Sticks and Stones

Clearly, who ever came up with this children’s rhyme, which was first published in 1862, couldn’t foresee the post-Financial Crisis environment.

If you’ve been managing money during the last 6 years, then you know all too well that words can certainly hurt your portfolio and depending on how you’re positioned when central bankers decide to speak, words can rip your face off.

This has never been more evident that the last couple of weeks. In the September 22 issue of TWR, “Divergence”, I discussed the fact that the most important variables in global macro are the economic conditions and how central banks respond to those conditions. There is only one true trade and that is the price of money, everything else is just a derivative of that.

Central banks control the price of money and use monetary policy to get the economy moving and encourage people to move along the risk curve. And encourage they do.

October 15

The S&P 500 opened at 9:30am down 1.35% from the previous day’s close amid a second confirmed Ebola case in Texas and the worst month-over-month retail sales growth rate since the collapse in January.

By 10 am here is what the global landscape looked like:

S&P 500: down 2.1% on the day, down -0.4% for the year and sitting at 6 month lows.

VIX- volatility: up 22.3% on the day and trading over 27 for the first time in 3 years.

10-year Treasury Yields: trading with a 1-handle at 1.9%, the lowest yield in 18 months.

Eurozone equities: -2.4% on the day, sitting at 12 month lows.

WTI Crude Oil: -2.4% on the day, trading at $80.01, the lowest price since June 2012.

The decline in global markets and subsequent rise in all measures of volatility deteriorated from there as Goldman came out and slashed Q3 and Q4 GDP growth expectations for the US and Walmart guided their future expectations lower. It truly was a dark and stormy night, with nowhere to hide, until 2:38pm.

That’s the time that Bloomberg reported that “Federal Reserve Chair Janet Yellen voiced confidence in the durability of the U.S. economic expansion in the face of slowing global growth and turbulent financial markets at a closed-door meeting in Washington last weekend, according to two people familiar with her comments.”

And just like that the clouds parted, the sun came out, rainbows were everywhere and assets across the globe had a tailwind.

 By 4pm, here is what the global landscape looked like:

S&P 500: down 67 basis points on the day, after being down as much as 3.01% intraday.

VIX – volatility: up 15% on the day, after being up as much as 36%.

10-year Treasury Yields: down 5% on the day, after being down as much as 15%, trading at 1.87%.

Eurozone equities: -1.4% on the day, after being down as much as 3.56%

WTI Crude Oil: -1.4% on the day, after being down as much as 2.75%

Most markets had intraday moves that we haven’t seen in years. S&P 500 had the largest intraday swing in 3 years. Long-dated US Treasuries' intraday move was the fourth largest since 2000. Yes, you read that correctly, there have only been three other days in the last 14 years that had larger intraday swings than October 15. Sticks and Stones.

October 16

The next day was wash, rinse, repeat. Markets opened on the lows but were immediately impacted by a combo platter of central banker. First, it was Benoit Coeure who announced that the ECB would being to buy bonds “within days.”

For some reason, markets reacted positively to this announcement. I thought we already knew that the ECB was going to buy bonds? But the real jet fuel for the markets rally came a few hours later, when Jim Bullard, a non-voting member of the FOMC, said that the Fed’s bond purchases should be data dependent and that the Fed should consider delaying the end of QE.

That is like the sweet, sweet nectar of the Gods to market participants. Since Bullard’s comments at 10:29a on Thursday October 16, markets are up and volatility has once again been subdued. The S&P 500 is up 6.7%, Eurozone equities are up 6.3%, 10-year yields are up 5.8% and volatility has declined 38.2%. Sticks and Stones.

Words Un-Break Market

If this is how markets are reacting to a few sound bites imagine how interesting things could get this week with actual events taking place.

We will get our first look at Q3 US GDP as well as the preliminary report on October CPI for the Eurozone.

But the marquee event of the week will be the latest FOMC minutes, which should announce the official end to QE.

Of course, as has become the norm, the minutes will be dissected for which words are used and which words are not. Investors will be focused on 3 things.

First, how will the Fed characterized the labor market?
Second, will they continue to characterize the time period between the end of QE and the first rate hike as a “considerable period?”
Finally, what, if anything, will the Fed say about inflation?

In the September minutes, the FOMC dropped the description of core inflation being “persistently below target.” In light of the development in global inflation expectations over the last month, will they simply bring that terminology back?

I have absolutely no clue what the Fed minutes will say or how markets will react.

That’s why we don’t have any new trade ideas and we're carrying 3 NEUTRAL biases and only 5 directional biases. We are also keeping both of our open trade ideas, both the SHORT Chinese equities and the SHORT US Dollar trades, on very short leashes, no pun intended.

No matter the magnitude of the movement of asset prices this week, the critical analysis is determining whether this week’s events cause a regime shift in various asset classes or a simple knee jerk reaction to whatever words were or were not included in the latest FOMC minutes.

Part of risk management these days is knowing that central bankers around the world stand ready, at a market’s decline notice, to step in to the spotlight and reassure investors that the speculative environment that they have come to know, love and depend on will continue.

Whether the easy money environment will continue or not remains to be seen, but it seems as though the further into this period of unprecedented monetary policy we get, the more short-sighted the bankers seem to get.

It's critical, now more than ever to keep your eye on the ball, which in this case is what’s happening at the margin of global fundamentals. I will continue to do my best to focus your attention on what I believe to be the most important developments each week.

Sticks and stones may break my bones but words will never hurt me…unless I’m investing during a period of unprecedented monetary policy. Sometimes, the most advantageous positioning in financial markets is in cash.

It allows you the opportunity to watch how things play out from the sidelines and provides you with ample gunpowder when the markets movements, up or down, create opportunities.

Now is one of those times