Sunday, July 22, 2018

Focus on the dislocations - these are the places of market opportunity this week

There are some recurring themes this week in our highlighted charts, debt and leverage will overhang any global economic discussion; however, we see some interesting dislocations that can offer global macro opportunities:

  • Short yields are now higher than dividend yields. 
  • Growth stocks continue to outperform value. 
  • The yield curve continues its slow flattening march. 
  • EM stocks are diverging from developed markets. 
  • Wealth as measured by equity market cap is falling. 
  • An increasing number of firms are losing money. 
  • Copper prices signal an economic slowdown. 
  • Global PMI, albeit still above 50 is moving lower.
Dislocations offer opportunities for exploiting trends or betting against the herd wisdom. This will not happen if markets are range-bound. Dislocations are attention focusers. These are the places I will be spending my research time.

Saturday, July 21, 2018

Keynes on money - Do not hold any as a store of value

"...for it is a recognized characteristics of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit. Why should anyone outside a lunatic asylum wish to use money as a store of wealth. 

Because, partly on reasonable and partly on instinctive grounds, our desire to hold money as a store of wealth is a barometer of the degree of our distrust of our own calculation and conventions concerning the future."


Money is not a store of value but a claim on value. 
- Brett Scott

As rates start to move higher, it is important to go back to basics on what is the value of money and whether it should be used a store of value. In a zero or negative interest rate environment, holding money is a good rational strategy, but times are changing especially in the US. This is not the case in the EMU where short rates are still negative and holding cash makes sense.

There was a significant search for yield given the absolute level of rates as investment substitutes. That search for yield involved taking more risk.  Now there should be a search for alternative stores of value through moving out of currency and demand deposits for near cash. With inflation higher, the cost of money as a store of value increases. The change in money stock will slow given the change in portfolio balances. 

However, care is needed to find the right store of value. Moving too far out the curve in the credit area has been costly given the widening in spread in corporate bonds. Floaters still face spread risk. Short-term Treasuries and agency paper are still a go to choice 2% percent yields; nevertheless, there are some short-term corporate paper that offer better yields. 

The only reason not to hold these yield instruments is if you have a wildly high aversion to risk or you believe there is so much uncertainty that even 3-month yields cannot be trusted. That is not the case so money should be moved out of cash regardless of any current financial asset uncertainty.

Friday, July 20, 2018

The dollar is sending signals if you care to listen

I am concerned about tariffs. They are strong effects on importers and exporters in industries affected by tariffs and we don't really know how tariffs will impact the supply chain and logistics for many companies. Nevertheless, the strong dollar will have a bigger impact on US exporters across the board. 

A strong dollar has global financial disruptions through the change in capital flows hat come with these gains. Last year saw a dollar sell-off and we in a longer-term range, but since the start of the Fed's end to QE and the raising rates, the direction in the dollar has been up. Look at some quick reasons for dollar gains:

  • Stronger asset prices. 
  • Higher relative rates.
  • Tightening of money relative to EMU and Japan 
  • Higher economic growth and deficits.
  • Structural reasons for return of capital to US. 
  • Dollar hedging from dollar borrowers.
The dollar is signaling what is happening around global markets. It may have been awhile, but more investors should get back into the habit of following currencies.

Thursday, July 19, 2018

How to build effective economic models - Translate to a narrative and have examples

... a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics; and I went more and more on the rules.
1. Use mathematics as a shorthand language, rather than as a engine of inquiry
2. Keep to them till you have done.
3. Translate into English.
4. Then illustrate by examples that are important in real life
5. Burn the mathematics.
6. If you can't succeed in 4, burn 3, This last I did often.

-Alfred Marshall

Even though he was speaking more than a century ago, Marshall provides useful advice from one of the great economist of all time. All models, including econometric ones with empirical results, should be able to be translated into plain English. There should be a simple narrative associated with the model and there should be examples that others can use to explain or describe the results. If you cannot tell an effective narrative using the model, then go back to the model and try again.  

The magic in models is their ability to compact a lot of information in statements where there should be limited ambiguity. It is a shorthand language that can provide concise intuition about a specific problem. The magic of narrative in translating this concise representation into useful stories that can explain the existing environment and tell us something about what may happen in the future. Narratives don't have to be compact or use a shorthand language. Narratives are the descriptive real world examples and need to be truthful. A model that cannot lead to a truthful narrative that represents the facts fails. 

There are useful models in finance, but there are also ones that steer us in the wrong direction because they do not fit reality. A key job of the investment professional is knowing which ones work and which ones are suspect.