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22 мая, 04:22

Arm Me With Carry, Conte Drop A Load On 'Em...BTP, How Can I Explain It?

With Italian debt markets feeling an awful lot like everyone's old friend Wile E. Coyote after a bad run in with The Market Formerly Known As The Roadrunner, the old saws are at it again: of course lending money at negative rates to Italy of all places was going to go poorly! Just like that century bond in Argentina was such a bad idea. Similar to the century bond claims, which have been given good treatment by others, including TMM's Shawn, context is absolutely necessary for the case of Italian debt spreads. First off, let's keep in mind that even with a serious rough patch in 2011 and the mother of all duration rallies in all things safe and EUR-denominated since, BTP futures have outeperformed bunds since inception. In the chart below, we show the relative performance of IK futures (~10y BTPs, currently IKM8) versus bund futures, since the inception of the IK futures. For the record, these two contracts' duration has always been within 5% of each other with a median of 36 bps difference since inception. So we don't need to worry much about adjusting for duration to get a like-for-like comparison of rate risk. We also have availed ourselves of Bloomberg's roll-adjustment feature to make sure that roll yield and CTD differences are all sorted out.Now, granted, there have been some excellent directional trading opportunities for the spread. 2011 is a good example, as was the peripheral widening of 2016 when markets digested Brexit and the risk of French elections gearing up. But all-told, you've earned 5% simply owning BTPs and shorting bunds via futures. And that includes the most recent move.Of course, that doesn't include the embedded leverage (roughly 29:1 on BTPs and 71:1 on bunds based on straight-up initial margins for both). But the key thing is, even with the huge drawdowns of the Eurzone crisis, BTPs have been a great bet for the past half decade by and large.We can also take duration right out of it. Below we show the total returns over the last 10 years for two series: the market-value weighted Italian bill index (BoTs) and returns for constant-maturity EUR LIBOR. Again: outperformance.Skeptics will, fairly or unfairly, note that the 8% spread over bunds for 12 month BoTs back in 2011 give one heck of a tailwind for returns here. They've probably got a point.To mollify the starting point crowd, here's the same chart started on the last day of 2013, when spreads had sunk into their contemporary range. Again: outperformance!The answer to the question "how could you lend to Italy at negative yields" is therefore pretty plain. It's because risk premiums could only get so high, and with negative "risk free" (always a purely academic concept, but here meaning "least risky") yields elsewhere, either spreads had to be ludicrously high or nominal yields had to head below zero. Financial markets are always and everywhere a relative game, and as much as we love heuristics like "nominal yields should be positive", sometimes they don't work and there's nothing we can do about it.As it stands now, the move higher in BTP yields has been swift and frankly gnarly. But when combining the extra risk of term with the extra risk of credit over prevalent short-term "risk free" (scare quotes again) rates, BTPs now carry 2.5x the premium that bunds do, and at a lower duration and lower convexity.With all of that said, the combination of rapid shock higher on pure expectation with relatively elevated risk premiums suggests to your truly that things are primed for reversion. How the whole Italian curve trades is going to be very much dependent on how quickly Lega and the 5 Stars hear the screamed message of "y'all are out yo' damn minds" that markets are sending. With the ECB taking down 3.5bn EUR per month in Italian debt (and now holding as much as Italian banks do, give or take), a ~3% of GDP current account surplus, and broadly stable global credit markets with just-fine-thanks growth, Italy's self-inflicted mark-to-market wounds will heal quickly should the politicians decide to heed the message they're being sent. The question is, are Messrs Salvini, Di Maio, and Conte going to get the message? If not, will one of the two parties cry "uncle" and put a halt to the bold experiment in Italian populism, or at least enough to signal that Wile E put on the breaks in advance of the cliff? Given that nobody has even introduced any legislation yet, let alone sat down across from the people that drove Our Man Varoufakis into the pages of Paris Match, there's now room to eye the risk premiums in BTPs and BoTs more jealously. Now, play us off, will you Yanis? We know you're down with BTP.

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21 мая, 06:40

Argentina: Chronicle of an IMF Bailout Foretold

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Greetings Macro Man Community--thank you to the new contributors who have done well taking up the TMM mantle. It’s great to see that the Macro Man tradition is carrying on. This isn’t me coming out of retirement, so much as wrapping up some loose ends. My departure coincided--nearly to the day--with a firestorm in emerging markets that hasn’t quite been put out yet. A combination of local factors, higher US rates, outright USD strength, and the subsequent reversal of portfolio flows has crushed a few EM currencies like BRL, TRY and ARS. Argentina is an especially compelling case--it was the prodigal son of emerging markets in 2017, having not only come back to the market in style, but also plugged the market in size with the famous century bond, a 100-year issue that gets financial journalists squealing with delight every time they think about it. Fast forward to, well, only later in 2017...and Argentina started to backtrack on inflation targeting, central bank independence, free movement of capital, and was experiencing a historic drought that was crushing soybean production--the country’s biggest source of export revenue. It started slowly...and then as ever in EM...all at once: Bang...in only a couple of weeks, the peso was 20% weaker and the central bank hiked three times in the space of a week, taking the overnight rate to 40% to stem the run on the currency. Having written about the subject in the past, I feel compelled to look back at my work and see what I missed, what I got right, and what was simply a big surprise: Back in September, I wrote this on Argentina: “I continue to believe global trends will buy time for Macri’s agenda to work--and while an Argentine election is always a bit of a crapshoot, the trend in Latam favors center-right candidates”  Grade: B. Global trends did NOT give Macri time for his agenda to work--but he did win a big midterm in October. So I got the theme right--Macri was engaging in a risky strategy to use cheap short-term funding and not cut spending quickly, hoping growth would eventually bail him out. It didn’t work. “Beyond the political risk, the fiscal situation is far from healthy--and will require a bout of austerity and likely significant spending cuts. The 2017 primary balance is a nasty -4%/GDP,  which means the government is going to be running up a larger debt load for the foreseeable future. “ Grade: A-. Many real money folks were simply enamoured with the story, and didn’t really check under the hood.  Macri cut the deficit, but ignored his addiction to short-term financing.“Either way, as the charts below show, an acceleration of public debt at this pace for a sub-investment grade credit is simply unsustainable….I expect Cambiemos will win in October, which should provide a short-term tailwind, but the medium-term is fraught and highly dependent on local and international factors that could throw the reform movement into a state of chaos.” Grade: A.  Maybe there’s a spot for me at Hacienda when Macri finally cleans house. Or a cushy consulting gig with the IMF? I’m feeling pretty good so far. Now, let’s talk about the currency!“Similar to the credit, this is an attractive carry trade if you buy into “the story”, but not without its risks. I think ARS will appreciate over time, but it won’t be quick.” Grade: D. I was clever enough to note the risks, and an abundance of evidence ARS had to weaken. Then had to add a throwaway line about about “ARS  will appreciate over time”. I blame my editor. Then I get into the lebac/NDF cross border trade. “The lebacs and ndf hedges mature every one to three months, so you have the opportunity to get out if the fundamentals or political situation deteriorate. That is unlikely...Long story short, at 500bps this spread is well in excess of the risk that the government will again implement capital controls over the next 3, 6, or 12 months.”  Grade: D+. In classic “crystal ball” fashion, I made the forecasting assumption that Macri wouldn’t have a real mess on his hands if the economy went south. That’s what happened. Now the IMF is in town and capital controls are most certainly on the table. It wasn't just that I was wrong, I was wrong about the downside of being wrong. Yet, in the end, if you followed my trade here you just might weasel away with your profits intact--and I was right that you have numerous exit doors to get your money back. You’re still up TTD, and at last check this spread is in decent shape--but there’s going to be some sleepless nights and pepto-bismol between you and maturity. To summarize, I think this shows that there are no easy routes to investing success.  TBH, I think I got more stuff right than wrong--yet the stuff I got right here was relatively tough to monetize, and the stuff I got wrong had the potential to be a first-class ticket on the fast train to EM Crazytown that ends in a smoldering pile of twisted metal and an uber to the unemployment office. With that, a quick post-mortem on how Argentina got to this point, and where they may go from here. First is this one--not the ARS chart, but the real effective exchange rate. I alluded to this but didn’t realize just how important it was and is. You can see here that the deval the country experienced when Macri let the peso float in 2015 was enough to get back to a competitive level, but high inflation and *not high enough* interest rates let the real value of the currency appreciate back to unsustainable levels. Hand in hand with that chart is this one: When Macri won in 2015 the country experienced a huge increase in portfolio flows and FDI--enough to fund the budget deficit and start re-accumulating international reserves. But what else do you notice? A significant acceleration in the current account deficit. That’s what came back to bite them in the back--especially after the central bank backtracked on the 2018 inflation target in December and inexplicably cut the overnight rate earlier this year--two measures that slashed real interest rates and waved a red flag in front of weary local investors that now might be the time to take their money out of the country. Then came the unpredictable. This is a chart of global  soybean production, with Argentina on the bottom tile. What you see there is a drop in production by roughly a third, which adds up to roughly $7 billion in lost export revenue just in soybeans alone. Add a couple more yards from corn and other agricultural products, and this is a pretty big event. This is why EM countries build international reserves, so they can use them to fund their short-term USD liabilities when times get tough or there is an unexpected hit to export revenue. That’s where Brad Sester comes in...the high price of international capital flows (I had a short debate on Twitter on this subject last week...it was an honor getting worked over by him)Brad noted just how inadequate Argentina’s reserves have been, owing to not only their rapid increase in short-term debt, but also the relatively small size of the local banking sector. This chart is particularly telling:    The spread between the dark blue lines and the top of the bars are the key. Short-term external debt and the C/A deficit were accelerating much faster than net reserves. I’d add that the government was also dependent on short-term local financing in the form of t-bills and Lebacs...from foreigners!! That doesn’t show up in these figures, but Macri eliminated all restrictions on incoming and outgoing capital in early 2017...when the economic situation got sticky this year, that hot money was looking to leave as quickly as it came. That culminates in this chart, which shows just what kind of figures were dealing with here. (the pathetic color crayon is my emphasis, not Brad’s) With all that, an appreciating USD, a reversal in global EM flows, and a debt-gdp level approaching 50%, you can see why Macri had to call in the IMF. I’m still not convinced that is the right political decision, but would be willing to stipulate he made a sound decision to go to them, before they came to him. Where does that leave us in the market? Would you be surprised to hear...not very far from previous levels?!?  This is a chart of the spread over UST for the Argentina 33s, a dollar bond that has been around forever. 100bps off the lows?!? 470bps over? Really? Yes folks, that’s where we are in the global credit cycle. A low grade credit with a documented history of being “debt intolerant” rolls over and requests an IMF bailout AFTER A 100BP SELLOFF IN THE CREDIT. Where does Argentina go from here? I don’t know. Part of me says they are going to pull a Houdini and get out of this mess. Another part says this is just the beginning of an ugly Greek-like cycle of austerity, reform, and the resurgence of leftist politics. What do I know for sure? Given the magnitude of the global credit binge, we’re going to see a lot more of this kind of thing. To avoid tough economic measures, Argentina exchanged safety and flexibility for cheap financing and fragility. All it took was a drought, a couple of bad political decisions and a 100bp selloff and it was game over. Argentina lost. Others will too. [email protected] @EMInflationista

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18 мая, 10:11

William Tell wake up, Switzerland has gone mad!

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William Tell contemplating SNB's portfolioOn June 10th, Swiss voters will cast their votes on the Vollgeld referendum: "For crisis-safe money: Money creation by the National Bank only! (Sovereign Money Initiative)." What is it about?  The idea is to limit money creation to the central bank only. That would be the end of the fractional reserve banking system in Switzerland. This system has ruled the global financial system since the 17th century.  Fractional reserve banking allows that only a fraction of deposits held by banks are backed by central bank money.The proponents of the referendum want to avoid another 2008 like bank bailout and argue that: " [...]under the 100% reserve system the central bank wouldn’t have complete control over the money supply, while it would under a sovereign money system. Further, under a 100% reserve system the possibility of a bank-run or the government having to rescue a bank is not completely eliminated, whereas it would be under a sovereign money system.”.  To control money creation the central can: "[...] to keep the amount of money in circulation stable or inject, the Swiss National Bank will need to re-introduce this money into the economy. It can do this in one of several ways: - by buying assets such as securities or foreign exchange reserves (as it can now) - by lending money directly to banks - by handing debt-free money directly to the government to be spent back into circulation or to reduce taxes or to be given directly to citizens.". These statements, coming from the vollgeld paper  have severe drawbacks, we will look at them later.If this referendum were to succeed that would be a jump into the unknown. It would represent a complete change of Swiss banks business model and it would have massive consequences for the Swiss economy. Some figures will help put this in perspective: Swiss banks provide loans worth 2 times GDP; the financial sector is about 10% of GDP and employs 5% of the labor force.Some will say it is not that easy to pass a referendum, the yes must get more than 50% of the votes at the national level plus win in a majority of the 26 Cantons. Moreover, a recent poll by gfs.bern shows No at 49%, Yes at 35% and Undecided at 16%, one out today from Tamedia shows No at 54%, Yes at 39%, Undecided at 7%.It's not because something has a low chance of happening that it must be discarded completely especially given the consequences are so asymmetric.The Swiss institutions (Confederation, SNB, Banks...) and most of the academics (a great paper from Philippe Bachetta can be found here) oppose the referendum initiative. I do share their arguments and will try to summarize them below.The proposal would separate money and credit.  It will move away from the historical distribution of responsibilities between the SNB and the banking system.The SNB will have to guarantee the supply of credit to the economy by the financial services providers. That would have to be done via securitized loans. The SNB will have to take credit risk and would have a more direct influence on lending. It creates a risk of political interference and a possible lack of competition in the banking sector. To be true credit risk is already present on SNB balance sheet via its 82 bios USD equity portfolio, but this is meant to be temporary, i.e. this is the Swiss version of a QE portfolio. Sovereign money will limit liquidity and maturity transformation as banks cannot create deposits through lending. It will restrict supply of credit to households and small and medium size firms with no access to capital markets. The referendum initiative does not address the too big to fail issue as misjudgement and over lending can still exist. It does not address the shadow banking issue either. SNB will switch back to monetary targeting, that's back to the future! Central banks all over the world moved away from it 20 years ago for good reasons.Sovereign money would be created “debt-free” rather than through SNB money market operations (purchasing securities or granting secured loans). It's not clear how money supply would be reduced when needed to.  It creates a huge uncertainty for the Swiss economy.One of the problem with the underlying idea of money targeting is that is there is no historical link between money creation and credit provision.M1 and Total Credit per GDP (The Sovereign Money Initiative in Switzerland: An Assessment Philippe Bacchetta, June 2017)The other problems lie in the implementation of the change. As banks will transfer their customer's sight deposits to the SNB, they end up with a financing gap. Sight deposits minus reserves represent 25% of credit and 15% of banks’ balance sheets. The Vollgeld paper sees it happening in 2 steps:1- SNB lends its reserves to fill the financing gap.2- Banks need to find alternate sources of financing. It can borrow money from the Swiss National Bank, it can borrow from other banks, it can incentivize customers to place their money in savings accounts, it can issue shares or bonds.It is not guaranteed that the new sources of funding will be more stable than the old client sight deposits. We could see an increase in savings deposits or Euro sight deposits which are not part of sovereign money.  It could lead to an increase in Euros transactions in Switzerland! We could see a switch to short term funding which is more volatile. Given sovereign money is a safe asset outside the banking sector, it will not take much for these funding sources to leave banks in time of crisis. Thus, the risk of bank runs is not reduced at all.Let's now have a look at the economic impact.As stated by Phillippe Bacchetta, the impact in the current state of negative rates would be very low. But... If normal positive rates were to come back, the impact can be up to -0.8%/annually.  This cost would be borne out by households and banks, it should be seen as a lower-bound, as other costs (implementation, regulation costs etc) are most difficult to assess.What would be the market implications? According to Beat Siegenthaler at UBS, the CHF could appreciate as this would be seen as a road to tighter credit and restrictive monetary policy. The SNB might also argue it is not anymore allowed to intervene in the FX market. I'm not so sure about this outcome, I guess bank stocks would be hurt pretty badly as their profitability will be curtailed and the high uncertainty surrounding their replacement funding. Given this is an idiosyncratic issue, and the fact the SNB argument is contradicted by the Vollgeld paper I have a hard time to see CHF rally. As the Philippe Bacchetta puts it “It is to be hoped that all these costs and potential risks will be all well understood by Swiss voters.” There are numerous examples in recent history of why a very technical project should not be put to referendum, people will mostly vote to voice their concerns and fears rather than making an educated choice on the question asked. There is a snowball chance in hell that people will dig deep enough to get a thorough understanding of this technical issue. The current wave of populism makes me very nervous as to the outcome of this referendum. I hope the Swiss are immune to it. MacroDiver

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02 мая, 15:20

Strong And Stable, Valuations Edition

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It's fun and trendy to point out valuations are elevated for a variety of financial assets these days, though thanks to the global bond market selloff over the last several months all manner of fixed income is showing some honest-to-goodness yield again. For the equities crowd, the "P/E" of the 10 year note (1/yield) is down to its lowest levels since 2011. It's a similar story for the broader Barclays Agg, the widely-followed aggregate for the fixed rate investment grade taxable bond market.So are equity valuations down to? Why, in fact, yes they are! Thanks to a weaker dollar, stronger US and global growth, and of course tax reform, since the end of 2017 next 12 month estimated earnings are up over 11%, while valuations have dropped 2.2x to 16.2x those next 12 months' estimated earnings for the index. We can already hear the hoots of derision at the very idea of using analyst estimates. Calm down, folks, we aren't going to litigate that and we have to use some forward-looking estimate of earnings, so we'll go with that one for now. Analyst earnings are always and everywhere acceptable as a baseline, in this correspondent's view, and can create respectable set-ups to play the contrarian of course. But generally they're a decent way to capture a reasonable expectation of what happens next.Okay so with that off our chest, we'll ask the question: is the US equity market really overvalued? The 16.2x valuation is pretty aggressive versus the ~11x forward earnings being priced in back in the dark days of autumn 2011, but they're hardly unprecedented. Buying ~16x forward earnings in late 2014 has delivered ~8-9% annualized price returns since, and 16.2x isn't that far from mid-2009 forward valuations. We of course don't need to be explicit about how that turned out for equity investors!But, but! Isn't the US expensive versus the rest of the world? Sure, that's reasonable. We pulled data for a few different MSCI indices; this isn't a comprehensive sample but should give a rough idea. At 16.39x next 12 month estimated earnings, the US trades at a healthy premium. The MSCI World index trades about a turn lower at 15.42x while Europe enjoys a robust 2+ turn discount at 14.31x. High-growth EM is down at 14.09x, while China (still growing in the mid-single digit range real, give or take some fudging here or there) is 12.30x (note: MSCI China is all H-shares listed in Hong Kong).The problem is that the US is relatively unique. Sticking with the MSCI indices, Tech's market cap is over 24% of total US market cap versus 16.2% for MSCI World. For EM, that's only 7.1%. Given gangbusters growth, it's pretty reasonable for US Tech to trade at a healthy forward multiple, 17.31x next 12 months' earnings. But wait: MSCI World Tech trades richer than that, at 17.53x! If you want to pay really exorbitant prices for forward earnings in Tech, head across the pond where the MSCI Europe Tech sector trades 20.6x next 12 months' earnings. EM Tech is valued at a similar level. So the US is expensive in aggregate, but its biggest sector actually looks pretty cheap!This was recently explored in a good post by Lawrence Hamtil. [We also note @modestproposal1 as a frequent contributor to this theme.] The key thing here is that if we want to explore differences in valuations, it behooves us to adjust for the differing sectors; it makes perfect sense for an all-Utilities index to trade at a big discount to an all-Tech index. That's a pretty extreme example, but the intuition should be clear: higher growth should be valued more dear, and the more growth stuffed into an index the more we should be willing to pay for it.To get things all nice and squared away, we adjusted the MSCI indices from the chart above to get to a nice like-for-like comparison where they all have the same sector weights both now and across time. The US multiple has actually gone up slightly, but so has everywhere else! Except for Australia, everyone else is within 3 turns now, and there's very little daylight between the MSCI World (third-highest) and Canada (lowest). The US still looks expensive, and in a certain sense stands out, but alternatives are all tightly grouped instead of dispersed. We're missing one other dimension here. In the charts below we show the next 12 month P/E, adjusted to global sector weightings, for the US, Europe, Japan, China, and EM. The US always retains a premium, but the re-weighting shows that the US investors have actually been quite discerning. At global weights, they've been unwilling to pay more than 19x forward earnings through a variety of market environments. US valuations have been high, but very stable...unlike the rest of the world. Our last chart below shows the current percentile of next 12 months earnings multiple for the MSCI indices we've been discussing. Once again, it's pretty hard to look at the US market as ridiculously over-valued. While valuation is certainly elevated, it's been higher about 30% of the time; Europe looks worse by this metric, as do Emerging Markets. Canada and Japan are relatively cheap versus recent years.Valuation isn't everything. Many punters - especially those in the post-GFC world - have seen margin incinerated on the backs of "high P/E, gotta mean revert" trades. One of the most famous mean reversion advocates folded last year, and for once that sort of about-face didn't mark a major top for a trade. Therefore in our view there isn't much to do here other than to argue there isn't a trade. Sometimes capital saved by not following popular memes is capital earned, to say nothing of the abject frustration of incinerated options premium.Note: all data for this post is via Bloomberg/author's calculations, value date 4/30/18.

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27 апреля, 08:16

EFF-IOER: What's Next?

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Same as  Cackalack Capital, this is my first post. I joined the troops after MM asked for some help. I am honoured and thrilled to get the chance at it. Please feel free to contact me with any questions, comments, ideas at [email protected]side the wild ride in Libor-OIS, which was the subject of a Cackalack post, something on my radar and somewhat less discussed, apart from some short end nerds like myself, is the narrowing of the EFF-IOER spread ( Effective Fed Funds -Interest Rate on Excess Reserves) . For almost all of 2017 that spread was at 9 bp. Then coming into the FOMC December 2017 meeting it started to tighten. Of course this is moving at a snail pace but a move from 9 bp to 5 bp in about 4 months for something that didn’t move for 18 months prior to that is entitled to raise a few eyebrows. Some would say the Fed started shrinking its balance sheet in October last year and this is draining reserves, putting upward pressure on the Fed Funds rate. That's true but... In October excess reserves were 2.12 Tn, in December it was 2.19 Tn, so this explanation doesn't hold for the December move. It now stands at 1.99 Tn, it’s starting to bite and will more so in the future as the balance sheet reduction accelerates (see graph below). Another culprit could be the diminishing weight of the standard FDIC assessment charge but here again we are talking pennies. The weighted average was 4.4 bp in Q2 17, 4.2 bp in Q3 17, we don't have the numbers for Q4 yet but even tough banks capital improvement will drive it lower it's unlikely to be the catalyst.What about Bills and Bonds issuance ? As we can see from the chart below, the Treasury cash balance started to move up in December and has been on an accelerating path since then. This is due to the large Bill issuance that started then and accelerated after the US budget was voted in early February. It is now sitting at 414 bios, over the Treasury projection of 360 bios for end of June, certainly aided by this month tax receipts inflows. The Bill issuance is also draining reserves and alongside the increasing Bond issuance it has an other side effect. It creates upside pressure on  GC overnight repo rates. As a proxy I'm using the GCF Index as longer history for SOFR and BGCR are not yet available. As we can see below the 5days moving average GCF - IOER spread has tightened from -7 to +1 in the last 2 months. A correlation with Tbill outstanding seems to exist.   This is changing the relationship between the various overnight rates and in my view is the main driver behind the move higher in Fed Funds.This month the Treasury has slowed down Bill issuance due to the tax receipt inflows but they will ramp it up again in May.   The Fed has also increased the passive balance sheet reduction from 20 bios to 30 bios/month at the beginning of April (it will be 40 bios from July and 50 bios from October). This 2 factors let me believe the Effective Fed Funds Rate has not finished its march higher and we could see it getting nearer the IOER rate in the coming months.Good luck,MD

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26 апреля, 05:52

LOIS Maximus

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Since this is my first post, hello! In the words most commonly used during the reign of Mike Francesa on WFAN, long time first time. I've agreed to do some posts since MM hung up the shingle a couple weeks ago, and am thrilled to be getting the chance at it. Please feel free to reach out to me at the following addresss with any questions, comments, concerns, or otherwise: [email protected] we'll be returning to the wonderful world of STIRs, and specifically the now-falling LOIS spread. This has been dealt with a number of times lately by Jurofalco ("An Exercise In Connecting The Dots") and Shawn ("The Anatomy of a LIBOR Panic" and "Why Is LIBOR Moving Higher"). I'll assume given that background readers are basically familiar with the story.Since peaking on April 6th at 59.6 bps, the 3m LIBOR-OIS spread has slipped below 55 bps.  That date is a nice, convenient trading week following the close of Q1, a date we think is significant. In the prior recent LOIS blowout, spreads peaked out just before an October 14th 2016 deadline for new fund rules which forced huge rotation out of prime funds and into government backed funds.This time, it's not a question of money market funds. Instead, as the prior posts detailed, the catalyst has been less clear but there's broad consensus that tax reform has played a huge role. Included in the year-end tax cut for US corporates was a provision that incentivized repatriation of offshore cash, specifically 15.5% on all offshore income rather than the previous 35% rate when repatriated; a lighter 8% levy applies for illiquid assets but the 19.5% lower rate for cash/cash equivalents is the key thing here. As a result of that repatriation, there have been a wave of announcements around what companies will do with that cash and other benefits from the tax cut. That all sounds boffo for USD! Unfortunately, it's not that simple. Offshore assets were offshore on paper only. For instance, see the tale of Braeburn, Apple's Reno, Nevada-based credit mutual fund corporate treasury operation. Profits earned abroad weren't kept in local currency, but instead sold into USD and held in accounts invested in USD. So buying USD on a repatriation thesis didn't work out so well. But the investment of those USD assets is where LIBOR comes in.It might be helpful to look at this visually. The chart below shows the share of US corporate assets sitting in liquid low risk assets (time/savings deposits, checkable deposits, money market funds, UST, Agencies, munis, mutual funds, and foreign deposits). Since the start of the current phase of US corporate-lead globalization, the share has nearly doubled. Short term interest rate assets only (time/savings deposits, checkable deposits, foreign deposits, and money market funds) have seen similar increases.In effect, the US tax system has created an incentive for big chunks of cash to sit "offshore" in low risk investments. At the same time, the offshore market has lapped up that dollar funding. Now, in a one-off shock, that dollar funding (or at least, a large chunk of it) has headed out the door. Eventually, it will work its way back into the financial system, but probably not in the same way. With Q1 now in the books, and the biggest marginal flow of the stock of offshore dollar assets finished flowing out, rates are now reversing. That's visible in both the LOIS spread (offshore dollar deposits) and the CP-OIS spread.There's one more piece to this story. FTAV has done a good job covering Credit Suisse's Zoltan Poszar's theory that specific provisions of tax reform are resulting in a shift in behavior for international banks' New York branches. This theory suggests those branches will shift from borrowing parent company cash to funding with commercial paper, and that repatriated cash will then be lent out via parent companies in the FX swap market (or, alternatively, those parent companies will need less USD borrowing via FX swaps because they now have USD funding back). Under this theory, commercial paper issuance by foreign branches should be rising, while the amount due to foreign offices from those branches should be falling. Instead, on a net basis, the amount due is going up.There's an argument about gross flows here to be made, but for now, keeping things as simple as possible, if tax changes are forcing US branches of foreign banks to reduce funding from the home office and replace it with CP, it seems unlikely that net liabilities to foreign offices would be rising sharply. The second leg also doesn't make much sense when taking a look at the data. Foreign commercial paper outstanding is up a paltry $13.5bn since the end of Q3, hardly the stuff of massive funding market shifts!So, takeaways. The argument we're making here is that LOIS's spike isn't going to lead to a permanent plateau. Similar to money market reform, it was a one-off event that the market had to digest. Changes in US tax law haven't created a permanent spread between LIBOR and Fed funds, but did create a lot of selling pressure for a while. Barring new marginal widening pressures like a large spike in credit spreads more broadly, LOIS should contract considerably from here. The easiest trade to would be to receive LIBOR versus OIS swaps, or own ED contracts versus forward OIS. If you're not able to avail yourself of the OIS market, an easier to execute version would be to own ED futures versus Fed Funds futures. As shown in the chart below, these are respectable proxies for spot LOIS, though of course they're not exactly the same thing. Assuming (perhaps too optimistically) a very rapid unwind of the LOIS spike, the June Eurodollar contract (M8, which has a valuation date of June 18th) should settle close to 25 bps tighter versus the average of the July (N8) and August (Q8) Fed Funds futures. A less aggressive approach would be to receive the September Eurodollar (U8) versus October (V8)/November (X8) Fed Funds futures. That gives more time for the spread to tighten, but the spread is already closer to its pre-blow out levels of ~20 bps. Because EDs trade with a DV01 of $12.50/tick and Fed Funds trade $20.835/tick, actual execution would be long 4 EDM8 versus short 1 each FFN8 and FFQ8 (or the later maturity, outlined previously). The best case for either version would be a move to 20-25 bps, with stops of 50 bps (EDM8) or 42 bps (EDU8) give-or-take. If held right to "maturity", the whole thing should be sold in the days before EDM8 or U8 cash-settle, to save a load of headaches.Astute readers will note that we're sort of cheating here; Eurodollars mature to the value of LIBOR over a 3 month period, but we're only using Fed Funds futures for 2 months. Unfortunately, the value dates, maturity, and mechanics of the two different futures contracts don't work out exactly, so barring some might specific hedge ratios this is just the most efficient way we can see to put on a LOIS tightener using generic futures. Do get in touch if you're aware of an alternative!

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25 апреля, 21:37

One Sour Kiwi: Yours! On Another Clip of NZD

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As we have discussed in the past, the dollar is finally bottoming. Perhaps the market is finally starting to care about real yield differentials again.If you thought this dollar move "has legs" to run, what should you short on the other side of the dollar?I think NZD is a prime candidate to be short.For those "big picture" and "picture only" peopleLet's be lazy and consult the big picture charts - looking at both the weekly and monthly.On the weekly, we've consolidated since the beginning of the year and look like its ready to run to the downside to at least a 66 handle, or maybe even a 0.62 handle. In the meanwhile, the monthly chart right now reminds me of what materialized in 1999 to 2000.Fundamentally, why is the Kiwi no longer sweet?Looking under the hood, I have identified potential fundamental drivers behind this chart.NZD/USD (and pretty much NZD/anything else) was so strong back in 2013/2014 because RBNZ was the only central bank raising rates to combat inflation post rebuild for the Christchurch earthquake.That placed the RBNZ on a slightly different policy cycle versus the rest of the G10 world. Since we are looking at NZD/USD specifically let's just focus on the RBNZ vs the Fed.So the Fed now is raising rates with the US economy ripping while the opposite is occurring in New Zealand.Most recently, the Kiwi sold off for the most part before, around and after their prime minister election. The weakness in the NZD was very real as it mostly coincided with a general USD sell-off.Nonetheless, during her first 6 months, Jacinda Ardern has proven to be centrist enough for the NZD to benefit. In addition, the continued decline in USD also boosted NZD/USD levels.A sour futureAt this juncture, the market should understand these dynamics mentioned above. So what can we look forward to?Well, first I personally believe the USD is bottoming for the tradeable future as noted previously. So there's that. For the sake of this argument, let's just assume the USD bottom and US real yields march higher.Now, moving on to the NZD side, we've started to see some of the Jacinda Ardern influence on the RBNZ. Ultimately, she is from the Labour party and her leanings to the left will be the driver for a lower NZD.[Jacinda Ardern] says GDP per capita is "barely growing" and unemployment is stuck at 5% but she says it should be below 4%.This is because, she says, the economy has become more geared toward speculation and extraction than value-added exports."Low wages aren’t simply a problem for low-wage workers, they are a problem for businesses and the economy."Ms Ardern says under a Labour/NZ First government, "we can finally have fair wages."From that article excerpt, it is painfully evident that she wants full employment and wage inflation - ya know, kind of your typical cornerstones for high levels of inflation. I talked about this before in an AUDNZD post, but I think the market is finally catching onto this as well.As predicted, to achieve this, the RNBZ will be the main vehicle. The incoming RBNZ governor has signed off on a new policy objective of caring about full employment along with inflation target. Although he has stated there will be no change in policy bias, I'm not convinced.With inflation still running on the low side of the central bank's target 1 to 3 percent range, my logic tells me there will not be rate increases coming out of the RBNZ for awhile.In addition, Jacinda wants unemployment lower! Like 3% lows. Let's take a look.Assuming this thing stays in the current downward trend, it can still take years of growth and/or stimulative policy before we can get to ~3% unemployment. And trust me, they'll need accomodative policy.Because when you look at growth:Regardless of what the IMF thinks they see in their projection, growth to me has started looking like it has become stale and flaccid.With regard to rates: the OIS curve is still 75bps higher a  year out versus the current RBNZ target rate of 1.75%. This could be too high if you assume they can't raise them and might actually have to lower them.Subsequently, in REER terms, NZD in a vacuum is still somewhat expensive and could easily depreciate 10 to 15% further before it becomes historically cheap.All signs point to lower for longer in New Zealand. As a result, even with this latest selloff, I still think there is still money to be made by calling your broker for a quote of NZD and telling him "Your!"Good luck as always,DR

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24 апреля, 19:37

Gold Hedge Not Working?

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A couple of quick things today:1) Just wanted to take the chance and thank Shawn again for the many insights over the last year or so. I thoroughly enjoyed and learned from your posts. With that said, I will do my best to try and keep this blog going while juggling my current work responsibilities.I've also personally grown through the feedback and reverberation of thoughts after my various posts and would encourage those who are interested in developing or sharpening their macro/trading analytical abilities to email the original macro man: mrmacro -at- gmail.com2) I wanted to quickly note one point: Gold in USD terms has failed to be an optimal hedge for the most recent move in inflation expectations.I've done a more in-depth study on gold as an inflation hedge in a past post here. I wanted to reemphasize some of those dynamics, as they seem to be at work.Many people buy gold as a hedge for inflation expectations. That doesn't always work. The real yield has held steady and has even risen as of late - if this persists, it will be very difficult for gold to catch a bid.Conversely, people expect inflation to be hampered if the real cost (inflation adjusted cost) of borrowing is rising. However, that is also a fallacy. Market inflation expectations are calculated via the spread between nominal bonds and inflation-linked bonds. As long as the nominal yield is rising faster than the real yield, you would, in essence, be witnessing a market expansion of inflation expectations.However, as previously mentioned, the rising real yield would be a damper on Gold prices.The market since the beginning of 2018 has validated this theory. There are potential scenarios for this phenomenon of flat or decline gold prices coexisting with rising market inflation expectations.  For example:- Imagine a world with persistently rising inflation (this scenario is much less controversial now than even 6 months ago). - Central banks are now inclined to lean on the hawkish side to combat inflation (this belief is much more prevalent now than even a year ago). - However, global central banks are "not allowed" to raise rates fast enough because there is so much debt floating around. A combination of increases in supply (increased treasury issuances for example), and rising inflation expectations, the bond market finally has the "ah ha!" moment by selling nominals en mass. - Real rates cannot rise as rapidly as nominals, as it would hamper borrowing costs too much. Nevertheless, it must trend higher slowly as there is a need to combat inflation.The end result? Lower gold prices and higher breakeven inflation.All-in-all, gold can be a good inflation hedge at certain times, but buyer beware - warning signs are evident.Good luck,DR

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13 апреля, 18:04

Help Wanted

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Well, as you can see from the post below there now a vacancy at the helm of the Good Ship MM.  I am still occupied penning an institutional version and befouling the airwaves at Bloomberg, and while Detroit Red will hopefully keep chipping in, Shawn will clearly be missed.However, his gain (and the blog's loss) could also be yours!  I certainly derived a great deal of utility from the authorship of this space, and as you can see Shawn did as well. As a means of keeping your skills honed (and trying out new ones!) in a forum that is both crucible (via exposing your view to public scrutiny) and shop window (by demonstrating how smart you are!) , I would humbly submit that being the new Dread Pirate Roberts Macro Man is close to unparalleled.And besides, check out these great benefits:* Salary:   $0* Health/vision/dental: None*401k: None* Vacation: At your discretion!In seriousness, if you are interested in taking up Shawn's mantle, particularly if you're an experienced punter between gigs, please hit me up at  mrmacro -at- gmail.com.-The Original MM

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12 апреля, 20:00

Goodbye For Now...and Some Market Parting Shots

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There’s something against human nature in saying goodbye. Even the individualistic among us are innately programmed to stay within a group, pack or family unit. We’ve all been in that situation where you are parting ways with someone you know you’ll never see again, but you just can’t bring yourself to say the equivalent of “have a nice life”, instead settling for something along the lines of “see you again soon.”  So it is with a tinge of sadness that I must say goodbye and end my term at what I’ve come to call Legacy Macro Man. I’ve accepted a new position back in the corporate world that will consume not only my waking hours, but will also lead me into some new markets that I have not dealt with in the past. Over the past couple of weeks I’ve been thinking broadly about how to analyze, manage and make money in these markets. I realized how much I have learned during my relatively brief spell in the blogosphere. I’ve learned a lot about trading not only from the folks that follow this blog, contribute their comments, and reach out to me directly, but also from the “competition”...the endless array of brilliant people posting their thoughts on social media or their own blogs.  As a PM, I spent years pouring over my own research, sell side research, research from a small group of independent consultants, and information and ideas from colleagues and personal contacts. It isn’t necessarily that the people posting ideas for free on the internet are better than these people that do it for a living (even though many of them do that as well), but they are most certainly different. And different is the one and only thing that generates alpha. Those contacts and new approaches to trading and investing will stay with me forever. With that I’ll end the sappy stuff and leave you with a few market observations:1) Inflation...still not dead! A while back I pontificated on the risk to a quick acceleration of inflation. Bill McBride over at Calculated Risk posts this chart monthly, which incorporates some alternative measures of inflation.  You can see they are all ticking up...then look at my favorite alt-inflation measure, the NY Fed underlying inflation gauges: The full data set measure, which takes in a wide variety of non-price data, has moved from 2% to over 3% very quickly, and shown little sign of slowing down this year even though stocks have been (at best) chopping around and credit spreads have been widening. Lastly, Ben Hunt over at Epsilon Theory had a great post earlier this week highlighting not only the risks from inflation, but the potential that the market will soon realize just how big a threat it because of the reversal of some statistical anomalies in wage growth data.  When you combine that kind of insight with Ben’s penchant for thinking up market metaphors related to his farm animals, you can really see his genius. Combine those factors with the following: unprecedented fiscal stimulus, a tight labor market, a highly volatile equity market, widening credit spreads, Chinese tariffs, Russian sanctions, a really ugly geopolitical scene specifically in the Middle east, and a presidential administration led by satirical cannon fodder like John Bolton and Larry Kudlow...and tell me again, where is forward rate vol?? Really cheap relative to equity vol. Buy it. 2) The long USD trade. It’s coming back. Trump is the figure that people around the world love to hate but the USD seems to have fallen into that category too. Last year, USD got hammered despite the Fed finally following through on its rate hike projections and a good year for growth...the game changer was the resurgence in growth throughout the rest of the world, specifically in Europe. Many of the indicators I highlighted last year as supporting the resurgence in growth and perpetuating EUR appreciation are showing signs of wear: Those figures in retail, PMI and the surprise index are hardly illustrating or portending an economic trainwreck but they do show that currency traders might have gotten a little ahead of themselves in pushing EUR above 1.23 earlier this year. Now, I have a visceral and philosophical opposition to charts that don’t have a proper axis, so with my apologies I’ll post this one to quickly illustrate how the market is long EUR:Despite EURUSD trading in a very narrow range. Economic divergence, extreme positioning and little price movement...combined with an abundance of geopolitical risks---buy USD. And lastly, I can’t sign off without a comment on EM. Trump’s foray into the morass of tariffs, sanctions and the Syrian conflict have triggered some serious divergence in some big EM markets.EM investors were limit long RUB and Russia rates with the steady increase in oil prices, then with the new sanctions these guys are caught with their hands in the collective cookie jar. The Turkish lira has suffered with a variety of internal stresses, a widening c/a deficit, and risk of spillovers from Syria. And ARS suffered in late ‘17 and early this year after the government and central bank collectively allowed for higher inflation and lower real rates. Meanwhile, ZAR continues to outperform after Zuma’s departure and some positive signals on the reform front. MXN has outperformed on optimism about a NAFTA agreement sometime in the next month and acquiescence, ambivalence, or ignorance about election risk, depending on who you ask. But most importantly is the China. CNY continues to appreciate. There is always room for 21st century Kremlinology that attempts to interpret the signals and objectives of the Chinese authorities. Maybe this is an oversimplification, but this is a momentum trade. The government and PBoC have sustained a number of trends in the past ten years, and the current one is to disincentivize additional export capacity to allow for a gradual moderation of credit growth and increase in consumption. Maybe that changes in the near future, but it is tough to argue that isn’t where we are now. So long as that is the case, and it is overlaid with continued decent global growth and renewed growth in global manufacturing demand and commodity prices, it still paints a positive medium-term picture for EM assets. In light of my view that we could see a short-term bounce in USD, I would look to to overweight the high beta, commodity producing “dogs”--especially in Argentina, which should benefit directly if China implements import tariffs on US soybeans--at the expense of the EMFX outperformers, who in my opinion, really don’t have anywhere to go from these levels. And with that..farewell!! You won’t have heard the last of me--I will stay in touch with TMM and throw in an occasional anonymous guest piece--most likely on some emerging markets issue I have stuck in my craw. And I will post some brief commentary via Twitter, a medium I’ve come to like quite a bit. Follow me here: @EMinflationista. [email protected]@EMinflationista

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05 апреля, 01:16

Reading The Tea Leaves For WTI

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In light of today's surprise EIA print. I decided to revisit the oil market to try and get a feel for sentiment and overall market fundamentals.First comes sentiment. Seems like most places I look, people are generally bullish on oil. Not a huge surprise. Usually, sentiment follows the prevailing price trend. And for oil, we've had a meaningful rebound from the lows. The oil glut crisis seems like a lifetime ago.Additionally, CFTC positioning is obviously pretty long. I encourage those with BBG terminals handy to go ahead and adjust it for Open Interest for a more accurate picture - although, I don't think it would change much.But as traders, we profit from questioning the consensus. So let's dig into some fundamentals.One of the drivers of the oil glut was the increase of US production and subsquently US oil exports. Reviewing the chart shows something peculiar. Around the end of last year, we've had a divergence between US oil production and US oil exports.We are still pumping out that stuff but are not selling as much of it? Could it be that we are simply consuming more?Well, it turns out that's not the case either.At the beginning of this year, we actually saw a trough in US inventory. Since then, that bottom has been clearly made and inventory has continued to build.Digging into the minutiae of the production numbers. We see that major players in the creation of the oil glut (Russia, OPEC nations) have steadily maintained their production. Now, I'm not saying the possibility of a production decline is non-existent, I'm just saying there's no sign of it right now via the official numbers.OPEC market share was crucial in the oil decline of 2015 as the OPEC nations could not step in to stem falling prices with production cuts.Today, it seems that the OPEC nations are back in a precarious position where they probably would not be able to continue supporting falling prices much longer.Moving on to the Baker Huges Rig count. This has had a meaningful recovery back to early 2015 levels.Finally, from a more peripheral perspective, we have had a bursting of the sub-prime car bubble in the United States.Subprime auto loans are trending towards 08 levels (probably a result of monetary tightening) and even prime auto loan losses have ticked up. Which probably ties into this next chart.Overal vehicle sales have stopped increasing and could be forming a top. As the glut of car buyers dry up, we can finally piece all of the pieces of the puzzle together.In my opinion, each puzzle piece snaps into place this way: The production that caused the oil glut never really stopped. In fact, non-OPEC production has only increased.The OPEC countries took a pause when they could to help propel prices higher. However, the sustainability of that strategy is questionable in the face of low market share as evinced numerous times in history, as recently as 2015.Auto sales have benefited notably from the emergence of subprime auto loans. As monetary in the US tightened, those subprime buyers are leaving the market. (The increase in LIBOR also doesn't help as it means tightening for everybody).As that source of demand dries up, sales are teetering on what looks like a top and could possibly be the shrinking demand explanation for the divergence of US production and export. A lazy way to measure this shrinking demand is looking at inventories. The world still mostly thinks oil is a long, but with the aforementioned points above, it's probably to jettison that position.Well, there you have it. Good luck out there.

03 апреля, 07:10

More Market Pain: The VIX, Swaption Vol, EMFX And Some Investing Philosophy

The Market: “Good morning!! How was the long weekend?”Trader: “Great I guess, party at the in-laws. How ‘bout you?” The Market: “I spent the last 72 hours furthering my plans to cause you more pain.” Trader: “Really...Why?” The Market: “Bwaahhhhhhaaaaa….assume the position!!”We can get into the cycle of looking for where the next bounce is going to come from, or if this is the second inning of a larger market collapse. What seems clear to me is that this is what we can expect from the market--far greater swings and moves on lesser news. That is an indication that liquidity is drying up and there isn’t new money coming in to chase valuations higher. The high valuations and tight credit spreads that practically every market commentator highlighted in 2017 are finally taking their toll. Don’t take my word for it, take a look at the 5yr chat on the VIX. I can name from memory each of the events that are north of current levels. That’s not showing off my grasp on market history--it is an illustration of the fact that they were all *big* events. Or just *events”. They had a name. They had a story. This market seems like just the opposite. It is a selloff looking for a story. Is it anxiety over tech? Is it fear about the impact of a trade war?  Or...is there just nobody on the bid anymore? My money is on the latter….yet what continues to befuddle me is the lack of movement or realized volatility in other asset classes. This is a regression of the vix against 3m/10yr swaption volatility. Quite frankly it is a pretty worthless regression analysis but I wanted to pull up a chart that illustrates just how low interest rate volatility is compared to equity volatility. There are also those that are looking for a USD to move higher as market stress increases. These two factors are probably two sides of the same coin. I went over some of the factors driving CAD and AUD last week. JPY has also traded by its own twisted logic...strengthening earlier this year on the back of of optimism about global manufacturing demand, local growth, and BoJ stealth tapering--and then as market stress increases, which has usually put a bid into the yen, it simply does nothing. What about the spicy stuff...high-beta EMFX? Surely the high risk/high carry currencies have sold off? Meh….not really. TRY has its own problems...if we throw that one out, the big “loser” in this chart is BRL at -1.5% YTD….a loss in the spot price you made up in carry!FTQ assets like treasuries aren’t rallying...rate vol isn’t moving much...and EMFX is showing unseasonable warmth. The rest of the picture isn’t quite adding up to me--at these levels I’d lean towards some combination of these assets--like buying receiver swaptions and selling EMFX as a better expression of a bearish view than simply selling stocks. On a more philosophical note, over the weekend I came across the excellent “Behavioural Investment” blog. It is a succinct, well-written set of posts on various investing issues that animate me--like cognitive biases, misplaced incentives, and the perils of generating alpha. The most recent post was entitled, “Things That Fund Managers Don’t Say Enough.” Here are a few of my favorites, with my editorial comments in italics:  “It was a genuine mistake – our analysis was incorrect, but I will make sure I learn from this for future decisions.”  CIOs don’t appreciate this level of humility from the PMs. Most would respond with “And next time I’ll make sure to hire someone that isn’t learning on my dime.” “Although the trade was profitable, the situation did not develop as I had imagined and its success was actually just a dose of good fortune” I always appreciated the bloomberg header of a good friend…”Better lucky than good!” There’s a guy that fears nothing. “I appreciate that recent market volatility feels significant, but I don’t want to focus on it because, on a ten year view, it is likely to seem meaningless”.  More PMs would be willing to say this if they had a ten year lockup on their investors’ money. “I appreciate that I previously held a high level of confidence in this view, but, after careful analysis of new evidence, I realised that I was wrong”. There are dissertations to be written about this one...if you’re hired to manage money you’re self-selecting as smarter than the market--so when the market shows you that you’re wrong, it is hard to admit….because some important people think you’re smarter than the market!!  How often do you see a professional athletes publicly admit they got worked by the competition? Pedro Martinez once said the Yankees treated him like they were “his Daddy,” and he literally never heard the end it. The lesson: know what you’re good at, stick to it. Stay humble, and don’t be afraid to admit mistakes within that circle of competence. And while there is good reason to stray outside of that circle from time to time--don’t allow you’re mistakes (and thus by definition, you’re successes) there to be big enough to have to be explained to someone more important that you.