I have been one of the biggest bond bears out there, yet even I have been surprised by the vehemence of the recent collapse. Even more shocking is how quickly sentiment has gone from “we will never get inflation and rates will be low forever” to “inflation is upon us and abandoning all fixed income will be the only thing that saves you!”
Funny how a 17 handle swoon in the US long bond will change the narrative.
I understand why Donald Trump’s Presidential win caused a repricing of the odds of inflation kicking up in the coming years, but I suspect Hillary would have also spent way more than the market expected. Not only that, it is not like the bond market sell off has been confined to the US. Bond markets throughout the world have collapsed.
Suddenly instead of predicting the world will end in a deflationary collapse, it is fashionable to expect a global economic revival. Watsa, Icahn, Druckenmiller, all high profile former hedge fund bears have thrown in the towel on their doomsday calls and sold bonds and bought equities in a big way.
Now I don’t begrudge an investment manager changing his or her opinion due to a change in facts. No sense clenching onto a view that is clearly wrong.
But whereas all these supposedly “guru” like hedge fund managers were too pessimistic before, they are now overly optimistic.
Trump has not even taken office yet, but the market has already priced in a defeat of the vicious delevering cycle. Whatever happened to all those arguments about the inevitability of demographics, excess saving, technological advancements and the whole host of other “unsurmountable” obstacles that would forever doom us to a deflationary collapse? The hedgies have tossed all those arguments out the window and now are pushing hard on the “reflation trade.”
Yesterday I covered all my short bond positions. For a huge Kodiak Brown bond bear like me, this was extremely difficult. Don’t misread this trading move as a change in my long term view - I still think yields are headed higher, a lot higher.
Yet bond sentiment has gotten so bearish, and these ridiculous hedge funds have pushed it so far so fast, I can’t bring myself to stay short into their frenzy.
The global economy is still highly indebted, and although a return of inflation will help erode real debt levels, this initial move higher in rates has not yet been accompanied by an actual rise in inflation. Rising rates due to anticipated government spending will only drag down the economy over the short run.
The biggest problem is the large move higher in the US dollar. Yeah, I know higher fiscal spending will enable the Federal Reserve to be tighter on a relative basis. Many comparisons to the Volcker/Reagan US dollar bull market are being tossed about. Even the German East/West unification seems to fit a similar model. During this period the German government was forced to be fiscally accommodative which caused the Bundesbank to offset with a tighter monetary policy sending the Deutsche Mark soaring.
Yet I am not nearly as optimistic the US economy can handle a stronger US dollar. I still contend there is a limited amount of world growth and currency strength is the recipe for a wicked bout of deflation.
Given the US dollar rally and the interest rate rise of the past week, I am not optimistic about the short term prospects for the US economy. We are still a couple of months before Trump takes office, and he will not be able to institute fiscal expansion on day one - these things take time.
I know markets are discounting mechanisms, but as most events in this limited alpha world, the market has quickly discounted the absolute best outcome and will be prone to disappointment.
For the first time in ages, I have dipped my toe onto the short side of the US stock market. I think all these hedge funds are chasing their tails flip flopping back and forth. As long as the US dollar is rising, I will stick with my small stock short.
I am also watching for a point to sell the US dollar short. So far the rise has been one sided, and we are now hitting levels of the previous double top. We all know there is no such thing as a “triple top,” so I am guessing we will break out to new highs in the coming days, but I suspect that might be the final nail in the coffin for US risk assets. When we get the next breakout, I will wait a day or two for the bulls to get overly confident, but then I will get out the pink tickets for US dollars.
One final point. Volatility has gone through the roof for most assets. Stocks have gotten somewhat quiet, but bonds and FX are trading like a rats on acid. Don’t misread one day price action as confirmation of a bigger trend. It will get more and more choppy. Trade smaller, and give markets a little more room.
But most of all, don’t take what these hedge funds are doing as something that needs to emulated. We are entering dangerous changing times. These hedge fund managers make all sorts of mistakes - just look at Carl Icahn’s “Danger Ahead” video. In fact, when he finally takes it down, I am going to sell stocks with both fists…
Thanks for reading,