tails... Daily candle tails on cash indices all over the place. I say they get filled as early as Monday, at least 1/2 to 3/4 way and then new rally begins to move the price above today's high. That's what this trader is looking for on Monday. Target to sell the scoop and get short after this possible rally starts? Fibs are a great thing if you believe in them. Other than that, resistance levels are aplenty now in this 11-12% trading range. I think we will have weeks to do that. Process...

@Buy Stocks, we come here to talk to each other and exchange ideas vs you who comes here to insult and brag. I wish I had a dollar for every liar who told me he bought 3/09 SPX low to the exact date and moment it happened. I added you to the list. You are the undisputed king of the trading fantasy land.

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Anonymous
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February 10, 2018 at 11:14 AM ×

Good to see my popularity here at record levels. That 1000pt Dow rally off the weeks lows must have hurt quite a few of you retail chumps :)

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johno
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February 10, 2018 at 10:15 PM ×

Finally time to read the post! Thank you, Shawn. I'll have to give it some thought. After you just posted all this great work, I hate to ask, but you do you have a view on another election where the leftist leads (but people seem to think/hope he won't win) -- Colombia?

Buy Stocks, I have no problem with people buying stocks (unless a person thinks inflation or economic vol is materially increasing or profit margins decreasing from here, they should own some stocks, IMO, and if those variables were at more historically normal levels -- and hence the upside/downside better -- I'd say they should own a lot of stocks). Just thinking they're geniuses and lording it over others who collect different risk premiums is what I find objectionable. I don't agree with Nico's trade or his trading style, but I'm not going to be rude to him. Maybe time will vindicate his approach and not mine. Who knows.

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Leftback
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February 11, 2018 at 1:10 PM ×

It was an interesting week.

Good to have you back, IPA. Reasonable ideas about how the week will proceed. It wouldn't be a surprise to see a volatile week with at least one more plunge, but perhaps the bears will show decreasing ferocity as we approach monthly expiration on 2/16.

As far as the overall direction of this market is concerned, it's likely we see a retrace from the existing lows, or lows to be made some time this week, IF, and only if, high yield spreads don't blow out. Widening of IG and HY spreads is likely to trigger the next phase of this sell-off, and whenever that eventually happens we will see a bear market. My guess is that by the time that happens, inflation fears, growth rates and Fed rate hike expectations will all have been scaled back.

The breakdown in WTI was either: a) overdue as it was overbought; b) inevitable as everyone was long or; c) to be expected on increasing supply. Wish we had traded that but we didn't; it's probably done dumping for now.

To LB, the important of crude oil is as an input to US inflation expectations, which we think are a bit over-done here. It makes sense to sell TIPS and buy nominal Treasuries here. The Fed will probably pause a bit on the balance sheet unwind now, it isn't going to blow up the Treasury market, the MBS market and the housing market all at once! The market shock we have just experienced is probably enough to slow the economy, or to reflect a slowing that is already underway.

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Shawn
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February 12, 2018 at 4:54 PM ×

WTI....i think all 3. Not sure it is done though given the supply response is in and the var tantrum/risk off will tamp down expectations for demand.

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Anonymous
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February 12, 2018 at 5:57 PM ×

johno, checkmate & IPA looking like total f*ckwits now that we're 1300 points UP from Friday's lows... LOL! You retail chumps do make me laugh though :)

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IPA
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February 12, 2018 at 6:25 PM ×

@LB and @Shawn, not sure on crude here (wrist still hurts:) but I am interested in some RBOB slightly below here. I think a possible buy is setting up in 1.63 - 1.66 area (l/t trendline, horizontal supports and major price congestion area). It's that time of the year (mid Feb) when refineries act up, fires etc. Maintenance season, reduced output before the summer-blend switch. I'll shout the entry here...

Lord, have mercy on this place!

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sdot54
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February 12, 2018 at 10:39 PM ×

@Buy Stocks you better think of fading this bounce. It's a dead cat bro. After the broad market sell-off last Monday we recovered some of it...same thing at the end of the week. That wasn't something that was hard to predict

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johno
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February 12, 2018 at 11:18 PM ×

Likely still a bull market, just more chop. '15-'16 we had the China slowdown, EM macro adjustment, the oil capex shock, etc., lots of deflationary risk to price. Last year was Goldilocks. This year we have Trump/Republican Congress doing everything to overheat the economy (people see what this budget is doing to growth estimates?) and hasten a rise in rates that might kill the expansion. Still early, IMO, but we are entering the "late cycle." I think that's what a swift 10% correction on no news (but higher rates and fiscal profligacy) is telling us ... it isn't all just a "technically-driven" adjustment. Question is where do you allocate your risk? EM is earlier cycle and USD is in a bear market, i.e. EM-supportive. Picking one country's equity market over another's isn't my forte so spreading it around EM Asia. China is particularly interesting here given the apparent liquidation of WMPs and MSCI inclusion later this year, but I'm not doing anything heroic.

This SPD referendum is getting interesting (recallthe CDU-SPD agreement was the proximate cause of a quick 200+ pip rally in EURUSD in Jan) ... voting between Feb 20-Mar 2.

Re the USD, while I think it's toilet paper, now that the Republican Congress is wiping its as$ with it, the "USD liquidity is everything" hedgehogs have their catalyst. Treasury cash balances are moving higher soon. Maybe just shows up in xccy basis rather than spot. Views?

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Eddie
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February 13, 2018 at 10:59 AM ×

Quoting Ben Hunt from Epsilon Theory:

"I’d argue that there is no more important question for long-term investors and allocators than getting the inflation question right. You don’t have to be precisely right, but you sure better be generally right. That’s the source of the “rethink” that’s happening right now, and that’s why we don’t believe that what’s happening in markets is a temporary blip or a “technical” adjustment. It’s the first stage of a fundamental shift in the behavior and beliefs of investors, and that’s a really big deal."

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Belektron
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February 13, 2018 at 12:44 PM ×

Its really important how the market will interpret the US budget. Is it:

1. big fiscall stimulus, rising corporate profits, lets buy stocks

or

2. who will fund the deficits? UST, IG and junk yields going up, lets sell bonds and stocks

In any case it seems to me mean-reversion mode in vol wont return for a while.

(further on, will market sell bonds also if 1 materializes?)

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checkmate
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February 13, 2018 at 2:02 PM ×

US yields rising changes the game plan for risk spreads. Where it become critical to the future of stocks is anybodys guess. Although some historical comparisons would be useful about now.

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February 13, 2018 at 4:26 PM ×

Dear Little Lefty, if you could send relevant paperwork related to , and only of what Kerry so kindly left me due to his unfathomable foresight in such matters of that time it would be appreciated to the extent that I will gladly be on my way.

Here is an address you can send said paperwork along with a short letter to the administration stating my name and student number :n9688471 with instructions to be passed on to moi.

QUT Business School
GPO Box 2434
Brisbane QLD 4001
Australia

PS: I know you don't want to pass it onto me but, at the very least you could pass it on for you Father. Just add it to the growing list of your Father's trophies that you have sold. ( don't go asking Rupes for advice, his not into trophies...oh...than again)

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IPA
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February 13, 2018 at 6:04 PM ×

Mental illness runs awild on this thread...

If you blinked you did not get filled in RBOB. Targets: 1.70, 1.72, 1.74, 1.76

So with all the talk about inflation, should we finally put this trade on already? Charts may be setting up for the puke of the century to unwind the longest positioning of a lifetime, and I am not talking about short vol.

TLT massive head and shoulders distance is 27 points with neckline at 116. The trade is not for a day, week, or even a month. Fed will cushion it and not let it bleed all at once. Ultimate target is 89 with scaleouts @ 109, 101, and 97.

Ready to be thoroughly ridiculed, just like on my DXY short.

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Skr
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February 13, 2018 at 6:13 PM ×

@Eddie, I would argue Ben is wrong. What the author has overlooked is value and behaviour. Measure inflation over how many years you like and compere it to the value relationship between employee and employer over the same amount of time.

The dynamics have changed much over the past twenty years, and as such it is a fools errand to believe inflation can in way be measured from past performance. It is however easy to measure public behaviour on past performance.

There has always been a balance between value and inflation, which for some years is completely out of kilter.

Rebellion, revolution, war take your pick but history shows one of these is the natural clear out.

The question should be, which one comes first.

Inflation - much ado about nothing when long term investing is involved.

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