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Why I’m still not excited by Jeremy Corbyn

My political leanings are not a secret in my day job, so naturally as the resident Socialist on the dealing floor, I spent much of Friday being told that I was smug, a Corbyn Fanboy and a raving commie. At least 2 of those things are pretty true.

I was certainly delighted with the result. Whilst I voted for Owen Smith in the last leadership election, I am ever a labour loyalist. So long as the party remains functionally accountable to the working class through its union affiliations and membership structure, I’ll be a fan. Policy wise, I am not particularly discriminating. I don’t think governments can do all that much to encourage economic activity – though they can certainly make economic mistakes. Due to Labours commitments to raise government spending, at a time when real yields on gilts are sharply negative whilst inflation  and wage growth remain low, I thought that voting for them made good economic sense. Head and heart were both behind the Labour Party.

And indeed, I’m excited. I’m excited for the same reason I was in 2015 when the “Milifandom” lit up twitter with their irreverant fandom of Ed Milliband – although ultimately Labour did poorly. I was excited too when I met people canvassing who weren’t getting their news from the newspapers, and had formed some pretty eclectic opinions that were markedly to the left of where the media claim the “centre ground” in politics is. And I’m excited still by the dominance of left wing political ideas on social media, to which they seem very well suited. The enormous surge of people joining the labour party has been joyful to see – and at total odds with the prevailing narrative of political apathy pushed by most pundits, papers and media outlets. There is, following this result, quite a tangible feeling of a surge in support for the left that, frankly, feels fantastic after years of being told my ideas are irrelevant.

Compared to this, Jeremy is frankly a little uninspiring – in the sense that he is very much a product of these powerful forces, not a driver. The huge mandate with which he won the two leadership elections he has participated in seems to me more to do with the huge influx of new political engaged people joining the labour party than any great personal traits that he brought to the campaigns. His ideas are broadly consistent with left wing ideas, but they are not brilliant and novel. There is nothing whatsoever wrong with this. In my view, leaders should reflect the interests of their followers, and should channel their efforts effectively. This can be done perfectly well without the meglomiacal flair that many bring to leadership roles – humility, consistency and empathy are all wonderful traits that Jeremy appears to have in spades, but they are not the stuff history is made of.

Now my most fervent wish is for all those who joined the party for the sake of Jeremy’s leadership to remain engaged. The mass movement, the buzz, the feeling of progress is the real story here – and the sooner that message can be made to resonate with people the better. For we face trying times. The UK is likely to underperform economically as Brexit related uncertainty eats into demand from consumers who will want to save for troubles ahead, and firms who will hold off investing and building inventory for similar reasons. The fecklessness of Theresa May’s government will almost certainly exacerbate this – and the almost inevitable failure of our talks with the EU will likely lead to further political turmoil. It is the vital duty of the new labour joiners to form a movement capable of facing all of this down, winning the next election outright, and then governing well. It is all exceptionally exciting stuff. The sooner we can get over our fetishisation of the “dear leader” the better.

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Q1 in Review, trades for Q2

 

Price action in Q1 has lead to complaints in financial markets. It’s always the same – there weren’t enough trends! I got topped and tailed! Where’s the theme? Why is there no conviction? One way to work out the degree of buy side angst is to look at whether it’s been profitable recently to buy out of the money options – ie – highly leveraged bets in favour of large price moves. Broadly speaking, when it has been, discretionary macro hedge funds (ie, punters) are happy – because at least some of them made good money, some will have taken a slice of the trend at some point, and even if they didn’t make much themselves, they know investors will be excited by the performance of the leading funds and more money can come their way. Q1 saw ranges mostly hold, and popular positions (short bonds, long $) stopped out.

I can understand this carping, but nevertheless it can be a little wearing! Just because the most vanilla, liquid FX pairs or government bonds or stock indices haven’t gone in a big straight line this quarter doesn’t mean it was impossible to make money. I didn’t recommend my full suite of ideas for 2017 here on the blog as they’re a bit distinctive and one shouldn’t mix day job with pleasure – but a good number worked. I’ve been fortunate as well in my PA trading to be long stocks and the Euro – as well as even more fortunately perhaps purchasing some cryptocurrencies that are doing their best to act like a breakout tech stock rather than a spooky alternative investment. Before the cynics of twitter jump down my throat and remind me I’m but a sell side spiv writing puff pieces online etc, just relax chaps. I’m being open and honest about my positions, successes and failures, and it’s all small beans anyway!

Anyhow. what to do as we move into Q2? Close on most people’s minds is the French elections. It  would take exceptionally low turnout for there to be any realistic chance that LePen actually has a shot in the 2nd round, but she will probably get the largest vote share in the 1st round. US retail flows into European equities make me feel that this could result in quite a dramatic selloff in stocks – as investors who are *ahem* not used to dealing European stocks and may not be able to find France on a map decide that it may have been a bit rash to invest in a country where the principal opposition is promising to devalue the currency and default on debt. Sure, there are plenty of constitutional impediments to this, and smart people tell me that it won’t be that big of a deal if she wins, but I seriously doubt that many holders of equities and French bonds will figure that out on the day.  I therefore join the crowd of macro funds salivating over the potential opportunity to load up on risk at the point of the election for my PA!

Some trades that I like before then are, broadly, to be short in European front end rates. Yes I know the data has become weaker and various speeches have confirmed that they’re going to be ponderous about removing low rates, but 2y1y OIS (EONIA) swaps are -14bp – so the market is pricing no exit from 0 rates for over 2y! I’d pay this here after the recent rally. The strength of UK fixed income this quarter makes me highly circumspect about the cross market trade that everyone likes to do of paying £ long end rates vs EUR – but I’m also happy to have a paid £5y2y position on the book. At that maturity, you roll relatively flat, and don’t really have to fight the LDI flow as much as if you pay in the long end – and with historically low entry, I would load small size and tough it out. On the 2y1y EONIA i would bet the farm. The ECB’s ability to whipsaw the markets based on communication via leak is legendary, but they’ve shot a lot of bullets trying to talk rates and the Euro lower- so I say take advantage of their largesse.

With two shorts in my imaginary book I need a long! My Q1 recommendations were all either fwd steeepeners or selling vol so I needed the same then and recommended going long UK ASW, which I lucked out on – I was just picking an ASW trade that’d benefit from excess liquidity in the system, or a sudden return to looser policy, and the UK having been smacked on ASW post brexit and being on historical lows looked the right answer. It’s done well so I’d take it off, and enter instead some conditional bullish steepeners on the US curve – buying receivers on the front part and selling them on long end. The inconsistency and hollowness of white house foreign policy is beginning to scare me a little. War is a massive curve steepener  – you can’t put up front end rates but you sure as hell need to issue bonds to fund it. With the Fed no longer there to fund the US’s bond issues, the long end should be vulnerable while all the steepness currently residing in fronts and reds would come out. 1y2y 1y15y or similar did the trick for me in Q1 – so i’d re initiate here.

The macro investing community has  had a rough time in Q1 – but it needn’t. The narratives of ECB tightening, Brexit, Trumpaggedon etc are all on the table for Q2 this year – and buying them cheap now whilst conviction is low seems the way forward to me!

 

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Escaping the Tyranny of “The Model”


Don’t worry, this isn’t another sore rant on the failings of mainstream economics – just a fine evening of friends and discussion in the pub prompted a thought that’s worth sharing, i hope! We all of us go through life with a necessarily partial and incomplete view of the world. A model that helps us make the decisions we are bound to make every day. Our conscious thought is a fleeting thing, constrained by our past thinking. Our unconscious is an almost boundless resource of insight and experience if we can but harness it. Unfortunately, when we think, we have to start from the model. The formerly partial and incomplete view of reality we had before. Just like in politics, a true revolution in thinking is impossible – we start with our model of the world and add or subtract based on experience and insight.

My own model of the world has been working well recently. My heuristics for looking at the market (look at what narratives could be embraced but are currently nascent, look at long-term real rates as the only true economic market predictions and everything else as guesswork/narratives) have been paying dividends. My PA longs in European stocks and the Euros have done well, as have my recommendations in my day job where I’m charged with making recommendations to macro investors about cheap bets they could take. I’ve been recommending buying calls on French Stocks and selling them on French Bonds, paying 5y European rates and the long end of Europe, and a few other niche things not worth mentioning.  My Mental model let me down so badly predicting political events of 2016 that I didn’t turn up to work for Brexit, or Trump! But my focus on real rates meant I had the right ideas for Trump, and has long made me short the GBP, or rather, ensure that I never currency hedge any foreign investments. If you’ll permit me just a little self aggrandisement, my mental model of the social world has also been working well recently! I am enjoying some professional recognition and success – due to my long-term strategy of ignoring everything management tell me to do and being honest with everyone around me – focussing on increasing my stock of trust and knowledge instead.

The problem with our models is that just when they are working, and we’re adding new experiences that could be helpful, we tend to close off. Things appearing to confirm our model induces complacency. Luckily there is a solution – exemplified by a helpful twitter user @LeithMotive who every day posts “You can be right about something, and still be a fud.”

It’s not what he says, it’s that he posts it every day! Due to his many contributions I like and respect him, so I find his consistent posts amusing and engaging. That means they get under my skin and I take it to heart – or rather to stick with my principal analogy – I’m prompted to consciously update my model. This is what friends with sharp minds and different perspectives do to us. We come to the table with them expecting, even hoping, to have our minds changed – our model updating. They free us from the tyranny of our own models – and allow us to explore alternatives. Sitting alone looking at data, all one has is ones own model. You can only see things in the context of what you thought before.  The famous problem of the blind men and the elephant is no problem at all when after their elephant prodding session – they retire to the local public house and discuss their findings!  A synthesis is possible – something much closer toa  revolution, and you know how much I enjoy those comrades!

I was reminded last night that a supine MPC could easily have UK rates even lower than their pancake flat, current state, despite some like Saunders saying he’d have raised rates if GBPUSD were this low. I was reminded of the shifting sands in the UK and  the twin possibilities of a united Ireland and an independent Scotland. I was reminded to pay attention to the RPI/CPI wedge, it’s use as a political football, and it’s impact on market perceptions of real rates. I was reminded of how fast and how far a Fed hiking cycle can really go, and how few market participants have actually experienced one! Nothing ground breaking – but an escape from the Tyranny of the model for a few happy hours – and a worthwhile exercise for all I hope!

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The trend is my friend

In November of last year I attended a meeting with some independent consultants employed by my firm to analyse US politics. It’s no exaggeration to say that they were ecstatic with joy at the prospect of a trump presidency. These were intelligent, accomplished, educated people with a strong grasp of the facts of world affairs and US domestic politics. Whilst they undoubtedly leaned to the right politically, their arguments were one of the principal reasons I was moved to examine my own thinking and write my grounds for optimism piece in early January. Since then, Equities have rallied, gold ( a traditional measure of risk appetite) has failed to perform, and an atmosphere of feverish expectation has gripped financial markets. Over the Christmas period, I thought long and hard about European fixed income markets – and came to the conclusion that for logistical (running out of bonds) and macroeconomic reasons (inflation normalising), the market would soon price the end of European QE.

Having banged the long equities and short European fixed income drums since the start of the year, I now find myself with the right kind of problem – how do I ride my winners? The principal justification for both trades has now come to pass. I had two ideas that seemed at variance with the rest of the market as of December – the first being that whilst any right thinking person might baulk at a reality TV narcissist running the worlds biggest country like a tinpot dictator, the fact of a businessmen in charge presiding over a cabinet of fellow billionaires, Goldman Sachs creatures and former corporate raiders would probably be really good for earnings. The market has now fully embraced that narrative, to the extent that even pouring money down the drain to build a wall with the US’ third largest trading partner is grounds for optimism. The market has indeed begun to look past the end of European QE, helped along by a generous slug of supply from every issuer under the sun in Europe as governments and agencies use the remaining support provided by the ECB to jam as much long term debt down the markets throat as it can handle.

Normally when one’s perception as at odds with the market – there is opportunity. Now that my ideas are more in line I am taking stock and considering what to do next. Broadly, I have decided to stick to my guns. I still believe that being short European fixed income is set to pay off handsomely this year. The main danger to this idea is the market getting a little ahead of itself, curves are already steep and I have from the horses mouth that this is not a deliberate or desired outcome of the recent changes they made to their buying program. They may seek to talk long end rates lower – especially as political uncertainty in France and Italy widens spreads between the bonds of different countries, which typically the ECB does not like. A resurrection of language about the possibility of re-increasing purchases would certainly hurt shorts – but such talk is largely empty considering the constraints the ECB faces buying more paper and should be faded. To that end, I am shifting my small PA short on long end European government bonds into the 5y paper, and recommending similar to my clients. I believe that most of the move in bonds so far has been about the large amount of supply- not the market looking toward the end of QE and normalising of rates.

In US Equities, I think the only sensible course is to stick with the trend. Despite an almost doubling of US equity indices over the past 5 years, pension funds allocation to stocks have barely increased. This to me says that large investors who ultimately drive the returns available in different asset classes have not been participating in the move – and will be acutely sensitive to further moves higher. People often talk about positioning in financial markets in terms of who is long and who is short- but for me that’s an incomplete view. To me – short means “someone who might have to buy” and long means “someone who might need to sell”. By that metric, no one is long. The speculative community who I am intimately involved with professionally – ie big hedge funds- are long via options and not in big size- so their sensitivity to moves lower is low, they’ll likely add. Pension funds and asset managers don’t own anywhere like enough equities. Retail investors are not buying on margin yet – which is the only time those guys are really long. Positioning therefore supports a continuation of the trend.

However, with some gains in hand, it makes sense to look for a hedge to lock in a bit of profit and, well, justify all this smart stuff I’m supposed to have learnt about financial markets by overcomplicating things a bit! I had a go at hedging my views by buying 30y tips – but fluffed the timing badly and got stopped out. Now I think I’d rather just pay some premium. Whilst I’m bullish on stocks because of earnings and positioning – I see no good reason why the various lunacies of the current administration should be any good for the US economy, neither do I believe that the Fed’s undoubted obsession with financial markets cuts both ways. Stocks down is definitely a reason to baulk at hiking rates – but stocks up is certainly no reason to raise them. Stocks up is just a good gosh darn thing. Why spoil the party. I don’t believe that the FOMC with all their collective wisdom actually think that, but the smart things they do think probably cancel out, so one is left with the cognitive biases – few of which are as powerful as the “good begets good” heuristic. Hey, our easy policies are generating good outcomes economically -and given that boor in the white house, we ought to be careful, right? I think so. The US curve is steep enough here to justify paying up for some call spreads on Eurodollars – or some wide 1×2 receiver spreads in swaptions if you’re feeling fancy, as a hedge for a slightly more bearish scenario.

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Reasonable grounds for optimism

It’s fashionable to be gloomy  – from the opinion pages of The Economist, to the major newspapers that endorsed brexit and are now acting salty about its consequences, to my own dear friends and co-conspirators on twitter, everyone agrees that 2016 was awful and 2017 is likely to be too. As ever – I want to strike a more optimistic tone. I not only agree with Chris Dillow that the long term consequences of the supposedly awful things that happened in 2016 (Trump, Brexit) will be less severe than people imagine – I believe there are sensible reasons for optimism.

Firstly, if we’ve spent the past years complaining about the economy ruining, stultifying effects of ever more “creative” monetary policy – we have to be optimistic that this influence is now waning. QE seems unlikely to be extended in the UK. In the US, we are informed that rates will rise several times. In Europe, QE is being tapered and for various wonkish reasons I suspect will be so again sooner than expected. Japan may be the fly in the ointment here – as higher global rates increase pressure in the BoJ to buy bonds to maintain it’s 0% peg on 10y yields, but it’s reasonable to expect that rather than sitting idly by – policy would change if needed. Capital markets less dominated by central bankers are a source for optimism. There are some substantive misallocations of capital going on in the world – with “safe assets” seemingly attracting an endless bid whilst countries where productivity growth is high struggle to attract it. In this vein, emerging market central banks feeling able to cut rates is a good sign.

Secondly, if you are a believer in democracy, 2016 may have seemed tough but the schedule for 2017 looks good. French elections should see a comfortable rebuke to fascism.  German Federal elections in october are a long way away and hard to call, but in spite of hysterical media reportnig around the world, opinion polls indicate no material increase in support for far right parties either. This should give leftists and liberals some breathing room. Trump will take many objectionable executive actions simply by dint of his erratic nature – but the actual workings of the presidency are complex – and he is both stupid and sorrounded by stupid people – so I’m cautiously optimistic that his presidency will turn increasingly farcical as time goes on. I guess as someone who beleives that Americas democratic institutions are thoroughly captured by elite interests anyway, i don’t see all that much harm in having him in charge. Granted, he will definitely use his power to try and enrich himself, possibly to gargantuan extents – but in the grand scheme of that the US government can afford to make him richer than any man has ever been and still function ok. Then specifically in the UK – Labour are making a sensible move by making Jeremy Corbyn’s genuine anti establishment credentials part of their core strategy rather than trying dress mutton as lamb and trying to make a normal politician out of him. This is a welcome step towards a coherent message. Media scorn and derision is inevitable and not neccesarily a bad thing.

Thirdly and much more specifically to the UK, we won’t know the shape of Brexit now for over a year. In no EU negotiation on anything has there ever been a situation where their position is clear – and in advance of German Federal elections it’s unlikely to be clarified until 2018 in any case. That gives us a year of relative political stability. UK data is extremely encouraging – and whatever you believe about the merits or otherwise of brexit – that situation ought to carry on for at least the next 12 months whilst it takes form.

Since the dawn of time – commentators have argued that the world is getting more complex and harder to predict. In my world of financial markets, I have never once heard anyone say that it is a good environment for trading. The environment is always “challenging” – the outlook is always “uncertain”. Anyone who opens a new year griping along such lines should be ignored. I say get stuck in and be hopeful.

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There are two types of people…

I have a simple theory of interpersonal relations that I want to share, thanks to a tweet by @allthatissolid

In it – he, a portfolio manager, asks whether he ought to take views and research etc from a young salesperson at a new bank. To explain how this works for those not versed in markets, banks or “the sell side”, provide market making services. They intermediate buyers and sellers, either by directly matching them up, or holding an inventory of positions in financial instruments that they can sell to their customers. They are engaged in the business of providing liquidity. The “Price” of this service is generally set in an oligopolistic way, ie, a small and slightly differentiated pool of firms compete to provide the same services – but the price tends to be set in a kind of dynamic game rather than in a marketplace. The price of liquidity can be either a fixed fee to do a certain kind of transaction, as with exchange traded products, or the bid offer – ie the distance between the price at which one can buy and sell, as in the OTC market. Whatever the market though, the point of the salesperson at a bank is to get him or herself in front of those who need to trade in financial markets – and have them trade with them rather than the competition. In order to bring in business, salespeople offer as much as they can in terms of information, research, pricing tools, market colour and anything else they can do to differentiate their bank from the competition – a task that given most banks have roughly the same capabilities, mostly comes down to a kind of pseudo intellectual beauty contest. In some cases, with more old fashioned male end users, and cynical sales managers, it can be an actual beauty contest.

That explanation furnished, let me lay out my theory. It’s simple enough. There are two kinds of people. “big world” and “small world”. Big world is my approach. I believe that the world is big  – full of unknowns and unknowable things, and with vast numbers of people, all of whom have some knowledge and understanding. In a big world, you don’t know who has access to what kind of information, and how useful it is, you can only find out via trial and error. You can apply some sensible filters based on peoples likely motivations and incentives, but by and large its important to be open and receptive. Furthermore, if someone close to you does well because of your actions – that’s good – because there is a big world out there, and it’s better to have the parts close to you doing well. Small world is the approach of most people in banks. Small world thinkers see a series of zero sum games, following well known rules, in a world where those beyond their immediate connections are basicaly irrelevant. They seek to understand things in a limited framework, and limit that understanding to a limited network. If someone does well, that’s advantage that they left on the table – and they won’t get caught out again.

A big world person encountered with someone offering up information and ideas sees another potential piece of the puzzle. Wherever this person is coming from, unless they have obviously ulterior or sinister motives, they represent another link, another angle on the world, another unique perspective and set of facts, beliefs and ideas. A small world person sees a fixed set of zero sum games. Time spent with this person is time not spent elsewhere –  on things that are known to work. There is a fixed pie of attention, or money, or time, and it must be doled out accordingly. For each kind of person – the reaction to a chirpy young salesperson calling up offering to give stuff away for free in the hope of being given the opportunity to trade – the response is obvious.

In my own personal experience I’ve been lucky enough to make calls in to many big world thinking people. Those people have given me time, feedback, information, and all kinds of new perspectives on the world. I’ve generally found that they are receptive to new ideas and information – and dismissive of flattery, puff and nonsense. I’ve also had the misfortune to had to deal professionally with small world people. Such people demand their own prejudices and idaes reflected back at them, and offer nothing – focussing instead in maximising their own gain from any interraction. I’ve not been around long enough to credibly say which group succeeds in the long run – but the attrition of the former is certainly lower than the latter.

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The next impossible

Today, in an effort to punish me for musing that a short squeeze might be on into the weekend, the worlds G10 fixed income markets sold off all pretty much in parallel. Treasuries, Bunds, Gilts, JGB’s… It didn’t matter. Everything came off, both real (inflation adjusted) and nominal rates rose across pretty much ever market. Except the front end of the Euro curve – where whilst nominal rates rose a bit, real rates fell. I’ll come back to this. Remember that a few months ago – this was impossible. Rates were never going up anywhere.

Why are real rates rising across the world at the same time that stock prices are going up?  All other things being equal, higher real rates should mean lower stock prices – but the bullish sentiments unlocked by the “Trump = Reagan” narrative mean that this relationship has broken down. In fact, to say its broken down gives it a false credibility – it’s a relationship that’s more theoretical than practical. Investors don’t look at bond prices and use that to discount the future earnings of the companies they’re buying in order to assess whether equities represent good values or not – they simply buy into and out of narratives – “Risk on” means you need to sell bonds and buy stocks OBVIOUSLY – and no, it doesn’t matter whether you have a fundamental rationale to do either trade-  you just have to because the inverse correlation is self fulfilling – if you own stocks, you’re vulnerable to a rally in bonds. If you own bonds, you’re vulnerable to a rally in stocks. The market doesn’t know what’s driving the “animal spirits” of risk on risk off -but its damned if it’s taking its time to find out.

But whilst today we saw that the risk on narrative is raising real rates everywhere in the world, it can’t seem to touch the front end of the European market. “Ah but QE!” – yes I know that – but as you surely know, dear reader the ECB is running into a brick wall in terms of bonds to buy soon and anyway, the market is so desparately short of collateral that they’re mooting (and banging newswires with) schemes to lend out the bonds they bought. But wasn’t the point of QE to swap bonds for money to help the economy???? Quite. Anyway you can’t do impossible things for ever and the ECB will not – and who remembers what happened when the Fed tested the waters about tapering bond purchases back in 2013 ? Clearly not many people. 5y bunds are trading at -40bp – which is the same as the ECB’s deposit rate.

Now is the ECB going to withdraw asset purchases overnight? no. But is the market going to believe that they’re going to keep monetary policy accomadative when they inevitably have to change the rules either in December or January? History implies not. The ECB is an institution riven with conflict, the market is pricing the next 5 years with policy as loose and accomadative as is mathematically possible. All it takes is that probability distribution to shift and those holding 5y paper yielding the same as the overnight deposit rate are going to be 5years worth of worried all at once. That’s the magic of fixed income markets. God I love them so.

 

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