Markets: Speculative Positioning Update

Below some selected charts for global speculative positioning (compiled from CFTC CME, CFTC CBOT, CFTC CMX and CFTC NYMEX data). The red line is the asset price levels (on RHS axis) and the blue lines is the outstanding net speculative interest

The theme is, as usual, momentum chasing, with most asset positioning closely tracking the performance. The exception to the rule is VIX. Of the notable changes, the wheat and the corn have seen a strong turn around in the short interests as is the case for Aussie dollars. The opposite was seen for gold, which has a serious reduction in long interest after peaking in March. Equities remain marginally net short, except Nikkei 225 where the long interests strengthened in recent times. Commodities mostly strengthened. And rates remain mixed, with strong short interest in the belly and otherwise for the short end as well as long end.

NIFTY: Election 2014 Positioning... Eliminate Tough Decision Making

The current move in NIFTY, expected to end in a crescendo after the elections, is probably one that will be the defining move this year. If you have already missed the rally so far, or fail to capture the large expected moves after the results are out, your portfolio performance is probably doomed for this year.

The question is do you really give a damn. You are in the game for the long term, right? it does not matter if you miss an election move or two.

So... a first strategy for election 2014 is, well, DO NOTHING. It is so often overlooked in the heat of things that doing nothing can turn out to be a pretty neat strategy. If it rallies after the results you will capture it anyways. If it sells off, you were buying value right? So unless we have a radical outcome, it should be an opportunity to buy.

Okay, now let's say you DON'T plan to do nothing. Here is a way to think about your move. 

Like poker, in markets too, apart from the goal of making money, another important objective is to avoid tough decision. Because tough decisions are always emotional, and that is exactly when you are most likely to make mistakes. And avoiding tough decisions in future is achieved simply by making choices now that makes your decision easy later on.

So let's apply this rule to see how you should be positioned. First thing first. I have no clue which way the market will move from here. Nor does anyone. Let's assume for argument's sake, the market has an equal chance of a large rally or a correction from here. If you go short now, and it does make a correction, congratulations! You made it. Now what if it does not? You make a loss on your shorts, AND you miss the rally. That's okay, no big deal. But what next? can you enter it now? You thought the market was already on the higher side and then it rallies quite a bit more. All you are going to do is to spend the next 6 months on the sideline waiting for a dip. A large one at that. You missed the entire 2014!

Now the other side of the bet. Suppose you went long. The market rallies. Well done. Now you take a re-look at the valuation and decide further action. And what if it corrects. No big deal. It just offers a more compelling valuation then. Way better outcomes no matter if you are right or wrong

And that's the kind of bets to make. Because with markets, the probability that your views are right is not much different than pure chance

NIFTY: Great Expectations?

Here is a fantastic background for India 2014, more so for the uninitiated! (Do click)

And now the questions is how much juice left in this rally and which sectors are really overheated. Below a snapshot of the relative performance of different sectors vis-a-vis the benchmark (NIFTY) index. As you can see the rally that started late last august once quite contained. But the pre-election rally (a possibility I noted before) has been, well, fantastic. With all the usual suspects racing away - only Energy, Pharma, FMCG and IT still lagging.

The question is what now. Obviously the pattern of the rally since March shows a lot have been on expectation of a radical shift in policy after the elections are done with. PSU banks, Real Estate, Financials, commodities and energy sectors especially seem to have performed on this expectation. How realistic these expectations are - a few wise words from JP Morgan (via FTAlphaville)

The belief in certain quarters is that as long as the next government were to go all out at de-bottlenecking projects, sentiment would surge and this would spark an investment revival in the economy. However, this appears to be an overly-simplistic read on the situation for at least three reasons.
First, the vast majority of projects are currently stuck because of issues that are under the purview of state governments, over which the central government has little jurisdiction...

They also warn of the circular link between the bank bad loans and stalled infra projects. Do go read the full text. 

One thing is sure, we do have rallied a lot on expectation. Or rather hope. That is not saying we can't rally further. But given the uncertainties of election outcome, the tail risk of hung parliament results may not be a tail risk. That can rattled the market which seem to have priced in too many rosy assumptions

Trivia: Dance of Democracy

The election time is here again in the largest democracy in the world. Here is a link from an old post back in 2009 (the last general election). A mathematical awakening for all those lost in debates over Mr Modi's ghosts from the past, Mr Gandhi's incompetence, Mr Kejriwal's lack of direction and irrelevance of others. 

Actually the only system that will work for you is a dictatorship in which YOU are the dictator!!

Jokes apart, democracy is built on institutions. I honestly don't mind lack of leadership, as long institutions  are strong. If you think a country is a super example of a complex system, it is far better for it to walk randomly and find direction through evolution and time, than hurtling at Mach 2 in a direction under a great leader only to realise later as a nation it was wrong direction to begin with. 

Have a great time voting. By the way the implied volatility levels where the options on Nifty are trading, my back of the envelop calculation shows if u want to cover the time decay from now till the election results are out, the volatility levels should be around 50%. That will be higher than the 2008 crash!

Travel Alert

Travelling this week. So limited blogging. (And more reading!! )

In Charts: India Under NDA, UPA-I and UPA-II

Presented without much comments

Note on the time periods
1999-2004: The BJP-led NDA government
2004-2009: Indian National Congress-led UPA-I
2009-2014: UPA-II from 2009 till date.

The Growth Story: GDP annual growth. Both suffered external shocks. The recession following dot-com bursts in early 2000s, and the great recession of 2008.

India Shining: The unemployment rate. Well the sharp change in the last figures, may be NREGA? This is just one side of the story. What about productivity? An income guarantee scheme may be good for headline unemployment numbers but not necessarily for the economy, at least structurally. I would say NDA scores.

Fiscal Responsibility: Debt to GDP. UPA scores. But story does not necessarily add up, see the fiscal balance and this chart together. Perhaps we are missing some pieces to the puzzle. Disinvestment incomes saved the day for UPA II? I need to research more on this point.

Twin Deficit Part I: Budget Balance (% GDP). UPA-II has the worst figures, but it also suffered from 2008 financial crisis and its after math (and the fiscal stimulus).

Twin Deficit Part II: Current Account to GDP. NDA scores hands down

The Common Man's Pain: Inflation (Compared to US Inflation - white line). NDA came in power after the peak in 1998. UPA II sees an alarming rise in inflation despite softening of global inflation. NREGA?

Rainy-day Fund: Forex Reserve Growth (YoY). NDA scores, hands down

These are just dumb charts, and incomplete without the story behind them. I do not see a clear winner here. But it seems UPA-II on the whole worse than both NDA and UPA-I

ECB Preview - An Interesting Chart

the market walking from one ECB meeting to the next, shown below - changes from a day before the meeting to the day close of business

Odd one outs are from Aug and Sep in 2013, when everyone was busy with taper (including, partially, ECB)

Recommended trade for todays and Fridays NFP - short the Euro. The movement of the Euro skewed to a sell off , for any prints of NFP (High print - dollar rally, low print - limited impact on EUR) and ECB outcome (within expected range, as the range itself is skewed to dovishness)

Books: (Flash Boys) Is It Rigged? and Should You Care?

The latest book by Michael Lewis had a perfect launch. It was covered all across the media (see here, here and even here). And apparently at least one HF farm has delayed their IPO allegedly because of this.

I have not read the book ( just got it, no matter how good or bad the underlying argument is, am sure it will be a great read. He is a fantastic story teller). But here is my first take on this.

HF trading broadly can be classified as below based on their style. Not all of them have similar impact on the market, nor they impact everyone similarly

Making the Market - this type of trading is basically played on volumes. This involves making the market (the intelligent part is how to stand on bid and offer better than others without running in to large inventory as a result of getting hit on them) and also on top handling large amount of trades by buying and selling names multiple of time (that's what market makers do) and earn the volume rebates from the exchanges. Overall good for the market. Do anyone get hurt. Well, if anyone, it is the competition.

Statistical Arbitrage - this is basically finding out tiny misalignment of prices (typical pair trading or correlation trading) or even trading patterns (technical trading - PDF). I would say nothing much unethical about it. Now this can be overall good or bad for the market. Stat-arb can bring stability if prices veer off from equilibrium by abring away the spread. It may also cause destabilization if everyone follows some technical trend. By definition, any kind of mean reversion strategy ought to bring stability and any kind of momentum strategy has the potential to be destabilizing. Overall, no bad intention here, just good-natured profit seeking.

Trading the Book - this is the most interesting part. I guess, based on the write ups and responses, this is what the book mostly about. Now this kind can be quite interesting. It basically aims to figure out what is going on with the flows and try to take advantage of it. At the simplest, it can be trading mean reversion after a large move in a stock. At the other end of spectrum, can be anything like front running or other predatory trading. Overall, mixed. As good as as the intention of the human behind the bots.

And these are the passive trading methods - generally taking the signals from the market and acting upon them. It can also be active, by generating signals and expecting the market to act in a certain way and then profit from it (those exploratory trading and momentum ignition  - here is a good paper on it, PDF)

And apart from getting privileged access to data, this is one place where this entire HFT stuff can cross the boundary of what is ethical.

Now the question is who gets hurt. After all

Chances are, if you are just a small guy, you are NOT the one

As a retail investors, your trades or orders are so small compared to the market that it is improbable to cause a HFT bot to stand up and listen to you. Nor it is possible for your trading pattern to respond to a momentum ignition of a malicious algo. If you want the maths behind this, it will be something like this (PDF). It is the big guys who can get really fried. And perhaps they do. I have not read the book, but no wonder David Einhorn is interested in IEX.

And if not unethical, then any conspiracy theorist worth his salt might suggest fight against the HFT is the latest Wall Street plot. When the big guys lose out to a smart little guy with superior codes, they will fight back. There are claims and counter claims and all sorts of theories.

To cut a long story short, it is a fight among the biggies. Stand back and watch. Don't forget the pop corn. As Josh Brown summed up so aptly, market was never fair anyways

Macro Economics : Shooting That Chart

We are talking about THAT chart (US corporate profit to GDP)

Here is an absolutely must read article from Philosophical Economics, which perhaps not yet been so popular. So far I have seen covered by only Cullen Roche and FT Alphaville (FT does a much better job though, but my advice, read the original one, and FT for TLDR)

However after all the excellent analysis it seems Jesse Livermore still can add to the lists why the dreaded Profit Margin vs GDP chart does not warrant too much worrying. 

In the accounting of profit on income basis, profit = income - wages - interest costs. 

Now with super low interest rates and a steadily dwindling wage to GDP ratio in the US, there is every possibility the "mean" that the chart would revert to has shifted upward. Else the rates has to go up and/ or the wage fraction of GDP (which means you now need to shift the arguments from stock brokers feeling bearish to economists talking about Secular Stagnation and Inequality)

One less reason to feel bearish. But let's stop at that before someone flip it to the other side