Thursday, May 26, 2011

Stephen Jen believes markets have topped.

Stephen Jen has left BlueGold Capital to open his own shop with another former BG quantitative research guy and is hiring! If you guys are interested... get in touch with him. It is a London-based HF.

Today he issued a nice and interesting commentary which I wish I would have written, but I guess his years of studying and experience are way ahead.

Very interesting insights which I agree with.

Bottom line: Had it not been for the news about DSK, the financial markets would have been so very boring in the past two weeks. The current risk-off phase makes sense to me.  In fact, I think risks are biased to the downside in the weeks ahead, as the second derivatives of global growth turn more negative, even if the first derivatives remain positive.  Furthermore, the nature of how QEII has helped buoyed risk assets since last September is likely to be fleeting - and certainly untrustworthy, in my own view.  As the Fed approaches the end of QEII, there will likely be an increase in the volatility of asset prices.  (1) The Okun’s Law not having worked (GDP growth without job growth) for much of the recovery in the past eight quarters has been used by the Fed as a key justification for QEII.  But as the labour market improves, despite the deceleration in headline GDP growth, QEIII would be a bit tricky to justify, even for the proactive Fed.  (2) It is my opinion that a meaningful portion of the rally in risk assets since Q4 2010 was liquidity-fuelled.  The Fed explicitly announced last fall that it would use QEII to ignite risk asset prices.  On this narrow measure, they have ‘succeeded.’  But as they complete this operation in the coming weeks, risk assets will likely remain very volatile.  (3) The European Debt Crisis is ‘cancer’ for Europe.  The idea of a currency union in Europe is not economically sensible, even if it is still politically attractive.  I continue to believe that there will not only be defaults by the insolvent member countries such as Greece and Portugal, the EMU itself is unlikely to survive in its current form over the medium term.  (4) I continue to suspect that, unless there is QEIII, it is likely that risk asset prices will peak in Q2; in fact, they may already have peaked.  A more stagflationary accent to the global economy will not be constructive for risk assets.    

Speaking about the European Debt Issue... to fuel some thoughts on my long German 5y CDS call this week Jen writes:
Why Europe’s policy choices are so difficult.  The situation in Europe is not good, and will get more complicated.  (1) The globalised economy is hyper-competitive; even once mighty nations like the US are struggling to keep up with Asia.  Portugal and Greece are not only uncompetitive within Europe, they do not have the institutional set-up, the necessary mind-set among the people, or the multinational companies to keep up with the rest of the world.  The indicator that best summarises the legacy debt and the inability to compete is (r-g), i.e., the interest rate to the GDP growth rate gap.  The weighted average cost of borrowing for the GIPS countries is more than three times higher than the expected economic growth rate for the next five years.  This gap will likely expand further, as economic growth is de-rated and interest rates rise further.

SLJ Macro Partners - 2011 05 26 - Stephen Jen - My Thoughts on Currencies

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

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