Although the Macrotourist once worked at a big bank that traded OTC derivatives and other institutional type products, I am now much more of a hack that is regulated to trading listed products that Interactive Brokers offers through their electronic platform. So when I explain my next trade, for those that aren’t pikers like myself, please keep the snickering to a minimum.
I believe that the Fed is going to eventually lose control of the bond market. When they do, there will be very few places to hide. Stocks will outperform bonds, but they are far from cheap and the rise in the discount rate will weigh heavily. Precious metals very well might work, but I am already long and do not want all my eggs in one basket.
I love finding trades that are flying below the radar with very little “buzz”. TIPs very well might be one of those trades.
Right now there is little worry about inflation creeping back up. In fact it is just the opposite. Most government officials are publicly fretting about deflation. When Central Banks and IMF officials are more worried about deflation than inflation, you know the time to protect yourself against inflation is near.
“With inflation running below many central banks’ targets, we see rising risks of deflation, which could prove disastrous for the recovery,” said Ms Lagarde, in a speech at the National Press Club in Washington. “If inflation is the genie, then deflation is the ogre that must be fought decisively.”
Government officials never correctly predict the next crisis. If they are worried about deflation, then I am worried about inflation!
Central Bankers on safari…</a> </div>
Sometime in the next year, while Central Bankers are busy battling the deflation ogre, I expect the inflation genie to be let out of the bottle, and we have all had experience trying to get our genies back in the bottle…
When this happens, bonds will crater. For those that need to own fixed income, TIPS (Treasury Inflation Protected Securities) will prove the best option. So although I understand that the rise in the real rate will also affect the price of TIPS, owning the BreakEven spread will be a great trade. The price of TIPS will dramatically outperform the price of traditional Treasury Securities.
For odd lotters like me, one way to put this trade on would be to buy the TIP ETF and short the TLT ETF (institutional traders – you promised no snickering!). I have made a chart that tracks the performance of this spread versus the US 10 Year Break Even rate:
US 10 Break even rate (white line) versus TIP/TLT spread</a> </div>
The spread tracked perfectly for many years, but broke down in the midst of the of monster bond bull market of 2011/12. During this divergence, it still tracked in the same direction, but the TLT-TIP spread narrowed much more than the US 10 Year Break Even rate. If you believe in mean reversion, then buying this spread offers even better value than directly trading the US 10 Break Even Rate.
Although I like that trade, I think that creating that same exposure through options is an even better trade. When the bond market crisis arrives, I expect volatility to go to the moon. Owning long dated options is a great way to benefit from both the change in delta and the increase in volatility.
I realize that owning options on two different assets does not necessarily re-create owning options on that spread. I will delta hedge and adjust to make sure that I am consistently long TIPS and short TLT. It won’t be perfect, but until my ISDA gets approved at JP Morgan, it will have to do.
I am buying long dated calls on TIPS and buying long dated puts on TLT.
Things that I am watching
Bull market turns 5 years old
I did not realize this on my own – it was in a ZeroHedge post that was borrowed from Brad Wishak of NewEdge – but I couldn’t resist making my own chart.
The previous bull market from 2002–2007 lasted 5 years pretty well to the day. On Friday with the gap up from the unemployment number that was then aggressively sold, the current bull market turned 5 years old as well…
S&P 500 – 2002 rally in white with 2009 rally in yellow</a> </div>
The chances of that being the high are pretty low, but wouldn’t it be stunning if it was?
Regardless of whether Friday was the high (low probability) or the high comes sometime in the next couple of months (much higher probability), it is important to realize we are near the end of this bull market, not the beginning.
Cleaning up a position
A couple of weeks ago I shorted a bunch of equity indexes. When Putin sent his troops into Crimea, we had a big swoon in the market that put these positions firmly onside. I was lucky enough to cover a quarter of the position into that dip when I reduced all my portfolio equally due to the positive volatility jump. In hindsight I wish I had covered it all… Since then most equity markets have rocketed higher and now none of these equity shorts are onside.
I am going keep my Nasdaq 100 and EuroStoxx 50 futures short, but I covered my Nikkei short yesterday.
Nikkei index</a> </div>
Out of all the charts, this is the most bullish looking. And more importantly, the Bank of Japan is by far and away the most aggressive bank out there. There are better fights to pick than fading a Central Bank that is printing with such wild abandon…
UPDATE: New position. Buy TIPS short TLT spread through long dated options. Conviction 3
UPDATE: Covered the Nikkei yesterday… Short Nasdaq 100 futures and short Eurostoxx futures Fed is going to taper until something breaks. Conviction 3. No stops for now
Short 10 Year US Treasury Futures with half of position married to out of the money calls Conviction 6
Short US 5 Year Treasury Futures. I expect the Fed to continue to withdraw stimulus aggressively. Conviction 3
Short US 2 Year Treasury Futures. I think the downside is a move from 31 bps to 25 while the upside is a move up to 50 bps. Conviction 4
Short Mar and June 2016 Eurodollar vs long equivalent BAX futures. Conviction 3
Long March 2014 VIX Futures. Conviction 2.
Long a tiny position of puts on TSLA and FB. Just for shits and giggles. Conviction 1. Stop – none: when they go to zero the market will do it for me.
Short Euro. Added to this trade into the recent rally. Conviction 4
Short European stocks via ESTX50 index vs Long S&P 500. I continue to believe that the ECB is too tight relative to the Fed and the BoJ, and that this will translate into relative weakness of European equities. Conviction 4
Short Yen. Conviction 3
Short JGB futures. I can’t call myself a macro trader without this widow maker on the sheets. Small position for now, but will add aggressively at the first sign it is working. Conviction level: 1. No stop.
Long Yen volatility. I believe we are entering a period of increased volatility for the FX pair. Conviction: 3
Long 30 year US treasury volatility. Swapping half of this position into Yen volatility. Conviction 2
Long various deferred crude oil futures contracts. I own a variety of different expiries in years from December 2014 all the way to December 2020. Conviction level: 4. No hard stop.
Long precious metals smorgasbord. Long gold, silver and platinum futures. I also believe that the closed end ETFs (CEF.A CN Equity or PHYS US Equity) which are now trading at discounts versus years of trading at a premium are a good way to play this idea. Conviction level: 4. Using the year end lows as a stop for half the position.
Long grains. Long deferred corn, wheat and soybean futures. Conviction level:5. No stop period.
Long Ithaca Energy IAE CN Equity. See previous posts. Conviction level: 5
Long Input Capital INP CN Equity. I have not yet written this up, but I really like this story. More to come in coming days. Conviction level: 5