On government (mis)intervention

So we’re in week 2 of the European Central Bank’s (ECB) quantitative easing.  Among the effects:

  • Bond bubble: some commentators have spoken phrases such as ‘bubbles are only obvious in hindsight’.  Well, despite articles justifying the purchase of negative medium-term bond yields, I hope it’s obvious to most that these 10-year bond yields are unsustainable:
  • Let's lock in 1% for 10 years, shall we?  Source: Bloomberg

    Let’s lock in 1% for 10 years, shall we? Source: Bloomberg

    Anybody notice in the above that countries such as Italy, Spain and France can borrow for 50% or less of the US Treasury?  Does that make sense to anyone?

  • Stocks flying: the S&P 500 is more or less even in 2015, despite tepid company results.  European stock indices are flying: the German Dax is up 23% YTD, for example.  While Germany is growing, that’s a big flier. (Side note: I’m happy I did that little bit of rebalancing a couple months ago).
  • UK house bubble keeps going: as written before, this market defies logic.  The UK government’s policy towards soaring house prices has been…um…subsidised mortgage financing.  It’s a sad joke.
  • US Dollar is king: as the Fed is turning the corner to raising interest rates, while Europe and the rest of the world are still cutting/QE’ing, the US Dollar index is up about 10% this year.  As mentioned before, if you’re American and thinking of international travel, or even moving offshore: go now.


Main street?  All the above is great news for investors (though not necessarily savers).  But I’m not convinced this QE helps these economies get back to business.

The direct intervention in financial markets means stock and bond capital gains are much greater (and more predictable) than business investment.  If you’re an entrepreneur, funding can be tight from the banks; why would they lend, when the government bonds they hold spare are making a better return on equity?  If you’re a corporate director, why borrow at low rates to build new plants or try new projects when the return on buying back shares is so good?

In sum: QE had a great initial function, in my opinion.  It loosened credit for big businesses; it jumpstarted merger activity; it finally anchored inflation expectations to essentially zero.  In my opinion, the usefulness of QE has been exhausted for the most part: as central bankers have mentioned around the world (and I’ve written about), it’s time for serious fiscal policy to kick in.  Let’s see some new roads, bridges, broadband, etc.


Friday listening: Promises, Promises

Piggies in trouble.  Source: Google Images.

Piggies in trouble. Source: Google Images.

I’ve been a bit discouraged by markets this week – the gyrations make for poor commentary.  I guess the general message is to be short: short stocks, short oil, short Euros, etc.  We’re back to zero S&P500 return in 2015.  Just stay long fixed income (particularly in Europe) and long the US Dollar.  That about sums it up.

Anyway, it’s Friday.  I’ve really enjoyed this BBC radio series called Promises, Promiseswhich traces the history of debt from an anthropological perspective.  Some really fun concepts and stories here, as narrated by the author of one of my absolute favourite books – Debt, the First 5,000 Years.  The radio series is 10 episodes of 15 minutes a piece, so very digestible for those short walks outdoors or quiet time in the house.

Let’s hope for better markets next week, eh?

Greeks, Germans and Game Theory

Maybe I’m too deep in the weeds, but the whole charade between Greece, Germany and the rest of the EU seems like a case of ‘truth stranger than fiction’.  Here’s what I gather so far, mainly from reading Bloomberg and a Twitter stream full of insightful people (NB: once started with Twitter, it becomes extraordinarily addictive; not unlike financial markets):

  • Greece survives due to the largesse/pleasure of creditor countries within the EU.  Remember who has the power?  If the credit tap is turned off, Greece will default.  Bank deposits have fled the country so fast, there is no chance to finance itself in Euros.  Simple as that.
  • The timeline is a bit fuzzy, but seems to be end-February.  If nothing is done before then, Greece is a goner.
  • If Greece defaults, the following is likely:
    • A very uncertain time, as folks attempt to figure out how an ‘orderly exit’ from the Euro could take place – there is no template, nor legislation, for how this would work.
    • Bond yields for other countries surviving on EU credit, e.g. Spain, Portugal, Italy, will likely spike higher.  Who’s to say they won’t be ejected as well?
    • I’m unsure what happens to the Euro.  I suppose it depreciates, as event risk becomes more of an issue.
  • Greece’s government has the explicit (perhaps necessary and sufficient?) mandate to  exit the current bailout arrangement while maintaining Euro membership.  Though the campaign speeches said this would be easy, it’s turning out not so easy to achieve both objectives.
  • In my opinion, Greece’s ace up its sleeve is Yanis Varoufakis, the Finance Minister.  He used to teach game theory, which one would assume is very useful for this type of goal achievement.  His methods have been definitely interesting to watch/read:
    • Rhetoric completely shutting down the possibility of extending the status quo.  In other words, things will definitely change.
    • Pointing out the damage a Greek exit would cause for the EU.  A sort of “don’t cut your nose to spite your face” argument.
    • Proposing relatively new financial instruments – e.g. GDP growth-linked bonds.  A good idea, but controversial for moral hazard-concerned creditors.
    • Continuous confidence in a solution which will suit Greece.  Establishing the inevitable.
  • Once negotiations began, Germany’s hard-headed Finance Minister, Wolfgang Schäuble, played the ‘bad cop’ in excellent fashion.  Basically shut the door on any extension that varies the terms of the previous bailout.  Doesn’t care about fallout – he announces all is OK.
  • In the middle are Michel Sapin, France’s Finance Minister, and Jeroen Dijsselbloem, the Dutch Finance Minister.  They’re obviously trying to mediate this clash of titans, hoping to navigate the two most extreme outcomes:
    • Unconditional Greece win: extremist parties in Spain and elsewhere win elections, then campaign for similar packages.
    • Unconditional German win: Greece default, with above consequences; a demonstration that budgetary discipline will be hard-met (a problem for countries like Italy and France).
  • The methods used for this fight, beyond the usual meetings of ministers, is striking.  Newspapers, blogs, everything.  The term ‘Sources say…’ has been used so much, it’s incredible.  The amount of disinformation is also incredible – as if both Germany and Greece have full-time PR wonks writing increasingly provocative statements against each other.  This morning’s move in the S&P is a good example when both sides get to the rumour-mill:
Timeline: Greece is screwed.  Then Greece is saved!  Then Germany says 'nein'.  Source: thinkorswim by TDAmeritrade

Timeline: Greece is screwed. Then Greece is saved! Then Germany says ‘nein’. Source: thinkorswim by TDAmeritrade

  • Where does that leave us?  The markets are still hitting all-time highs, so clearly everyone expects a last-minute deal.  Given the EU’s history, that’s probably a safe bet.  In the meantime, folks like me sit chewing fingernails – my trading system really believes in a fortuitous outcome, so I’m left hoping and praying.

In sum: I figured Greece did some sweet game theory-inspired strategising, in hopes of getting an extension under more favourable terms.  Germany has been absolutely, 100% defiant.  Though the markets are betting on a swift resolution, my stomach is more uncertain.  In the end, the Syriza guys can at least give themselves credit for using all available tools to make the best of a bad hand.

More market confusion

Yeah, this sums it up.  Source: Google images.

Yeah, this sums it up. Source: Google images.

I’m confused.  Let’s review:


  • Greece, despite some excellent game theory usage, looks ever more likely to drift into capital controls at the very least, and perhaps full ejection from the Euro.
  • Ukraine’s ceasefire lasted…oh…a few hours.
  • US equity markets now trade somewhere around 20-21x earnings.  Well above long-run average.

In sum: these moves kinda give me the heebies.  Glad to have a system trading for me.  With the long-run portfolio, I’m slowly but surely decreasing exposure to equities.

The S&P 500 – Old school chart patterns

I’m intrigued by the recent congestion in S&P 500 prices.  Up and down it goes.  Here’s a chart of the past 6 months-ish:

Mirror, mirror on the wall... Source: thinkorswim by TDAmeritrade

Mirror, mirror on the wall… Source: thinkorswim by TDAmeritrade

Unlike the relative smoothness of trends in the past, we’re now in an undecided market.  According to (very) traditional technical analysis, I reckon this could be a sign of multiple chart patterns:

  1. Head and shoulders top: see here.  The recent run-up might negate, but still seems to signal further downward move.
  2. Double top: here.  Is 2060 on /ES the top, and we’re on our way back down?  Or maybe we need another run to 2080 to verify the old top, before heading back down?
  3. Triple top: here.  Maybe we can say the runs to 2060 are just 2 more tops added to the 2080?  In which case reversal time?
  4. Falling wedge: here.  Perhaps we’re seeing the high/low runs compressing in a falling wedge, indicating a possible upside breakout?

So many people sign up to newsletters (some of which are very exclusive (read: expensive)) which purport to have amazing chart pattern analysis.  Others buy expensive chart pattern software.  I’m clearly a dunce, as I can’t figure out whether one pattern is better than another in the case of the S&P today.  Assuming complete ignorance, I could equally weight the above observations and come out on the side of a continued fall in S&P prices.  I place roughly 50% confidence in my assertion – so less than the weather forecasters who predicted at least 2 feet of snow in NYC yesterday.

In sum: back to the drawing board.  Not literally – probably won’t use hand-drawn lines to guide my trading anytime soon.

Greek elections: The difference between known- and unknown-unknowns

I win!  Now what?  Source: Reuters

I win! Now what? Source: Reuters

Congrats to the protest voters in Greece’s election on the weekend, with the anti-austerity Syriza party taking a majority position in their parliament.  A few thoughts:

  • Now what?  The story of Syriza brings to mind the Tea Party in the US.  It started as a small protest party with extreme views – a simple message of ‘We can’t handle this debt burden that was left to us.’  Now that the party is in control, simple messages don’t work as well for continued governance: for example, Tea Partiers became very selective in which debts were OK to keep (Social Security and Medicare, mainly).  The press has already picked up on the challenge for Syriza going forward, as they figure out how to balance the simple message with realpolitik.
  • Markets priced the news well.  Yes, the Euro crashed for a little bit.  Stocks took a little hit.  But within hours (at least as I write), we’re practically back to where we were before the election.  So the market did a great job of pricing this known unknown: the winning margin of Syriza in Greece, and how aggressive they’ll be in renegotiating their debt burden.
  • Contrast with SNB manoeuvre.  The weekend news provides a good foil for the SNB move a couple weeks ago: that unknown unknown meant the markets had no time to price expectations.  On the plus side, market efficiency meant the prices moved quickly to reflect new info.  On the minus side, those discontinuous moves brings much heartburn to investors/traders.
  • What would you do?  Suppose you’re in a big position of power, and you have big news to communicate to the markets.  Do you drip in the info, like Super Mario and the ECB?  Or do you shock and awe, as the SNB did?  Markets clearly prefer the former, but maybe there are reasons for the latter method.
  • The bigger message.  I wonder if this qualifies under ‘folks with pitchforks’, when we talk about the demise of the Western middle class.  Now protest parties (e.g. Podemos in Spain) are expected to get a lot more votes, which will bring similar uncertainties.  Without being too ominous, the status quo seems to be unravelling.

Gadzooks! Which is the safest of them all? Clearly Swiss Francs…

This is one of those moments most currency traders and macro hedge funds feel REALLY sheepish/scared:

That'll hurt.  Source: thinkorswim by TDAmeritrade.

That’ll hurt: Swiss Franc futures reverse mightily. Source: thinkorswim by TDAmeritrade.

Imagine the situation:

  1. Beginning: the Swiss Franc seems a safe play.  Very carefully managed by the Swiss National Bank (SNB), which REALLY doesn’t want much variation in their safe-haven currency, you assume a stable relationship.
  2. The initial trade: Swiss interest rates are very low – in fact, negative.  This sets up the proverbial carry trade – borrow in Swiss francs to fund a bet in any currency.  Let’s just use the USD, as it has a terrible low interest rate too, but is still pretty safe.  So you pick up 50bps (around 0.25% in the US, set against -0.25% in Switzerland) in a pretty safe pair.
  3. Life is good: this interest rate differential is picked up in the futures through the near-continuous downward trend we see in the chart above.  Ahh, relax and go short this futures contract.
  4. Today: Oh Shit.  The SNB decides enough is enough, and stops putting a floor on its safe-haven currency.  Interest rates move to -0.75%, so your carry signal says stay short the contract.  But the underlying moves about 30% against you, negating about 60 years worth of the old carry returns.  Oh dear.  Hopefully you didn’t cash out at the worst point, as the pair has only moved about 15% at this point.
  5. Statistics?!? Who cares?  The implied volatility of the future has been around 10% p.a., or around 0.7% daily.  So a 30% daily move is about…45 standard deviations.  We’re talking infinitesimal probabilities.
  6. When writing uncovered calls really sucks.  God forbid you had a system of writing calls to collect the carry here.  Suppose you wrote a $1 call on the contract above yesterday, giving yourself a bit of room on yesterday’s $0.987 close to collect the carry.  Your premium? About $.005 for a 30-day option, which is now MTM at about $0.124 (essentially delta=1 here, so whatever the difference between $1 and the current market price).  Your loss is about $0.12 per contract, or $15,000.  So you collected $625 in premium to now need to post $15,000.  Ouch.

In sum: I’m sure we will find out about certain funds which collapse from this type of trade, or those who trade against consensus and made a ton.  I am very happy not to have been playing this currency.  For option traders – this is the reason you use defined risk trades: yes, you give up a fraction on every trade you do, but it can save your bacon when things like this happen.