Friday, June 22, 2007

I think and think for months and years. 99 times, the conclusion is false. The 100th time I am right - Einstein

At times it's worth taking a step back and let you be inspired. Once in a while I ask my CQG program to give me its "predictions on the market", i.e Elliot Wave count... this exercise gave this result based on monthly data, so long-term trends:

Crude: Higher. 1st target 87.35 potential for 110.00
Gold: Lower. 551.00 1st even 491.00
EURUSD: 1.4550 potential for 1.7000 (See chart below)
10y US yield: 5.85/6.00% long-term back to 7-8 pct.
S&P: 4th wave correction to 1324.00 or even 1224.00


(Click on chart and u get larger version)

Well, stop a minute you will say, it's a computer doing this! Yes, it is my friends, but as the latest Bloomberg Magazine told us: 1/3 of all equity trading is today done based on algorithms, rising to above 50% in 2009! In other words wave counting, pattern recognition, volatility cones etc is today very much part of the day to day functioning of a fund manager or money manager at large.

The issue being that it's first self-fulfilling, i.e successful but ultimately it will crowd out performance as more and more manager use same iterations to reach investment results.

I fear that present time is one of these things happening. The co-correlation I illustrated yesterday in assets, tells us such a story. Never has the bandwidth of research been so narrow in my life as a trader!

Simply, we ALL use same risk model, same risk prediction , same charts, same metric and same quantitative input, the power of pc's, Internet made this ONE game and perception wise a ONE WAY street.

I do, however, always being sceptical, think this is cross road. Why?

1. Volatilities are rising from lows and with good reasons. Volatility is NOT initiated from financial products, but rather from economic and political data. Greenspan made sure everyone did the same thing: Trouble? I will cut! Uncertain about future growth? I will cut! Financial distress in financial sector? I will cut!

The Greenspan put worked its magic taking average return in equities and fixed income way above the mean-reversion return expected

But now? We have been changing our "Fed view" three or four times. Fed staffers tells us: monetary policy does not work. Riksbank is lost in their own predictions. BOJ caught in political headlights! Hence.. less predictable actions from central banks and politicians = More Volatility!

2. Complacency - investment banks are so align on everything

3. SWF - they ARE changing the game both in FI and Equities. They will reallocate and it will raise ethical questions as Asian government, put diplomatically, seems to have less of an issue with insider, preference treatments, than European equivalents. The end result. Steepening in yield and LESS money for the US.

4. Saving glut have peaked - so far only circumstantial evidence, but Middle East got more import, less export for now, meaning some of the funding is disappearing.

The Asians will see more opening of markets and hence they will have some destruction of capital as surely they will be invited to the party near closing time.

5. Real rates is rising. Inflation is coming back in Q4. No one believes in break-evens or inflation forecasts from governments. On top of this more and more central banks losing credibility:
(Read: Sweden, RBNZ, BOJ, and to some extent FED). ECB is in the corner and SNB stands alone warning as they should.


So.. back to the PC's predictions:

EUR.USD & 10 y notes: SWF, China buys less US assets, the US economy looks to decouple from rest of the world, as the indirect tax of homeland security acts makes it almost impossible to do day to day business or to keep money in the US. This drives yield higher, and increases an already massive financing needs.

Try to add up: US current account+ overseas buying of stocks by US investors (Clue: the number is bigger than 600 bln. per year!)

Crude: The supply & demand functioning is simply defunct. There is simple logistic issues getting crude to the users. On top of this Middle East have rising import needs......plus hurricane season is here...

Gold: The most difficult one to explain. It seems market has simply become to bid on ETF's fund etc, and we need clean-out similar to what we saw in natural gas last year?

On this gloomy note - how can you be anything but sitting in the rain in London? Our present strategy :

FX: Turned US negative again. Long GBP.USD (watch the repatriation story in The Telegraph this morning...) Short EURCHF, I am probably the only one LISTENING to Roth in SNB, but....short EURGBP, carry... :-) (and I like my homeland). Short EURNOK. Long EURCZK. Short USDJPY (new), long JPY calls.

Equities: Short Dax spot again, long DAX puts, S&P puts......neutral banking sector...looking to sell...

Fixed income: Long EURIBOR December, trying to find some long-end shorts.. Bunds or T-bonds....Looking to sell agencies....

Commodities: Out of crude again. Looking to buy grains. MTD: +60 bp.

Nice week-end - enjoy the Midsummer.

Steen

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