Friday, January 16, 2015

The Morning Call---The Swiss National Bank does a number on the carry trade

The Morning Call

The Market

Lots of volatility in the news and in equity/bond/currency/oil prices yesterday.  In the case of the indices (DJIA 17320, S&P 1992), they closed within uptrends across all timeframes: short term (16387-19157, 1902-2883), intermediate term (16408-21573, 1729-2443) and long term (5369-18860, 783-2083). 

They also remained below their 50 day moving averages and broke the lower boundary of those pennant formations that we have been watching.  They also finished below their prior higher lows, in effect, negating any possibility of resetting the lower pennant boundary. We need another day or two under our time and distance discipline to confirm this move; and given recent volatility, it makes sense to hold to that discipline.  But at this moment, the technical outlook is not that promising.

            Volume was fell; breadth was negative, but once again not nearly as much as I would have expected.  The VIX rose again, ending above the upper boundary of its short term trading range but still below the very near by upper boundary of its intermediate term downtrend. Again our time and distance discipline comes into play.  The break of the short term trading range will be confirmed if the VIX remains above that boundary through the close on Monday when it will re-set to an uptrend. 
            The long Treasury moved higher, ending above the upper boundary of both its short and intermediate term uptrends---suggesting that this price move is getting overextended.  It remained within its long term uptrend and above its 50 day moving average.
            GLD popped, closing above the upper boundaries of both its short term trading range and intermediate term downtrend.  If it trades above the upper boundary of its short term trading range through the close on Monday, the trend will re-set to up.  If it remains above the upper boundary of its intermediate term downtrend though the close on Tuesday, that trend will re-set to a trading range.  This pin action has all the appearance of bottom in gold.

Bottom line: yesterday’s price action witnessed the busting of major trends in almost every index we follow.  If these breaks are confirmed it strongly suggests a weakening global economy spawning increased economic/security instability and the growing likelihood that the US economy/Market will not go untouched.  That said, given the current level of volatility, forward looking statements similar to the foregoing have a very short half-life.


            Yesterday’s US economic data was largely negative: higher jobless claims, higher PPI ex food and energy and a terrible Philly Fed manufacturing index.  Offsetting these stats was a better than expected NY Fed manufacturing index.

In sum, it was not a good day and making it worse were (1) poor earnings reports from both BofA and Citigroup and (2) a resumption of the decline in oil prices.

Overseas, the central bank of India joined the QE crowd by lowering interest rates.  But that otherwise giddy news for the speculators, hedge funds and carry traders was dwarfed by a stunner from Switzerland---it discontinued pegging the Swiss franc to the euro.  It did so because recently the Swiss franc, like the dollar, has been a safe haven trade, i.e. investors are selling non Swiss franc denominated assets and buying Swiss franc denominated assets because they fear negative economic/political events in those non Swiss countries. 

Which is good, right?  Except Switzerland is a small economy, as opposed to the US; and the money flows into the Swiss franc had become too much of a good thing because (1) the Swiss central bank was depleting its reserves buying all those other currencies and (2) those reserves were then going into Swiss banks, expanding their liabilities to an uncomfortable level.   In addition (and this is only my speculation), since this action comes so close the ECB meeting in which many believe that Draghi will unveil EU QE, it seems likely that the Swiss bankers got a whiff of Draghi’s plan (EU QE would have accelerated the move into the Swiss franc) and they decided to strike preemptively.  So the authorities broke the peg.

Now why is that a negative?

(1)   there was serious hedge fund and carry trade money bet on the Swiss government guaranteeing the value of the franc.  When that went away, those guys instantly took it in the snoot.  And if they were leveraged [which they probably were] and/or involved in the derivatives market, they were really hurt.  In fact, at this moment, we have no idea about the size of notional value tied to currency trades involving the Swiss franc. If they are as large as many believe and one of the big traders goes toes up, the pain could be even worse.   I am not trying to play chicken little, I am just pointing out the risks [see below],

(2)   in the current climate of extraordinarily expansive monetary policy, investors/speculators have depended on the central banks to provide policy stability, which is to say, keeping the Markets informed of all policy considerations so that a change in policy won’t catch them in a vulnerable [too leveraged in too risky assets] to a sudden change in Market direction.  In short, the relied on the central banks to cover the backs.  When the Swiss National Bank executed this dramatic policy move with no warning, the confidence investors/speculators placed in those bankers was badly shaken [read they took some huge losses].  That doesn’t mean that the central banking community is going into a food fight but it has added a risk factor in the pricing of currencies and securities that wasn’t there before.  I have said more times than I could count that one of the major risks to our forecast was the public losing faith in their banking system.

(3)   it demonstrates that artificial central bank interference [like QE] is ultimately unsustainable and can end far worse than it would have if nothing were done.  Will that end artificial central bank interference?  Probably not.  But it won’t end the risk that artificial bank interference poses to the global economy or its getting priced into securities.

One final thought, what if (1) Draghi’s new EU QE is a token move with no real substance---something not entirely out of the question since Draghi hasn’t done jack shit to date to ease EU monetary policy?  (2) so the Swiss bankers have egg on their face. Talk about a loss of confidence in central banks.

(1)   broker/dealers are closing their doors due to Swiss currency moves (short):

(2)   Greeks stage run on their banks (medium):

(3)   Intel and Goldman Sachs are off in pre-Market trading as a result of some poor comparables in each of their earnings announcements.

Under the category of ‘correction’, yesterday I reported that Russia had cut off oil going through Ukraine to six EU countries.  I later attempted to do a follow up on the story and it had disappeared from the news agency’s (from which I picked it up) website.  I can only assume that the story was originally unconfirmed and subsequently proved inaccurate.  My apologies.

Bottom line:  the news flow was truly awful yesterday---poor US economic data, more earnings disappointments from major companies, the price of oil resuming its decline and the hurt laid on the carry traders by the Swiss National Bank.  What concerns me most is the potential loss to central bank credibility.  If that disappears with their balance sheets as bloated as they are, we could have the mother of all mean reversions. In fact, that stock prices weren’t down more is something of a victory.  However, in my opinion, this is no time to be raising the risk level in your Portfolio.

I can’t emphasize strongly enough that I believe that the key investment strategy today is to take advantage of the current high prices to sell any stock that has been a disappointment or no longer fits your investment criteria and to trim the holding of any stock that has doubled or more in price.

Bear in mind, this is not a recommendation to run for the hills.  Our Portfolios are still 55-60% invested and their cash position is a function of individual stocks either hitting their Sell Half Prices or their underlying company failing to meet the requisite minimum financial criteria needed for inclusion in our Universe.

            More on the ‘unmitigated positive’ that is oil (medium):

      Thoughts on Investing

Take a few moments, here at the beginning of a new year, to think about how do you handle your market biases and convictions. We all know the glaring examples of “biases gone bad”: Permabears, some of whom have been firmly bearish on stocks since the 1970s, pump out denunciations of every rally, and eventually are given the media spotlight on every 20% market decline, never mind they left several thousand percent on the table by refusing to buy stocks for decades. For some, market biases are inextricably interwoven with emotional, philosophical convictions. Consider the goldbugs who see buying gold as a citizen’s only responsible course of action; they foretell, with vehement certainty, the total collapse of a global financial system riddled with greed and corruption. For many of the most egregious examples of biases, a very long timeframe can hide many errors. Peak oil? Give it time. One need not be concerned about moves of hundreds of percents against the bias because the day of reckoning is coming. Furthermore, noisy markets will always provide a jiggle here and to keep the faithful in the fold. As my grandfather used to say, “a stopped clock is right twice a day.”

When I sat on a prop desk, about once a month I was treated to the absurd spectacle of a trader who “had conviction” on a stock. In his case, this usually meant fading a strong trend because the market was “wrong”. Over and over… and over, with the frustration mounting each time as the losses piled up. Sometimes his trading day ended in a dramatic keyboard smash that sent keys flying all over the room, accompanied by screaming, swearing, and kicking of desks as he charged out of the room to find a less self-destructive activity, often at a nearby pub.

We don’t have to look at such extreme examples to find harmful biases. Even disciplined investors may have an emotional attachment or aversion to certain asset classes, or a reason to “know” that something is going to happen. Subtle influences like this can be constructive (even if they are eventually proven wrong) because they can provide an overarching theme to an investment program. In the best cases, disciplined risk management may allow flexible positioning, perhaps even against the bias, when appropriate. (For instance, I have been fairly bearish on gold in my published research for a couple years, but yet we have found ourselves long, and profited, on several of the rallies. Though our longer-term conviction on stocks for about two years has been bullish, we have no problem flexibly taking a short position if market conditions dictate.) However, biases bring danger and often do more harm than good.

There are a few solutions to this, some of them tied in deeply with investor psychology. Some traders will find best results if they can try to be as free of bias as possible. This ideal allows you to respond with great flexibility when market conditions change, but it could lead to many investors being shaken out of positions on minor reactions against the trend. Most of the serious damage I’ve seen done by biases comes from using biases outside of your timeframe. If you are a daytrader, it probably doesn’t do you much good to have a longer-term perspective on a stock because your battle begins and ends in seconds or minutes. You truly don’t care where the stock is going to be next month. If you are a longer-term trader, focusing on short-term volatility can be harmful–you don’t care what happens today; you care about moves over strings of many days. For many traders and investors, a bias can so easily become about being right rather than making money, and this is only magnified in the world of interactive social media.

Biases are useful, essential even in some cases, but they must be managed properly. Here are two simple tests to apply to any bias you hold: One, it must be based on something you can see in the market within your analytical framework. Immediately, this condition removes irrational, emotional biases from consideration, though we should not underestimate the power of the mind to force existing evidence into a procrustean bed of preconceived certainties. The second condition is very important; any bias must be falsifiable. In other words, you should be able to say what, exactly, would have to happen to cause you to declare that bias wrong. If we do not allow unfalsifiable biases to creep into our investment process, there is no place for the permabears or goldbugs at all, and daytraders will smash fewer keyboards when they accept that it might not be the market that is wrong–perhaps their bias is wrong. We are all at the mercy of a somewhat capricious and, at times, merciless market. Risk management, and being able to flexibly respond to the developing message of the market are critical skills. Do your biases help you or hurt you?

    News on Stocks in Our Portfolios
·         Schlumberger (NYSE:SLB): Q4 EPS of $1.50 beats by $0.04.
·         Revenue of $12.64B (+6.1% Y/Y) misses by $80M.


   This Week’s Data

            The January Philadelphia Fed manufacturing index came in at 6.3 versus expectations of 20.0.

                December CPI fell 0.4%, in line with estimates; ex food and energy, it was unchanged versus forecasts of +0.1%.




A liberal democrat on Obama’s foreign policy (short):

  International War Against Radical Islam

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