Strange But Untrue and Other Facts That Don't Matter

Like good sports commentators with slow runs of play to fill, finance turns to statistics to fill the time. To many of us, data is data and the more reliable data you have the more chance you have of being able to to sift the odd gram of gold out of the muck. But there comes a point where the noise exceeds the signal and, as Theodore Roszak said, there is "Data data everywhere and not a thought to think"

But slow days and newsless days (today being a pretty good example) has everyone turning to lower grade soothsayer techniques in the absence of others. Was there a power failure at the Financial Meteorological station supercomputers leading the weather forecasters to turn to slicing up small animals and spreading out their entrails instead? For TMM's inboxes are filling up with statistics which instead of being valued for their ability to forecast are being offered just for for their bizarre interestingness. That Met Man would say "Oh I don't even care if it will rain,  just look at that squishy red bit, I didn't know it would be connected to that moving wormy thing". The financial equivalent of which is -

"Of the four negative weeks just two of them included losses over 1%".
"Tuesdays have been up days for the last x weeks"
"The S&P 500 trades at 12.8% or higher from its 200 DMA just 8.3% of the time".

How riveting yet absolutely devoid of predictive powers. This is the financial equivalent of the football commentator explaining how many times the letter "e" appears in the away team captains' grandmother's names over the past 40 seasons. Markets have to say something. There can be no silence. Audiences don't expect silences and the suppliers of information abhor a silence, be they media or sell side information providers. We are pattern recognising beings but there is a point where data mining crosses over into the astrological. Finance's version of "Thats Amazing"

However we are reminded of a very apt interview question for would be traders that does rely on Bayesian probability - "If I was to flip a coin 99 times and it was to come up heads each time, what would you call for the next flip and why?" Of course the 50/50 rule is the one that "Jim Smug" fresh out of Uni would answer, but we are looking for the cynical old salt who announces. "Heads because the coin is obviously bent". But in the cases above, the twist of fit and assumption to derive the next move is just far too far away to be useful.

TMM have long been wanting to write a book to counter the books you find in your friends' lavatories entitled "Strange but True", the ones to be found next to the 1986 Guinness Book of Records and the odd "White Company" catalogue that proves that men aren't the only ones to dawdle on the pan. But TMM's book would be called "Strange but Untrue" - A compendium of strange facts and figures all of which are amazingly untrue.

Originally it was to contain Strange but Untruths such as
"Most shark attacks occur in less that 1/2 an inch of water"
"17% of the air you breathe on the subway is human skin"
"If you spread the surface area of your lungs over the area of a tennis court you will die" Actually that one is true.

But we have realised today that the world of finance is so full of data from which absurd sound bites can be fashioned we thought we would add our own, so if you are in the business of peddling information to clients or just bored and want to confuse a 12yr old quant analyst please feel free to pick one of the following and present it with a serious face and "knowing" eyebrows .

"The 4th friday sees a reversal of a percentage equal to all the rises on the Wednesdays divided by those of the Tuesdays"
"The PE ratio of the leading 20 Estoxx is equal to the fibonacci retracement of their Market caps".
"Just 26.78% of the best performing days are in the week before Lent (conditional upon Easter being in April)"
"If you read the first initial of the DOW components in reverse market cap order they spell CRASH COMING"
"19.87% is the average PE of firms with PEs between 19.75% and 20% and is also the year of the great crash."
"The last time the SPX went up a bit, up a bit more, down a bit, left a bit .. FIRE. .. They missed earnings by 12%".
"Currency codes have only 3 letters against most nasdaq stocks having 4 because spot dealers attention span isn't as long."
"The introduction of the Euro was a really good idea".

All of which may be completely untrue. But the market loves a statistic or a truism and TMM often spend their day wincing at some of the old catch phrases that are wheeled out as simple justification for not knowing. We aren't just talking the nonsense that comes out in annual reports, analyst or Investment Manager reports such as -

"Your board continues to implement the new multi-polar strategy, though current headwinds offer significant challenges"
"The current unfolding barbell perfectly describes the arc of investor indecision as the underlying market shifts to the paradigm we descibed in last months bulletin"
"The Investment managers after careful consideration have adjusted the benchmark – investors will be pleased to see that the latest quarter has substantially out performed this new threshold"

We mean the ones that are considered gospel and if muttered knowingly are meant to end debate, such as -

"More people have bought than sold". - Or "Everybody's buying". - For a trade to be complete every sell has to match a buy.
"Whatever goes up will come back down" - Voyager 1 is a good case "not" in point. As are UK rail fares.
"You can’t go broke taking a profit" - Unless you spend more on your vices than the amount you take as profit.
"Prices always move for a reason" - Rarely for the reason most people believe.
"New new things always make money" - Unless they involve trains ( railroad stock dumps / Eurotunnel) or Vanadium Redox Batteries as TMM found out to their cost. .
"Charts tell the future" - Do they? Can you tell us the future from this one please?

Have you got it? Many things are not as clear as they would seem yet somethings are clearer than you think.

Disinflation.

Well we had better mention the Aud before we kick off. Macro great, bounce none. So we reinstated the shorts through 0.9950. But anyway, onwards..

Much has been made recently of the disinflationary trends globally together with the apparent end of the commodities super cycle which is now evident in global price indices. Please note we are using the term "disinflation" (a decrease in the rate of inflation) which should not be confused with "deflation". Now, this has been reasonably well noted by market participants, but TMM thinks that the effects are not yet well explored. Specifically, TMM thinks the decline in inflation volatility has subtle but strongly positive effects on financial asset prices and a negative effect on commodities. To that end, history may serve as a guide. The last time the US went through a period of stable inflation, whereby both headline and core (i.e. headline ex energy & food) inflation were closely coupled, was in the 1990’s:




TMM recognizes that given the backdrop today, the 90’s may seem quite different. But it’s worth noting that for this exercise, we are not comparing absolute levels. Instead, we are concerned with relative changes. In other words we are more concerned with the direction rather than the size of the move.

The Effect on Bonds is a bit tricky to measure, since Fed policy is such a big driver. But in this respect, we can use the yield curve as a very rough proxy for the yield premium on long term treasuries. And the story there seems to be one of a declining yield premium. From 1995 to 1999, the 5s30s yield curve actually flattened, even though the Fed cut rates by over 100bps. It’s quite possible that the improving budget deficit at the time may have had an effect , but the budget deficit is also improving now. All in all, this makes sense – with decreasing inflation volatility, (and by extension central bank activity) investors are likely to demand a lower premium for long dated bonds.





The Effect on Stocks is also quite positive, as they are also a long dated financial instruments. With declining inflation volatility, nominal earnings volatility can also be expected to decline, which should reduce the risk premium. There is an old 20-CPI estimate for the S&P PE ratio which has had some reasonable success over the long run. This is now suggesting that PE should be in the very high teens:




The disinflation impact on gold, however, appears to be quite bearish. The chart below shows gold in white, Fed Funds rate in Orange, CPI in Yellow, and the price of WTI crude oil in purple. Note that from the mid 90’s, the price of gold fell ~60%, even though during this period the Fed cut rates, we got a series of systemic events (LTCM, Asia crisis) AND oil prices rose. Again, the improving federal budget deficit may have also contributed back then – but that is also happening now.




In addition, there are some unique instances that are worth mentioning. Obviously disinflation gives DM central banks more room to pursue QE. But ironically, the disinflationary impact probably also makes QE less effective at generating inflation. Case in point: Headline Inflation in Japan has averaged 40bps above core inflation over the past decade. This suggests that once the inflationary impacts of the weak Yen runs its course, it will be even harder for the BoJ to achieve its 2% inflation target. The small caveat here is that the Nipponese CPI basket can actually be changed or rebased to give the appearance of higher inflation, at least temporarily. TMM expects such a change within 2 years and remember the basket being manipulated in 2006 to, believe it or not, print inflation lower (smoke and mirrors and government payments).




For Europe, current austerity targets look even more difficult to achieve, given that EMU inflation has averaged 56bps over core inflation the past decade:




So where does this leave us? Last to the party with yet another reason as to why equities will keep on going to the moon and gold through the floor? We would actually like to think we were one of the first to arrive at this current party but popped out at the end of January to get some cigarettes only to find that everyone is high by the time we return. But this is a longer term trend and as we are calling for the party to go on into the night we might as well wade in.

But how? We actually think that the chances of a melt up are still pretty high. Some of us were there in 1997-2000 and can smell exhuberance and fear. That darkest of fears, the one of missing a profit. As we have said many a time, it ain't over til 25yr olds are driving around in 3 series BMWs bragging about their portfolios. We are adding to low delta SPX calls. Gold? Well we are already short and happy to ride that into a golden sunset.

Friday Ramblings

Continued good jobless data has reset USD and US mood in general and there has been a proliferation of US Jobs analysis resulting in line-drawing that extends to 6% unemployment levels after further +200k NFPs. The USD/JPY break was perhaps the sound of the market cracking as this weight was added to that of Abe and EU policy moves and clues.  Whilst everything US is indeed looking better than a lot of everything else, it may be getting a bit short term extended. 

AUD appears to be on the receiving end of Soros / CB de-diversification / pick your bogeyman. Either way we are pleased, but note the sensitivity of Aussie inflation to imported goods prices. You can only make money on bills and AUD up to a point. We will add that the USD/JPY break has pulled many USD crosses through short term targets and though we expect AUD to underperform we are lightening our AUD/USD shorts at this level looking for a bounce to resell on.

Schauble's talk of loosening his garrotte of austerity around the throats of periphery pre-G7 (why are they holding at a public hotel rather than at "Chequers"?) may just be pre-talk camaraderie, but there is a theme.  Despite weak Italian data we see the Eur/Usd down move abating as growth prospects balance the -ve rate fears and instant USD effect.  It's still actually in a range.  

Equities in general - Towel chucking from perma-bears, yield calcs on zero cost funding and much much more continue to fuel the boom. We have a piece prepared on background "why buy equities long-term" but its such a common call we are caught behind the curve. We are dip buyers like the rest of the planet. Meanwhile, make us a price on how long it will be before regular daytime TV features stock trading programs again. 

TMM note the mad rush into "safe" assets like XLP, XLU, and the like. TMM have more to say on this at a later point but suffice to say all low volatility dividend payers are not created equal - we will revisit this soon. 

Tesla has proven that there's bad investment advice, then there's the advice you get from Sarah Palin. TMM think ultimately better battery technology is a great leveller in EVs much like cheap polysilicon was for solar. TMM think the Suntech chart from 2007 may be instructive here. Some of us were long but are no longer. Tesla worth more than Fiat? Short term that price action has got "dotcom" written all over it. 

On general asset price rises - QE is fuelling asset price rises but doing little  for income. In fact income ratios are falling as asset prices rise. Great for holders of capital but until they withdraw it to spend, the gap of wealth between poor and rich continues. QE has to reach income before it works. TMM have been wondering if just bypassing all the links and handing £5000 to every head of population would be quicker and benefit the poor over the rich.

Commodities:- TMM note that while equities are now trading on concerns of QE, zero financing etc much as commodities did in 2009, commodities are now trading on FUNDAMENTALS. Fancy that. Note crosses like Palladium / Silver - the former will stop being produced at these prices as every South African mine goes under, the latter falling due to structurally declining demand trends ex hoarding which also happens to be going backwards. Its a pity all those commodity funds are getting redeemed just at the time having any expertise has value but that's life with hedge fund allocators we suppose.

TMM are also wondering if speculation can hold inflation lower than it where it naturally should be. As the speculative drive into commodities, especially oil, seven years ago drove up actual inflation, perhaps the expectation of no/low inflation drives speculative positions into short commodity trades that feed through into real low inflation. If so, they are winding up a coil for a sharper snap back in inflation when the time comes.

Finally for all those long Nikkei / yen hedged - Been a good ride hasn't it? But crowing demands beer buying for the house

Central Bank Alchemy and more Negativity

It's been a week or so since our last post and May is lining up to be another case of capitulation. Capitulation on the inflation trade, capitulation on the growth trade and capitulation of the "world is normal" trade. And throughout this equities march onwards. Buy buy buy buy.

There's plenty being said at the moment about what other people think, to the point that TMM are getting quotosensitive (much like "photosensitive", but this brings us out in hives when we hear other people's opinions repeated as religious portents). If we want opinions from people who have just as little clue as everyone else then we will talk to ourselves thank you. We don't care what Bill or Warren or Paul or Roggoff or Rienhart or any pundit thinks. We should stop reading what other people think and start thinking for ourselves.

 Is this part of the Twitter problem? Recycling of thoughts diminishes the ratio of originality to quote to such a point it's not worth thinking for yourself? Or is it something to do with education? One of TMM's offspring was writing an essay last week and had an original thought to add but felt they couldn't because they had to reference all thoughts and ideas. "Reference yourself" we suggested. But no, a rare original thought bit the dust because someone else HADN'T said it first.

 The Roggoff Rienhart witch hunt appears to us to be more of a blame game in a world of desperation rather than anything important. Are people really not thinking things through enough for themselves, that a spreadsheet error can cause global policy error (this isn't rocket science). Oh actually scrub that, we've just remembered how the Buba work.

But, wow, imagine this ...

WEIDMANN: " Hey Wolfie, you won't guess what, I've just found a +/- error in cell A3, you know all zat shit about ze periphery and all zat austerity stuff, guess what?  We should be giving them MORE not less HAHAHAHA",
SCHAUBLE:- "No shit! That's hilarious! Do we tell Cyprus?"
WEIDMANN:- "Nah, fuck 'em. Let's tell zem we want a special haircut on ze depos, you know a "cyprus special", its like a normal haircut but twice the price and rubbish "
BOTH:- "MWUAHAHAHAHA"

Policy is not swung on spreadsheet corrections and if it is then it's time to change the policy makers.

TMM have been doing lots of pondering recently, mulling their own thoughts around and it's pretty hard not to just come out with a rehash of many themes we have posted here already over the past couple of years. So excuse the a number of back links. But one over-riding trend is the growing push against austerity. Populations get impatient and the data is still looking dire. Money multipliers are not working and the machine is grinding to a halt. Well that's the concern. Desperation is kicking in and any money that is being printed doesn't appear to be ending up where the printers would like it to. So today was another of those days when the world looks to the central bank wizards for results, but at this rate the great book of Central Bank Policy will one day be filed in libraries under "alchemy".

Dr Aghi, Abe and Bendrick hard at work -



So what did Dr Aghi come up with? On the face of it not a lot. A predicted 25bp cut and no special methods other than the special method of saying thalt he is prepared to use special methods. One of which is the much talked about possibility of negative rates -

"On the deposit facility rate, we said it in the past: we are technically ready. There are several unintended consequences that may stem from this measure. We will address and cope with these consequences if we decide to act. We will look at this with an open mind and we stand ready to act if needed"

Looking at negative deposit rates “with an open mind”? This has prompted TMM to go back to thinking about the if/how/why/whether they will be implemented. In this respect, a speech by Benoît Cœuré in February 2012 seems especially applicable and we wonder if Dr Aghi is paying direct reference to it - here is the link, along with some select sentences:


• From a technical point of view, there is in fact nothing that prevents central banks from paying negative rates for the security they offer to depositors, at least temporarily
• Given the costs associated with holding large amounts of banknotes, it is likely that significantly negative interest rates would be required to trigger a switch from money holding to investment in banknotes.
• And there is a degree of hysteresis: a temporary situation of zero or negative interest rates can have long-lasting implications for banks and their trading incentives… The Japanese experience is of course relevant here. [9] Within three months of the introduction of the zero interest rate policy, the volume of transactions declined by around one-half and low turnover persisted until end-2006 when the zero interest rate policy was discontinued.
• Important market intermediaries, such as money market funds, could be driven out of business, as their business model loses profitability, for both domestic and foreign investors with excess liquidity may shift their investments to alternative, more profitable market segments.
• zero or negative interest rates may produce adverse effects on the profitability of commercial banks and financial intermediaries more broadly. In a financial crisis this can result in a credit contraction. All in all, the impact of zero rates on the profitability of banks remains uncertain and highly dependent, among other determinants, on parallel regulatory response.
• Overall, a switch to zero or negative interest rates bears some risks – mainly of a microeconomic nature – which would have to be weighed against potential benefits in terms of additional macroeconomic stimuli. It also has to be noted that such steps would be warranted only in the face of clear downward risks to price stability, which today are not present in the euro area. In particular, the discussion about deflation risks remains largely speculative.

For comparison, here are the ECB staff forecasts then and now:






Now, TMM recognizes that Euro area HICP inflation has been especially subdued recently. But even with these considerations, the ECB would have to sharply change the definition of ‘downward risks to price stability’ for negative rates to be justified given current forecasts, assuming it is still using the above prerequisites. Of course, it is possible that the ECB council has internally relaxed its criteria for negative rates – but that does not yet appear evident based on ECB member speeches.

But all this has led us back to looking at the effects of negative interest rates and some of the possible consequences, however we have discussed most of those HERE (Was that nearly a year ago already? Don't crises drag on?). But we were particularly reminded of this post by Cœuré's line "Given the costs associated with holding large amounts of banknotes, it is likely that significantly negative interest rates would be required to trigger a switch from money holding to investment in banknotes" which prompted us to think of ways of making holding cash even less attractive.

 Other than those listed in the previous post we suddenly had a Eureka moment that unifies an old anthropological conundrum of the small Micronesian Island of Yap with todays ECB policy dilemma. If you really want to make cash unattractive as a handy medium of exchange then you can't do much better than the Rai Stones of Yap . It is therefore obvious that the origin of these stones was a case of runaway deflation caused by a tribesman incentivised by large bonuses, leveraging his balance sheet by using complex derivatives to the point of creating a credit bubble resulting in a deflationary economic collapse and the implementation of negative rates on cash deposits by the Yapese central bank followed by the logical introduction of the most useless form of cash on the planet.

So TMM would like to introduce you to the new 1 Euro coin.

And how it will be used:-

The ECB committee popping out for a box of matches.