fredag den 30. maj 2008

Fighting Demons

The market right now is on the edge - the real money managers looking to reallocate and the hedge fund managers like myself needing to reassess the standard protocol. Their reasoning? The dramatic increase in interest rates; whether this is driven by drifting inflation expectations or the need to re-establish positive real rates makes for a huge difference in investment outlook.

Forget Bill Gross’ talk on how inflation is measured ( - the 1y Fed expected Fed is going through the roof:

Chart 1: 1 Year Forward Fed rates
Source: Bloomberg and Credit Suisse (1 year forward FED rates based on swap market)

As can be clearly seen the expected FED moves in May alone moved from zero to almost 100 bps over the next meetings. This is was exacerbated by the hawkish Atlanata Fed President Fisher ( ) - who however, never have been at the core of Fed thinking.

The risk is market is getting ahead of themselves here, meanwhile the inflation expectations seems well anchored (which is even more surprising considering the money printing practice of the Fed) @ 2.65% and the tight range of 2.40% to 2.80% since June last year.

Chart 2: Forward break even rates

Source: Bloomberg and Fed - This is US 5 yr by 5yr forward inflation break even (TIPS minus Treau. Fwds)

Conclusion: The move in rates must be the readjustment of real rates, plus positioning of the market. The latter, in my simple farmer’s view being the main driver. There are cyclical reasons why we can be expect this to be the peak of the this rate cycle:

Mean reversion: 10y rates have been trading in nice formation with 4.09/10 now representing the upper border - and an expected reversion back to 3.60/65 being the name of the game.
Cyclical: Summer months generally makes for good bond markets
The incoming data globally, but also in the US is going to reflect the slow which happened in late part of Q1 into Q2 (See last blog comment)
The risk is obvious here - the market continues to price 130 plus Crude into inflation and the worlds finance ministers keeps spending more money fiscally in order to reignite their slowing growth.

The world is asynchronous in the sense that everything seems decoupled and trends are short and reversals nasty in depth and size. This has to do with the overall phenomenon of the uncertainty of the path forward: Where we have been "blessed" with falling inflation , stable growth and inflation through this major credit cycle, we now have almost TOTAL uncertainty:

Will the consumer come back or not; Should ECB cut or raise rates; Are Fed done lowering rates or not: Will BOE hike or lower rates, this makes for an INCREASE in overall financial volatility - the only REAL trend this year.

The most important question right now - remains the US dollar - for me a stronger US dollar is the path of least resistance for a lot of the issues of the world:

It will fight the inflation in the Middle East and Asia.
It will indirectly reinstate the confidence in the US economy and investors, like tourists in the US, we will start to see "bargains" based on cheap US dollar.
Trade flow - the biggest single input to the US economy will be stronger exports (it is already responsible for most of the growth in earnings in the US)
The leading indicators I use (talk about a contradiction in terms) clearly show the game have changed of late:
Chart 3 - Leading EURUSD indicators
Source: Bloomberg and own indicators. DTXDOW = DAX index divided by DOW .US2-10= 2-10 y us rate spread.

Both of the indicators point down.. EUR slowly starting to follow.

The retail sales this morning from Germany, plus the revisions backwards indicate that most of the Q1 surprise performance was clearly in investment, not in consumption. I expect to see a dramatic slow-down in Europe. The recoupling is happening, and if so, the EURUSD should speak loud and clear as an indicator.

Bottom line: A cyclical stronger US dollar has been my main theme all year, but I have been playing one final high in EURO (wrongly), it is now time to step aside, and initiate long US dollar, not based on the uptick in rates(which is more than matched by ECB) but in RECOUPLING and a continued lead in stimulus from the US.

When I make speeches these days I like the analogy between the economy and Alpe Huez stage in Tour De France: The US is on the mountain very close to the peak, though still climbing, but the steepness is far worse than Europe, who is trailing down the mountain and only 1/3 up the mountain, where the steepness starts to hurt, while Asia and Middle East is still on the lead into the mountain having been the muscle men (momentum) sitting at the front of the peleton; the fact remains: They ALL need to climb to the top and down again.....!!!

Enough- Heading off to my summerhouse for the a weekend of 30 degrees celsius - the hottest month in history, it could be the hottest few quarters coming up as the world economy is on the edge, the edge of what remains the question.

Good luck,


tirsdag den 20. maj 2008

when in doubt......go on holiday?

My colleague David Karsbøl have developped a model based on the supposed short-term model of The US Treasury mentioned in Paul O'Neills book, where he states based on only weekly data alone The Treasury's growth model exceeded Wall Streets economist forecast accuracy (Mind you that's an easy goal to set yourself!), but the point being this:

David models continues its free fall indicating we are now moving into solid negative growth and consumer demand.

The later is best seen through the spectrum of credit cards - The US consumer has always been willing to flaunt the plastic even when they have negative equity, but in the land of designer credit cards things are turning to the worse:
Moody's Investor service reports that the charge off rate, which measures defaults as percentage of loans outstanding - rose 6.05% in in March, from 4.64% a year earlier.

The charge off rate peaked above 7% in the 1991 and 2001 recession.

The underlying trend indication is for worst to come as:
1. The repayment amount are decreasing. The US consumer is simply paying less into the bills, obviously indicating either consumption preference or lack of hard dollars...

2. The amount of people skipping 3rd and 4th payment also on the rise.....again not exactly the best sign..
The thing to understand, and this is important.... The financial "melt-down" in banking has been avoided (for now) by Bernanke and his Merry Men's circling of the wagons, but the next phase is one of considerable weakning global demand, the tail risk being we will revert back into credit crisis, as personable income collapse, margin erodes, corporate defaults starts to rise, and banks continues to hoard capital.
Trichet, a man who at long last is gaining some respect from me, hit it spot on yesterday: "The worst could be to come, and an ongoing, very significant market correction is in process"...

My respect for Trichet is rising(note: rising - not gained!) as maintaining unchanged ECB rates does the job for now - it gives him some credibility vis-a-vis inflation, and he realise, correctly, cutting rates not doing anything to real economy as the banks are in trouble.

He also, between the lines with his insight into the European banking system, indicates the European banks needs to earn up to the credit issue and the incoming freight train called potential stagflation.

The European banks are heavily subsidised through the liquidity provision in place, with Spanish banks issuing mortgage backed paper at 101 with ECB and seeing the actual price in the market trading @ 90 bid at best - talk about indirect support.
In terms of the temperature of the market, the bullish consensus hitting new highs, and CNBC commentators, their guests, can not stop talking the market higher - I have been neutral but I am slightly concerned about the market from here;

1405-10 in the S&P was supposed to get us flying, now in the 4th week we trade 1395-1435 and

VIX volatility is coming off - we are due for volatility spike and a range break-out.

I feel downside is the more likely as Q1 earnings was massive disappoint overall.

Stripped for oil companies, the 441 companies who reported so far saw profit tank 30.2% this quarter and 26% in the last.
Energy companies now make up 50% of all profit in the S&P!
Not exactly reason for joy - the fact is the market became oversold in January and March, and now its overbought, the next bigger directional play will be based on how the real economy tracks from here - my take as described above being a path of grinding slower growth, something a very smart friend of mine calls: growth recession indicating negative quarter by quarter growth but probably not outright recession numbers.

It should also be noted Q1 from growth perspective saw one-off factors which will be hard to copy in Q2 - Germany and Europe saw unusually high investments rates- probably covering the fact that most European companies faced bottle-necks in production, input materials and labor.

While in the US the massive inventory build was hardly a choice situation for US companies...but as always I am merely putting odds on this not making predictions.


Moving away from Beta long, to net short exposure on market as of today; short banks-, big europeans industrials, and net indices - all on valuation and lack of technical upside break.

Still like credit overall in high grade names.....

EMG- extremely overpriced - looking to sell.......

FX - still firmly believing in new cyclical final low for US dollar- pricing in 100 bps hikes in the US a joke right in front of prolonged slow-down..........Long CAD, AUD, EUR vs. US dollar.
FI - mean reversion play long Bunds @ 113.38 ish... mainly options...

Commodities- stopped in agri- and still long long-term puts in crude....but looking for normalisation of commotidies to gradually reflect growth slow-down.

Best of luck,


onsdag den 7. maj 2008

US Dollar all change?

This mornings FT got some intereting headlines for the cyclical bulls like me:

Europe and US unite on stronger dollar
By Krishna Guha in Washington and Ralph Atkins in Frankfurt

The US and Europe now have a united desire to see the dollar strengthen against the euro, senior officials have told the Financial Times.
Policymakers welcome the recent rebound in the dollar, which at one point on Wednesday rallied to a six-week high against the euro. They are concerned that the currency markets have been paying too much attention to short-term economic weakness and market stress in the US, and not enough to the medium-term prospects for the US and Europe, a senior US official said.

Before we all get major excited about this change of wording mainly from "US sources", there is obviously some sceptisme on the true nature of US interest here.

From my stand point there are several reasons why US dollar is close to cyclical low:

1. The growth cycle - US have done its job on the monetary side.
2. Trade and Current Account - Export component will add 1 pct. to GDP - and going higher
3. Recoupling - clearly the incoming European data is weakning ...
4. Crude prices - the high oil prices will depress growth world wide, but more so in Japan and Europe long term.
5. Time - the US dollar follows relatively simple bust/boom cycle - remember 2000 ? No one wanted to believe in the central banks commitment to stronger EURO, now the opposite view prevail.
6. It is in the interest of EVERYONE to have stronger US dollar. For Asia to contain inflation risk, for Europe to help reignite the growth and competitiveness, and in the US to secure long term capital flow will reverse from net outflow to netinflow.

We may be early but we are changing our view to fully committed to stronger cyclical US dollar, a view we have been having all year, despite the risk the EUR/USD will see one more final attempt to new highs, and my very sceptical view on US administration suddenly getting concerned.

My model also sold EUR/USD on the break of 1.5360 - wit stop loss above 1.5710 for the brave.


Equity - Closed to long S&P with failure to keep above 1305.00, same for Dax. Net small short through Dax puts. Long DBA - Agriculture

FX - Short USDJPY vs 105.71 cap (from 105.25 ish), short EURUSD(model - @ 1.5315)

FI - Long bunds through options - will 114.30/40 go or not? 10y 3.95% still contains 10 y. rates - watch for developement

Commodities- Crude rules. Market is starting to price deflation in as spikes in oil prices is going the net deflation trade as seen through optics of history (1970s). Given up on reaction down, and I am SERIOUSLY concerned about Middle East geopolitical crisis emerging.

Good luck,

Steen Jakobsen

Sidelined for now...

Wednesday, May 7, 2008
Sidelined for now...

Been doing a lot of reading and research last 5-6 days and to be honest not really getting me anywhere - there are several conflicting themes playing out right now:

1. Inflation vs. Reflation. Clearly commodities are pointing to inflation risk, but market understand that ultimately commodity spikes leads to deflation rather than inflation, which is the scenario central banks wants the least.

The reflation scenario is based on that EMG countries, realising slower growth is busy ramping up demand through infrastructure investments, and in the US tax rebate and soon to be announced help in mortgages makes for perfect ingredients in reflation soup.

For now the reflation themes wins - but the risk being crude above 150, even towards 200 US dollars could reverse EVERYTHING back to credit crunch.

I take note that the US is building its strategic reserves in times of record high crude prices – and it seems from the “intelligence environment” that Bush has approved covert operation in Iran and that the Pakistan lease is getting shorter (Stratfor analysis). The main outside risk right now to the bullish market is on of geopolitic tensions in the Middle East, if so our year old call for 170 USD crude could be validated.

2. Coupling or decoupling. The bulls wants to believe in decoupling as it free up arguments for why you should be invested in EMG and Asia/Middle East.

The truth probably in the middle rather than either side. Europe clearly (Latest factory and retails data confirming IFO) in period of downward adjustment of growth forecast - while Asia is booming.

On the corporate level the managers are all guiding higher as they can not see things slowing(for now), which lead me to an excellent argument which Alain Bokobza, Head of European Equity & Cross Asset Strategy from Soc Gen made to me in private presentation today; the issue with corporate often more one of bottleneck than lack of orders, companies like Siemens guided lower due to constraints on delivering on orders(Which cost them fines) rather than lack of demand, the same goes for much of the infrastructure industry, but end of the day having orders, not being able to deliver will lead to lower margins, and this is before "recession cycle" really starts to impact demand/orders. The infrastructure business is problaby overvalued and overexposed, and that’s without considering the industries long term contracts with its lack of control over rising labor and input costs!

Growth and FX differences. The Middle East and Asia clearly needs to let their currencies strengthen or face further social unrest. The food crisis is now for real, the best and fastest way to limit the negative impact is to let currency go stronger - this will be followed by fiscal stimulus, probably in the shape of subsidies hands out (I see more and more talks about Alaskan like once-a-year dividend).

Bottom line; one part of the world is facing rising inflation, the other likely to see deflation, and central banks are confused where to turn first.

Market positioning. Market is now long, and with good reason. Technically 1405 was line in the sand for S&P and next level should be 1450 - however with 100% support from Newsletter analyst’, the market is clearly committed after the 12% move from the lows. Why are we still hovering around 1417 if this was positive?K

Keep your eyes on The Congress, they are working hard to reduce the economic pain for Joe Average American, it will not be long before some kind of relieve in real estate is announced. Similar to Bill Gross I believe its imminent and the "cheapest" way to stop the ever falling housing market.

Fact is for now the Fed has done EVERYTHING to safe the banks, and close to NOTHING so safe the average American. Only 3 in 10 people in the latest Uni. of Michigan survey expected to spend their tax rebate, the rest would use the cheques to reduce debt - if that is NOT a sign of new times and trend in consumer spending, I do not know what is.

Conclusion. Rather than "betting the fund" on something I cant predict I remain open and ready to act, for now the upside looks more likely than downside, but the odds are 52/48 in my optic.Good luck,