Of Secular Stagnation and Other Worries

We have seen quite a bull run in the bonds market since the start of the year. Which has caught many people off the guard. The usual suspects are flow chasing yields after equity peaking off the tops, and risk off from Ukraine crisis. But perhaps something more at play here, and we take a look about the secular stagnation and a global japanification that is priced in the rates markets now. After the good rally this week

The peak nominal equilibrium rate priced in is maximum for USD. This is in spite of the recent difference between GBP and USD. This prices in a convergence of UK and US inflation and a higher long term real GDP for US. The recent bullish phase has been less about re-pricing the pace of rate hikes, and more about the terminal rate, i.e. estimate of natural rate of interest. Except in GBP where there is a large re-price of peak rate time (by 3 years!)

This, in my opinion, reflect a much less optimistic re-assessment compared to last year. The terminal rates should be determined by the potential output of the economy, and the pace of hike is an estimate of central bank’s degree of dovishness. This re-pricing of terminal  rate shows a possible shift downward of potential output itself

This brings us back to the pricing of a possible secular stagnation and Japanification. We run a simulation assuming 1) a further 50bps reduction in the maximum future rates (secular stagnation) and 2) as mentioned under 1, but also the maximum rate is attained 8 quarters from the current priced-in pace of hikes. The effect of these on long end rates are obvious, both depress the long end further, and 2) is more severe than 1). 

However, the interesting point to note is how the curve slopes get re-priced. From current level, scenario 1) shows a flattening, while scenario 2) shows a steepening. Indeed the curve slopes in JPY are in general steeper than G3. I think any re-pricing of pace of hike is less likely, especially if inflation has indeed bottomed out (for USD and GBP). We still have a chance for re-pricing of pace of hike for EUR. So as I see it, flattening to continue in USD and GBP, and expect further steepening in EUR.

Oh, and there is this interesting piece from FT Alphaville. Do check the link. 

NIFTY: Are FIIs Really Overweight India?

I have my doubts

Here is an interesting article from the good folks from FTAlphaville

What is striking is that although the general feeling is that the FIIs have been "euphoric" about India and its' resurgence under Mr Modi as the PM, as I see, the data fails to show the same. Here are couple of charts to drive home the point.

So irrespective of what analysts at foreign banks says, I think a large part of the rally in the Indian equity markets so far this year has been driven by domestic buyers or may be even retail money. And a lots of potential FIIs flows sitting on the sidelines. Through the last phase of the election campaigns and actual elections, my perception is that FIIs have been cautious and decided to follow a wait and watch policy. And it would not take a dramatic positive results for NDA to kick start the next leg of the bull run. A simple confirmation of average exit polls prediction will do.

What Happened in Rates Today!

The euro swaps saw an almost parallel rally, continuing yesterday's move. The dollar swaps rallied with a slight flattening. And the awesomest moves were in sterling swaps, with a sharp rally and an equally sharp steepening across the curve, following BoE's report on inflation. Is it overdone? More likely than not. But fading still looks on the riskier side. Best to book profits on long steepeners and short payers. The next expected big move is not before June ECB.  But honestly I have no idea what is behind the  big sterling moves today. The report dashed the hope of imminent hike in bank rate, but was nowhere beyond expectation. And given recent moves and positioning to best of my knowledge, don't see any strong technical reasons either. Need to dig deeper. Something here is not consistent.

Yet Another India Vs China Story

A very interesting piece from IMF Direct blog!

It captures how the trade integration within Asia has phenomenal compared to other regions globally for last two decades, centered on the China growth story. And it also highlights how this has resulted in increased synchronization, and increased propagation of growth shocks between regional partners. This, is claimed, has given rise to a high correlation among Asian economies, as they provide this chart for quick evidence

And when I look at this chart, I find India has a pretty interesting position. In fact some might argue, based on this chart, that betting on a Chinese shocks can be structured through short Australia and Korea and long India and Philippines, adding statistical leverage.

Although I am doubtful this negative correlation in economies will translate to the correlations in markets in the event of a severe chines slowdown. Irrespective of how good or bad the economic story is, India will face consequences on international financial flows if we see a real serious slow down in China. The question is what happens when the dust settles down. India is a net importer from China, with some overlaps of export to other developed countries. So certainly will suffer much less directly through a slowdown in China. In fact can even benefit from reduced competition in global markets. But by any means economic downturn of the second largest trading partner is no good news, even if it runs a net trade deficit.

But if the slowdown in contained, I think there will be some focus on this issue and India will see some part of the flows from the Asia focused funds, trying to limit Chinese exposure

In fact, long-term market correlation supports this. NIFTY has been much more correlated to S&P 500 ...

... than Shanghai Composite

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