Finishing 2016…and a Sneak Preview of 2017

It’s been just over 10 days since the US Presidential election, and I sense that many Americans – and market participants – are still in a state of “denial or anger”. That said, some people have moved on towards ‘acceptance’ (e.g. Dalio, Buffett, President Obama, etc). From my perch, it’s too early to say.

Based on public reaction, there are reasons both to be hopeful, and to be concerned (whether these hopes and concerns are meritorious or not, remains to be seen):

Reasons to be hopeful – the appointment of the likes of Jamie Dimon, Nikki Haley, Mitt Romney, etc mentioned as potential Trump Cabinet members – have given hope even to the likes of the Vox founder, a known Hillary Clinton propagandist  https://twitter.com/ezraklein/status/799369055207497728

(most of) Donald Trump’s own words – e.g. 60 minutes interview – emphasize unity, repudiation of violence, economic expansion (e.g. infrastructure spending), etc.

President Obama and Donald Trump’s public behavior towards one another has uplifted public/market confidence as well.

Reasons to be concerned – the appointment of the likes of Steve Bannon, Jeff Sessions, and Michael Flynn have caused fear in many Americans. By some measures, reported acts of violence have creeped up.

The rhetoric regarding “bringing jobs back to America” is encouraging, but it’s just that: rhetoric. What happens if rates rise in a meaningful fashion, leading to runaway inflation? Rising unemployment and inflation would be a very difficult situation – whether the Trump administration is at fault or not.

My View: Too early to say.

As it pertains to financial markets, I have observed:

  • Eye-popping exuberance in US Financials – some would say record breaking exuberance, as gauged by highest recorded RSI in the XLF ETF history. Question: have financials’ equities historically benefited during rate rise cycles? Which sectors have tended to benefit? Suffer? Why?
  • Statistically significant price movement in Government Bond Prices – “USTs yield haven’t moved this much since [20+ years ago]”
  • USD strength, EUR weakness, MXN (record weakness) – To my surprise, I heard that a large institution actually put on a long MXN USD trade, pre election, as the “long Hillary” trade. Well, we can imagine who/how has been ‘unwinding’ that position since November 8th. Also, imagine how countries with significant $-denominated debt are feeling right now? Not only has there been upward pressure on all government bond yields, world wide, but the $ strength as well. This trend cannot last indefinitely without some severe consequences.
  • Russell 2000 Longest Winning Streak for over 13 years – Some refer to this as a  “Make America Great Again” trade. What exactly is included in this Russell 2000? What are its member constituents?
  • Rumors that an “Axe Capital” peer is experiencing historic short term losses
  • Historic [by some measures] Equity Price Dispersion – Given the extreme dispersion in equity prices – historic or not – I find it ironic seeing some people say “it WILL be great for stock pickers, going forward” – how about it IS and HAS BEEN ?
  • My friend jokes that a Trump 1st term, 2nd term, and legacy now are all priced in.
  • the below is interesting, especially if you recall what happened in January/February of this year (not to say history will repeat exactly)

 

My prior posts have been helpful and remain relevant:

The 2nd Half of 2016: Nationalism & Political (In)stability – July 16, 2016

The sum result on financial markets is not immediately clear, especially as it relates to US financial markets. What is clear(er) to me is the growing importance of global macro, or at least understanding how global macro impacts one’s investment strategy. Specifically, I will be surprised if the following are NOT true, going forward:

  • (Continued) Record-breaking bi-directional macro volatility
  • Confusing, inconsistent, and sometimes outright non-sensical correlations between headline political instability/violence versus financial markets price activity

I expect the 2nd half of 2016 to continue with record breaking market activity.

 

Regime Change(s) in Financial Markets and Politics – MARCH 3, 2016

 

Politics

  • Rise of Nationalism. Pretty much everywhere.
  • Trump is winning. Bernie Sanders Super Tuesday results disappointing. The loudest Trump critics appear to misunderstand him and his fans. No matter, both point to regime change. Note that “regime change” in Asia and Europe before the modern era, were often accompanied by executions.
  • Supreme Court, replacement for Antonin Scalia.
  • Regulatory enforcement is rising (after decade-low levels of white collar fraud enforcements through 2013/2014″ e.g. Valeant Pharmaceuticals. Regime change.
  •  Europe – Brexit, Spain (Visca Catalunya), threats to Schengen, etc.
  • China – Xi regime gives off the impression of a more nationalistic tone.

 

The above lead me to believe that we are transitioning from one state to another… methinks the ‘regime change’ may resemble the transition from the dot com bubble/bust to housing bubble/bust. We’re somewhere in between two different regimes.

 

What I like entering 2017:

The short answer is, TBD; I’m not sure. That said, if I had to place all my capital into one trade for the next 12 months, there is one that comes to mind, with unlevered expected return of over 20%: it’s a quasi-arbitrage situation. It is a meaningfully sized position.

It involves going short the underlying security and long the one related to underlying one. I say quasi, because if the equity markets were to correct (or if the underlying security were to continue declining), I believe there would be a meaningful risk that the current gap (which shouldn’t exist, or at least, be this wide) widens further. But that would excite me only more.

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