After a week’s vacation, I have returned with some new found conviction regarding my big picture outlook. I am even more firmly convinced that the market is underestimating the chances that this recovery has become self sustaining.

At the point of the withdrawal for both QE1 and QE2, the market was optimistic that the economic recovery was self supporting. There was very little talk about the need for another QE program. The outlier call was from the skeptics who felt that the economy was not ready to stand on its own feet. The vast majority of market pundits scoffed at this forecast and proclaimed that the idea of another QE was ludicrous. As usual, the majority of economic forecasters were dead wrong, and the economy was no where near ready to stand on its own feet. The hangover from the credit binge of the mid 2000s was still being felt.

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After it became obvious that much more QE was needed to break out of the deflationary vicious cycle, the Fed went “all in” with QE3. It is easy to become numb to the massive numbers of bond purchases for these Quantitative Easing programs, but this program was truly “game changing.” It is also easy to forget that the Fed had previously embarked on the previous two QE programs with a set amount of bonds to purchase, whereas QE3 was open ended.

The market has taken for granted the mad desperate Hail Mary pass that Ben Bernanke & Co. floated up into the air with QE3. And yet now, the receiver seems to have caught the ball, but everyone is still convinced that he is going to drop it.

Whereas with QE1 and QE2 the market was overly optimistic about the possibility of a self sustaining recovery, they have now over corrected and have become much too pessimistic regarding the end of QE3. The Fed is still buying bonds every week for the QE3 program, yet the market has already discounted a post QE3 economic roll over. There is practically no one who is forecasting a self sustaining economic recovery.

This skepticism is creating a great opportunity. I firmly believe that the end of QE3 will not result in the same sort of economic stall that was met with the end of QE1 and QE2.

The velocity of money has stopped declining and the massive amount of monetary stimulus from the three Quantitative Easing programs is going to ignite.

It might not cause the type of inflation that the Fed desires, but make no mistake – it is going to cause inflation. At the end of the day, I believe that too many economists have somehow convinced themselves that monetarism no longer works. I think they are being foolish.

Have a look at the steady decline in the average CPI forecast.

http://themacrotourist.com/images/Azure/CPIForecast2014.PNGCPI Economist Forecast</a> </div>

Since the end of the credit super cycle in 2008, the private destruction of credit has indeed being truly massive, which has offset the Fed’s equally massive QE policies. But that does not mean for a second that the Fed cannot create inflation. Given the will, the Fed can create inflation. Full stop. They simply need to be committed. The first two QE policies were simply not big enough. And now with QE3 they have more than likely overshot.

The market is skeptical, but I think this creates a great opportunity to short fixed income.

But most importantly, given that I believe that the velocity of money has woken up, I am going to be very selective about shorting the stock market. Don’t misunderstand me – I think the market is dramatically over priced and due for a massive correction. But if I am correct, then the bond market will be the eventual trigger for a stock market correction.

Bull markets do not die of old age. They die when the Fed tightens.

It might be that the Fed will never get around to tightening, the bond market might shit the bed first. But the bond market will be the catalyst to cause the end of the bull market in stocks. Without a big backup in rates, the equity market will most likely grind higher.

I have become more convinced that the short side of the bond market is a much better trade than shorting stocks… Eventually this will shift, but we are in the early innings of a massive bond bear market. I am going to focus my energy on shorting the fixed income market and leave the stock market pink tickets on the shelf for a little while.


Things that I am watching

Has Soros has lost his marbles?

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As you know, I am a big Soros fan. However he is getting up there in age, and I am on the lookout for signs of senility. His latest comments about using the Strategic Petroleum Reserve to punish Putin have perked my antennae.

“Strongest sanction” against Russia “is in the hands of the United States” because U.S. could sell crude from the Strategic Oil Reserve and depress prices, investor George Soros says during panel discussion in Berlin.

Selling oil out of the SPR (Strategic Petroleum Reserve) is about the stupidest thing I have ever heard as a plan to punish Putin. If you sell oil today, unless you are going to permanently reduce the SPR size, you are simply going to have to buy it back in the future.

The only way that this works is if Putin’s cash flow is so bad that you in effect force a margin call and make him sell his long term holdings at depressed prices. However, I would be very skeptical that the US would be able to squeeze Russia to the point where it causes anything more than a little short term pain. And while you are trying to play games in the oil market, you run the risk that if something truly horrific happens, the SPR would be insufficient.

I wish politicians and retired hedge fund managers would stop thinking about using the SPR as a political weapon. It is like using your family’s insurance policy for a little short term speculation. The SPR is for emergencies. Emergencies like Hurricane Katrina, the first Gulf War, or some other unimaginable tragedy.

As much as I respect good ’ole George, I think he should focus on his younger girlfriends and leave the SPR alone…

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Positions

As I mentioned before I left on last week’s vacation, I was going to reduce my risk so that I could relax a little. I ended up leaving on more than I would have hoped, but for the most part this was a good thing. I did cover all my macro stock exposure, and I reduced my naked short bond positions by approximately a quarter.

UPDATE: will add to the position this morning…. Short CAD. Will add through 1.12. Stop 1.09. Conviction 2

Buy TIPS short TLT spread through long dated options. Conviction 3

Short 10 Year US Treasury Futures with half of position married to out of the money calls Conviction 4

Short US 5 Year Treasury Futures. I expect the Fed to continue to withdraw stimulus aggressively.   Conviction 2

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 3

Short Mar and June 2016 Eurodollar vs long equivalent BAX futures. Conviction 3

Long March 2014 VIX Futures. Conviction 2.

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