The famous philosopher Ferris Bueller was never much of a follower. Ferris preferred to blaze his own trail. So it’s no surprise the greatest Chicago Cubs fan in the world (and let’s not forget the sausage King of Chicago), has not been stuffing his portfolio full of VIX products, but instead quietly accumulating a large long gamma position in sovereign bond options.
Many market pundits believe we are doomed for a repeat of the 2008 credit crisis. The drum beat warnings about the looming stock market crash have been growing incessantly louder. Some hedge fund managers have even taken to creating dark ominous websites to warn us about the dangers.
Although I believe getting long VIX down here is fine for the trading set, too many traders are focusing on stock index volatility and missing out on the asset class that will be the epicenter of the next crisis.
I don’t buy the argument that the true excesses of this cycle are concentrated in risk assets. I have lived through a few bubbles, and every single one was accompanied with an unshakable belief from the masses that this time was different. Whether it was dotcom bubble, the US real estate mania or the Chinese commodity craze, all of these market episodes had one thing in common - an overwhelming universal acceptance that fading the powerful trends driving these moves was sheer stupidity. Of course everyone now conveniently forgets this reality. Most pundits claim these excesses were obvious, but rest assured - trying to take the other side of these trends was one of the most difficult tasks in investing.
Today there are precious few claiming that fading the recent stock market rise is sheer stupidity. In fact it is strangely the opposite. Tons of really smart investors, whether it is Howard Marks, Stan Druckenmiller, George Soros or Raoul Pal have all issued amazingly well articulated arguments on why stocks have tons of risks in them.
Yeah, I get it. It’s extremely difficult to make a bull case for stocks without sounding like a weird perma-bull.
Yet, how can this be a bubble? Bubbles are created when everyone believes something can’t happen.
“Dotcom stocks can’t go down because we have entered a new era.”
“Housing prices have never fallen on a nation wide basis before.”
“Commodities can’t tumble because China will keep buying them for decades to come.”
I know those lines seem quaint, but I heard them over and over again during their heyday.
Do want to know what I hear today? And trust me, I hear it from everyone. Whether it is money managers managing gazillions of dollars, or the guys in the hockey locker room, everyone believes the same thing. We can never get inflation, and even more importantly, rates will never increase.
I have heard the most eloquent arguments about why it will never come. Globalization, demographics, technological advancements, insane debt burdens - tons of people way smarter than me have all tried to convince me about the folly of my belief. Yet instead of making me question my forecast, it only reinforces how cheap betting the other way must be.
Literally no one believes inflation and higher rates are coming. Yes, they might mouth some words about inflation picking up over the short run, but there is unanimity about the utter inability, and zero probability, of Central Bankers’ mad scientist experiments running amok on the upside. All that goes through investors’ minds is a re-run of the deflationary collapse of 2008.
This point was really driven home for me recently when I watched a rare “reflation bull’s” presentation. Reflation bulls are hard to come by, so I was very interested in hearing his arguments. After going through all these great points about why the market was underestimating the possibility of economic growth in the coming years, he then proceeded to recommend going long US treasuries for one last kick at the deflationary can. Huh? He thinks inflation and growth are coming, yet believes US treasuries represent a great tactical trade from the long side?
The market already knows all the bad news. It is more than built into the price of fixed income. This strategist has an out of consensus call that growth is returning, yet he couldn’t bring himself to pull the trigger on recommending selling fixed income with both fists. Instead he is playing for one last bond market rally before his scenario plays out.
That is what bubbles are made out of. Even the bears can’t bring themselves to recommend shorting it.
Don’t think there is a bubble? Have a look at the equity flows since the 2008 crash:
Now contrast that to the yield chasers:
I just don’t buy that the excesses are in the stock market. There has been a massive chase for yield fueled by the belief inflation will never return. It has been exacerbated by Central Banks who believed monetary policies could solve a problem that required a fiscal response. This has driven investors into fixed income and all of its derivative offshoots.
Have a look at the price of financial assets versus real assets:
I know the financial assets in the graph above includes stocks, but equities have only been reluctantly dragged higher by the collapse in interest rates.
Government bonds are the true originator of the bubble. They are the patient zero from which all other assets are priced. Of course all risk assets are overpriced - bond rates are just bat shit stupid.
In true bubble fashion, options on government bonds are amazingly cheap. Why shouldn’t they be? Rates are never going up again! Right…
I was hesitant to write this piece today. After all, bonds have had a rough couple of weeks.
They are extremely oversold, and a little rally to correct this condition would not be unheard of. I was even more scared of bottom ticking this short term trend when I read this great piece of research from Credit Suisse:
From a short term basis, there is no rush to climb aboard this new downtrend. We will most likely get a chance to short bonds at higher levels in the coming days.
But don’t forget what the longer term picture looks like:
What do you think Ferris is going to do?
My guess is that Ferris isn’t scared to go against the crowd. I hear he bought a ton of June 150 puts on the long bond. He is also trying to get long some German bund variance swaps but he hasn’t completed the ISDA documents and none of the big banks want to trade with him.
Thanks for reading and have a great weekend,