The Tail Chaser: August 2011

Thursday, August 25, 2011

Buffet's dialog with Brian Moynihan last night...

Had to spend a few minutes trying to entertain my readers, so I wrote those lines below...

WB: "Brian... are these rumors true? How is your bank doing?"
BM: "We're fine, Warren. Chill out. So, what's up?"
WB: "I was thinking about an investment in BAC. What do you think of a partnership?"
BM: "YOOOOOOOOOOOOOOOOOOOURS!!!!!!!!!!"
WB: "But, but, Brian..."
BM: "Warren... let's just make it so it won't look we're in huge trouble."
WB: "You're not in trouble, are you? Obama said.. "
BM: "10y Preferred, dividend of 6%, ATM spot of 7.15 strike. DONE!"
WB: "But what will Munger think of it..."
BM: "Bernanke will cover you. Don't worry."
WB: "Okay, okay. I saw this movie before..." (walks away quietly, calls bridge partner Jimmy Cayne)

Tuesday, August 23, 2011

Some useless charts on the US...

Some charts on the US Economy.
Hand picked to scare people out. Not so scary, come on. Just interesting.

Hugh Hendry - Eclectica Fund July 2011 +4.6% MoM

I like the guy, you know. So I am happy his views are paying off.
Mr. Hendry's letter is out. His fund is +4.6% in July, total YTD > +8.0%.

I wish he would add a bit more of his macro views in his letter.
I liked the idea of the Danish CDS, but the German CDS, in my opinion, has about the same effect.
Danish CDS is already @ 100/108bp, as of 2pm Rio-time.
So @ 21bps... it seems he got that one quite right too. It's likely he nailed it around the lows when opening the positions.

And Bob's Back saying "It has only just begun"...

I think Bob has a lot more experience than I do, so I will simply leave you with his words. I admire his experience considerably and think the guys has gotten very good calls out.

And we're out of the currencies

Last Friday we got out of the expiring ESQ1 Put Fly 1150/1125/1100 position @ ~10.17. Unfortunately we didn't have balls to take the whole lot to expiration or even a tiny part of it. That would have been a 7.9 : 1 trade. But the ESU1 Future settling at 1124, very close to what we call 'the fly's ass' in Brazil, was pure luck. We got out at an average price of around 10.17 which I thought was an already fantastic 2.8 : 1 risk-reward. And with 'fly' above I mean the insect. Tiny, huh?

I am here to try to bring in positive returns and to reduce the overall risk of the portfolio. Gambling, I want to think, is a small part of my job.

We also announced the exit of the Currency Basket. Entry here.
Well... I had been in love with that currency basket for a long time, but I only talked about it here on the blog a few months ago, when the bullish components of it were losing steam already. What a lesson.

That is why I got out. Only the bearish component of it, the CHF, was steamrolling over the other currencies.
The CHF moved 12.3% x entry, while the other currencies moved very little.
The second lasgest move was -2.9% in the CAD. Then +1.4% in the NOK and +1% in EUR, +1% in BRL, +0.9% in GBP and -0.3% in CLP.

It was clear to us that the long CHF was very crowded trade when, even with equity markets going sour, credit markets finally giving up and widening considerably and with gold making new highs fastly, etc, etc... CHF was squeezed lower by 5%. Bells rang and we got out.

Comparing the GBP and the EUR x the Commodity / Higher growth currencies I noticed low volatility, but also no help. So basically my reading was "home bias" is working against me and stronger political and economic "we want stability and status quo forces" from the developed economies working against me.
Not to mention the brazilian and chilean authorities intervening in the markets. The swiss authorities intervening. The japanese authorities intervening.

I lost the big move on this basket (shown below, in another chart), but it is okay. It was a great lesson.
I still think that in the medium-term/long-run this basket will outperform, but in times of stress there is a lot more capital from the US, Europe and the UK around the world, as direct investments in hard assets, as hot-money, as carry trades.

I will then save volatility in my portfolio and reduce the overall exposure to currencies. We are living interesting times now. And every time I mention interesting times it should be translated as "I expect great opportunities ahead". Perhaps now is the time to be very cautious and looking at cheap entry points in a variety of plays, perhaps even bullish trades, being a bit contrarian.

I have an eye out for the 6m or 1yr Argentina CDS. I will speak more about this later. If risk markets collapse Argentina will be beaten up so badly that very interesting opportunities will whisper in my ear "Buddy... it's time. Wake up. They export soybeans and corn and wheat. And after volatility is down there will be inflows. Low levels of debt despite bad politicians and run away inflation."

So... Two charts:

1. The total return on this basket we announced here, including carry (+2.36%)
2. The return on this same basket, but since 1-june of last year when I first looked at it and started mentioning it to friends and colleagues (+14.36%)

Friday, August 19, 2011

Quick update

Busy times over this way.

We got out of the ESQ1P Fly 1150/1125/1100 during the day today... Avg price was around 10.17pts. Entry @ 2.70.

Posts here:

Entry: 11-Aug

Exit today:

35% @ 8.5
35% @ 9.9
30% @ 12.45

Also got out of the currency basket.

More on that later.

I'll finish this quick post with a question:

What can the G7 do?
Printing money means currency debasement.
No wonder precious keep going up.

Now there's no economic activity.

Be back later with more thoughts.

Friday, August 12, 2011

Nothing new to say...

So what have we seen in the past few days/weeks?

- The ECB stepped in the bond markets buying now also Italian and Spanish bonds. Yields in 10-year tenors, for example, dropped over 100bps to around 5.00% even though equity and credit markets collapsed, then recovering some of the losses until today's close.
- Bernanke, even though having 3 officials against him, pushed to keep the Fed Funds rate at 0%-0.25% for another 2 years and strongly signaling that he acknowledged the economic deceleration and that the Fed will bring the horses if need be.
- European policy makers banned short-selling of bank stocks in a range of countries
- A variety of newspapers articles and commentaries by brazilian policy makers (President, Finance Minister, Central Bank president) arguing that in case the economic backdrop goes bad "brazilians have many tools to be used and they will use it".

So really... there isn't anything new to say.

The markets moved down in great speed and volume and finally the credit markets felt the pain too.

US Treasury yields collapsed (downgrade? what?), CDS spreads widened remarkably, bank stocks collapsed, volatility exploded.
Rumours of repo lines being cut for some french banks went around.
An ugly 30-yr US Treasury auction was placed (10bp tail...).

So basically we're seeing monetary easing in the US through extended 0% rates.
We're seeing some type of QE in Europe through the ECB bond buying of all kinds of sov debt.
And other policy makers world wide seem to be watering their mouths over rate cuts.

But what is really new?

The only thing new is that economic data remains bad.
Industrial activity numbers out of Europe were bad.
Confidence in the US was bad. Bad as in 31yr low.
Trade Balance in the US was really bad.
And other stuff..

And, by the day, the market pushes policy makers further down the 'bail-out' road. Testing them, more and more.
How much time until they get down their knees and, without any more bullets left, just raise their hands and start praying to their gods?

Things are getting ugly.
And I think they will get even uglier.

I wonder how Bernanke sleeps at night.

PS: EDZ1EDZ2 3m USD Libor future spreads remain negative @ -9.5bps. The low was @ -13bp.

Wednesday, August 10, 2011

Is the Credit Crunch Crunchy?

If you have some experience in funding markets, repos, etc your input here is very, very welcome. E-mail me if you could add to this analysis. Thanks a lot.

[Yes, today I heard rumours that american banks were pulling Repo Lines from SocGen]

Yesterday we posted on Twitter that some interesting market movements in short-term ED futures was in place right after Bernanke guaranteed cheap money for 2 years.
In minutes (or seconds?) the EDZ1EDZ2 3m USD Libor spreads collapsed form around 20bps to negative territory and as the risk markets recovered and shot upwards moved alongside.. closing back above 0.

Today it is now back in negative terrain.

Why?

The Fed Funds rate is around 6-10bps, 30day average of 8bp.
The current 3m USD Libor fixings are around 25-28bps.
And the spread between, all 3m USD Libor, Dec11 fwds and Dec12 fwds is @ -4bps, after reaching -6bp intraday.

What does this mean?

Possible scenarios:
(A) Considering that the 3m USD Libor has a high correlation AND beta to the effective FF rate, people believe the Fed will increase its FF rates soon enough (before Dec11), but will later have to cut the rate again during 2012.

(B) People are betting that the 3m USD Libor will actually be lower than it is today (with Dec11 equal to today).

(C) People think short-term corporate/banking rates (interbank funding markets) will freeze, as it happened in 2008, and short-term funding costs will explode with banks and shadow-banking-system going bust.

(D) Someone long this spread in huge amounts (or somehow affected by these 2 maturities in ED futures) is being squeezed and liquidating its position against market rationale.... at negative fwd rates even with base rates very close to 0.00%-0.25%.

Now the probabilities:

(A) NO: The Fed just said it will keep rates at 0%-0.25% until Mid-2013. So.. No. Won't happen (not even considering bad economic fundamentals here).

(B) NO: There isn't a lot of upside for receiving rates here if you consider that the Dec11 rates will remain equal to the 3m spot of around 28bps now. Upside would be gaining a maximum of 0.00% - 28bps and the downside is just massive. There are bad portfolio managers and heads of repo and treasury desks out there.. but, hey, come on!

(C) Yes? People have in mind (or already know that some repo lines are being pulled?) that there is a credit crunch coming and, with Bernanke guaranteeing zero-rates forever [reason for a steep curve], there's little downside risk to betting on that: short-term rates exploding, but falling back to normal levels after there's huge liquidity injection and central bank guarantees from all major central banks world-wide (TARP2, USD swap lines, etc...)

(D) Amen.

Tuesday, August 9, 2011

Reducing 20% CDS Position: Is Ben 'Greenspan' crazy?

Earlier today I posted on Twitter that I had reduced 20% of the 'Long German CDS @ 40bp" trade entered in late May.
The trade was entered @ 40bps on May 23rd, for Sep16 CDS expiration.
The exit price, for this tranche, was at 80bps.

So PnL was +40bps, for the swap's duration of around 5.20 at exit = +2.08% for the position, plus the negative carry of 9bps, Total return = 1.99% for 50% of the NAV ~ 1.00%. (20% of a 250% of NAV total position).

There's still 2x the fund long this CDS... paying the cheap carry and exposing the book to its MtM.

Why get out of this position?
Basically reduce risk, pocket the money. Get room for more trades in the near future. Good opportunities seem to be coming to the surface.
Reducing this 20% of the position gives ammunition to be breaking-even on this same trade if Germany 5y goes to around 32bps. At 32bps I'd double the size of the original trade (5x the portfolio) if fundamentals remain as they are now.

Why? I do not think things will be solved in Europe.
But the recent decision to buy Italian and Spanish banks, in my humble opinion, casts a cloud over what will be done.
For the good and for the bad.
I think that this decision, at first, as shown by market prices (Periphery CDSs tightening and Germany widening) is still pro-trade, that is why I remain long the other 2x the portfolio.
This movement in the european CDS spectrum, coupled with the downgrade of the US also casts a cloud over the AAA-status of other european nations.

What will be of the EFSF if the europeans get a downgrade?
And who will fit the bill if the market pushes the ECB into buying more bonds, leveraging up its balance sheet, because the widening in Spanish and Italian bonds go on even after the first efforts this week?
Who is realizing a loss on the bonds bought by the ECB at 300-400bps over bunds, at 5.00%-6.00% in 10yr bonds?

I understand that policy makers do not want to see economic depression in Europe (and likely the world?) if the banking system busts.

But policy makers also aren't allowing the system to balance, even if slowly. They aren't allowing the system to get even close to equilibrium.
There has to be losses to someone in order to get things back in shape. There has to be losses to someone to teach lessons to risk takers and policy makers.
And for years now letting entities (banks, investors, corporations) incur losses is not on the radar.
I am afraid that the can-kicking system adopted by DM policy makers, and followed by EM policy makers, is creating such distortions in investing behavior that things will get only worse and worse.

Today at lunch with a friend of mine who is also a portfolio manager we even came up with a scenario where this behavior will just bankrupt every healthy sovereign balance sheet in the world. Every year the systemic risk is larger and more countries, after a recession, move to 0% interest rates, bail-outs, huge fiscal stimulus, etc, to avoid recessions.

Yes, there is nothing new in what I am saying. Jim Rogers slaps us in the face with his objective comments about bankrupt Europe, US, Japan and UK, etc every week on CNBC or the likes. The same with John Mauldin on his weekly letters. Or David Rosemberg. Or Niels Jensen. Or John Hussman. Or Albert Edwards, David Einhorn, Howard Marks, Kyle Bass, George Soros, etc, etc. It amazes me that even though these guys, who have been in the markets for years making good risk-adjusted returns, and journalists and others speak nothing new the group mentality doesn't change a bit. And policy makers don't change their attitude.

Anyway... we're here to preserve capital and try to profit from these dislocations. Be they positive or not.

Today's FOMC decision to outright say the cost of taking risk will remain at 0% for 2 more years and that they're ready to bail the globe out if necessary really got me thinking. Unbelievable.

Monday, August 8, 2011

Bottom-fishing time? No. We love being brazilian.

Regarding bottom-fishing:

This weekend a french friend of mine who actually lives in São Paulo visited Rio. We went out for brunch on saturday morning and it was a good 4-5 hour chat about business in Brazil, entrepreneurship and, why not, markets. All overlooking beautiful Ipanema and Leblon beaches. My friend worked as a derivatives trader for a german bank and is now ahead of his own capital markts advisory business in Brazil.

He defended, as an european, allocating capital into US dollars and Euros in some bank in Germany or the US. I countered with my already published view that somehow this dogma is changing slowly and the reserve currency status is being challenged.

I moved into talking about my financial homeland and thanked my parents for being in Brazil at exactly this time in history. Why?

For a very simple reason: We, brazilians, are paid a very generous 12.40%/year risk-free rate in local currency (~6%+ real interest rates). That means that our bar is raised THIS high when it comes to investing and taking risks. It means we should be VERY patient and really look for opportunities before allocating any risk.

An investor with The Tail Chaser Fund (say he would want to pay 2% in management fees to read these badly-written lines that justify my trades, and 20% of his profits!) could still reap 3 to 4 times more in Brazil compared to an american or european 10-year fixed-rate investment. Of course, different currency.

Not that The Intrigued Trader is any good, but if he just sat down and waited, the chance of outperforming funds in USD or EUR in those 10 years would be very, very high.

Another friend of mine who made some big bucks working hard in the real economy business emailed me today asking if these were 'buying times'.

My reply was as follows:

"It is early to buy.
There are very interesting prices for many securities (here I talk about brazilian stocks), but I will only make a move in stocks when the Central Bank signals rate cuts and there is a global move into cutting rates and pushing forward more fiscal stimulus to 'save it all', etc.

I believe that with the markets so screwed world-wide I still need to see economic activity showing evident signals of deceleration/recession (Europe/US/Japão), a fall in commodities to reduce global inflation...

And consequently rate cuts where there is still room for such...

For now it is only CDI (float) or fixed-rate long-term bonds (duration of 5.4y, NTN-F 2021)"

So... Markets have been pricing in this deceleration in activity, but we're only in risk-aversion mode and not yet in "economic contraction mode".

Markets are pricing some things in, but not everything in.
As regular readers know... I am quite a realist, not bear.

Good luck to us all.

Hugh Hendry - Eclectica Fund June 2011

The new letter from Hugh Hendry's Eclectica Fund is out: +0.6%, YTD = +3.6%. Improving outperformance versus the HFR Macro Index.

I am pretty sure that he is rather busy as no fundamentals were discussed in the letter, but only the funds performance attribution was mentioned.

Interesting times these are. Interesting times...

(click for larger images)

Stance on the US downgrade: neutral

My stance on the downgrade of the US: neutral

Why? Because any diligent investor with some historical knowledge knows that the USA is not a AAA credit when you factor in the theft of value their 'currency debasement' program posts.

The holding of US Treasuries today, in my opinion, goes based on:
- 'this currency is also my benchmark' so I can justify to my investors that nothing can be done to stem this loss of real value unless I take risks (buy gold, or stocks, etc)
- The USD has a reserve-currency status which means that people will run away from other currencies to store value in USD when the shit hits the fan
- Positive historical correlation with risk-aversion (as above)
- Central Banks and global treasury departments having to intervene in their currency markets to stem appreciation. I think Central Bankers have an edition of "Currency Crisis Management 101: The Asian Episode" in hand and they want to avoid credit bubbles in their countries. They hate the UST, but they must try to avoid the worst problems (zero-rates) hitting their home field.

When Asia opened last night alongside western electronic futures equity markets gapped lower and commodities came along. The CHF was rock-solid, the JPY was robust. The ECB spitting a press-release that signalled they'd be active in the larger periphery debt markets propped up the EUR x USD. Some people I talked to on a chat were talking about limit-down on the S&P, others were worried about the US Treasury markets...

My stance is that the markets will keep its downward trend with large volatility, but nothing 'unheard of' unless we see the US dollar drop against EM currencies and US Treasury rates wider.
That has not happened yet. THAT would be limit-downs and panic.

I don't think this downgrade will have any significant medium-term effect in market prices and the US will remain for some time as it is now: supreme, but losing value as time goes by. Because that is the path they have chosen to fix their fundamental problems of a fat balance sheet, delevering.

To another topic now...

A friend sent me an interesting piece last week that pointed that the next QE that we will see is the European one, not the Bear-man-QE one. It was from Michael Aronstein from Marketfield Asset Management, being interviewed by Bloomberg. Spot on.

European banks are getting killed with these exploding yields of the periphery. Austerity packages and signs of an oncoming recession helping of course.

And then we saw last night's comments from Europe: let's dig Italian and Spanish bonds out of the hole.

So basically the periphery funding dries out and risk sets in or the Europeans decide to print Euros to save themselves. Either way the Germans pay the bill and the EUR looks worse.

And what happens with the German Bunds and German CDS? Wider. It seems that Michael was right and indeed European leaders will bring in their new QE program to stem this risk-off mood we're in. That has been the case today at least. Too early to call anything permanent, but yes, Bunds are wider, the EUR is lower x G7... Let's see how this ends up.

Outlook: more intervention, more QE, more money printing, more currency debasement, slow growth...

What trades are you looking at waiting for an better entry point?

Thursday, August 4, 2011

Some fast thoughts.

[I didn't review spelling or even re-read before posting... so forgive me if I sound confusing]

Basically putting up a lot of charts here on the blog takes some time and patience. There are so many interesting ones to analyze. So I will simply sit down and organize a few thoughts.

It has been some time since I wrote anything.

So...

No, I am not surprised that markets are falling or showing signs of stress.
Yes, I am surprised that it happened this fast.
Yes, I am surprised that Italian yields have soared so fast and by this much after the European policy makers got together to come up with the last solution presented.
Yes, I am surprised that the EUR has been holding up so well.

What also surprised me?
In the economic data front the 4Q10, 1Q11 and 2Q11 US GDP numbers (and all the other past revisions down) looked horrible.
The ISM Manufacturing came in ridiculously low. Historically recessionary I would think.
The Non-Manuf one also dropped.
The employment component of both of them don't look good. Coming in worse too.

The Debt-Ceiling event for me was simply a political spectacle and I really don't have much to say about it. Borrowing words from some articles and commentaries I read lately, the debt-ceiling issue simply brought in more uncertainty to investors and corporations that wanted to allocate capital and sweat.

The Global PMI (ISM included) numbers have been declining. OECD Leading indicators have been declining.

That is what happened.
Now what do I believe will happen?

Markets will keep going down for some time until policy makers come scream in our faces "Hey! We're at zero-rates, but we can do something! Not sure how!".

The Open Trades:

-- Long GOLD (XAU) / Short Silver
It is a bet that fiat currencies will implode and with it industrial activity will keep declining

-- Long USDCNY Calls May14 k = 6.80
It is a bet that the market will price in capital outflows from China if international trade goes down dramatically. This is also a LONG VOL play. Done below 8% in vol, this 3y play is all vega. If the 3y NDF helps directionally (indeed helped a bit up from 6.16 to 6.24)
Also a hedge for the currency play described below.

-- Long JPY 3y10y Swaption Mar14 k = 4.0%
That one trade against Japan... I have talked about it for some time. It will only make money is there's debt monetization and inflation in Japan... pushing interest rates higher. That is catastrophe in my book.
The JPY has so far gone up against many other currencies, helping with deflation.

-- [replaced below by another trade, I will correct it shortly] Short USD/EUR/GBP (33.3% each) x Long BRL, CLP, CAD, NOK, CHF (30%/15%/20%/20%/15%)
The "Printing Presses" trade x population growth, productivity growth, commodities and safe-haven.
The solution for these 3 economic blocks with high deficits and low growth and zero interest rates is money printing for fiscal boosts. If they succeed growing the other nations will be hella healthy. If they don't they will print themselves out of the hole and inflation (commodities?) will set in.

-- Long German CDS Sep16
Greece is insolvent. Portugal is insolvent. Ireland is insolvent. If you consider that there has been a lot of tightening world-wide (in EM basically) and that the european austerity packages won't boost european growth.... Europe has no way out. Now add in confidence going down in Italy and Spain, as their activity and fiscal situations aren't great... And we have Germans paying the bill again. But this time for something they aren't the ones to blame for.

I'm out for a beer.
Hugh Hendry should sleep fine tonight.

Monday, August 1, 2011

IRA - Black Friday and the end of risk free returns

hattip: www.ZeroHedge.com

The world players are so loaded-up on US Treasuries that they can't even sell it to reduce their risk. Incredible.
Many countries already trade through the US CDS curve in certain maturities.
I am pretty confident that their debt doesn't trade through US Treasuries just because the Fed Funds rate is nailed to 0%.