Walker Percy was a Southern writer and philosopher and one of the most influential American writers of the 20th century. In Percy’s “Life in the South” essay he describes at great length his belief that bourbon should be “knocked back neat.”
“The joy of bourbon drinking is not the pharmacological effect of the C2H5OH on the cortex but rather the instant of the whiskey being knocked back and the little explosion of Kentucky USA sunshine in the cavity of the nasopharynx and the hot bosky bite of Tennessee summertime—aesthetic considerations to which the effect of the alcohol is, if not dispensable, at least secondary.”
Percy goes on to tell the story of drinking gin fizzes with a Bellevue nurse he met in the Boo Snooker bar of the New Yorker Hotel in 1941. He didn’t realize gin fizzes were made with raw egg whites, to which he is allergic. Needless to say the night didn’t end the way he had intended and it led him to conclude that: “Anybody who monkeys around with gin and egg white deserves what he gets. I should have stuck with bourbon and have from that day to this.”
Prior to the financial crisis, trading in free capital markets was akin to knocking back bourbon neat. It was a more pure experience when fundamentals mattered and technicals were more reliable.
Since 2008, it's been a steady diet of gin fizzes as Bernanke then Yellen and other central bankers monkey around and imprison the very markets that were once free to move where they saw fit.
Last Week Sets Up A New Trade
The markets reaction to last week’s comments from the Fed Governors as well as the the Fed’s mouthpiece from the Wall Street Journal, Hilsenrath, is proof positive that we are living in a gin fizz world. The week started with 2 different Fed governors questioning whether the timing will be right this year for the Fed’s first rate hike.
Then Jon Hilsenrath said that the chances of a 2015 interest rate hike are diminishing because of the recent economic data. The comments were followed by lackluster readings on consumer spending, inflation and industrial production.
Retail sales dropped the most since January and although its still moving along at a sluggish pace, its obvious that consumption remains in a downtrend. The latest inflation readings showed that core CPI is still under 1% and CPI has now fallen month over month for 5 consecutive months.
And finally, industrial production fell again last month, making the last 8 months the worst time period of industrial production since the Financial Crisis. The markets responded by continuing to sell Dollars and buy bonds and pushing expectations of the Fed’s first rate hike to well into 2016.
This shows just how imprisoned financial markets have become to the Fed’s actions. But lets take a step back and try to see the forest, despite the trees.
I have said repeatedly that the best edge that an investor can have is gained developing a method for better understanding what is happening right now, in the present and then being able to articulate that into the positioning of his portfolio.
Trade The Market You Have
Most investors spend their time analyzing what has already happened, like GDP numbers that reflect economic activity from 5 months ago. Or they spend their time forecasting what will happen in 3 to 6 months, or longer. With all of the sophistication and technology in meteorology these days, weather patterns can’t be accurately predicted further out than 5-7 days. Some would say getting it right the next day is a stretch. So, if weather patterns can’t be accurately predicted, does it make sense to believe that we can predict what will occur in an ecosystem as vast and complex as the global economy and financial markets?
The good news is that superior returns are not dependent on superior forecasting. For instance, let’s look at the USD. The USD peaked in the middle of March and has been in a downtrend ever since. Since the Fed’s no rate hike decision back in September, the USD is off about 2%.
But don’t let the price action over the last 6 months, or the last 3 weeks, the high probability trade is for the USD to trade higher from here.The Fed doesn’t need to raise rates in order to spur the USD higher. It simply needs to keep the trajectory towards a rate hike intact.
As long as the Fed’s on a path to normalizing its rates policy and the rest of the world, especially the Eurozone and Japan, are actively easing, then the global environment will continue to be pro-USD. This means USD weakness should be used as an opportunity to get LONG before the next leg up.
Speaking of the Eurozone, I used the USD’s weakness and subsequent rally in the Euro last week as an opportunity to express my USD bullishness with a SHORT Euro trade inTWR.
From a price perspective, I’m not sure we could have had a better entry - the reward/risk is skewed heavily in our favor. And as I always insist on, the underlying fundamentals of the trade are also congruent with being SHORT the Euro. The ECB is in the middle of a round of quantitative easing. That is Euro bearish.
Last week’s inflation readings for September showed an outright decline for the first time in 6 months and has decelerated for 4 straight months. That is Euro bearish.
At its September meeting, the ECB staff reduced both growth and inflation forecasts. That is Euro bearish.
This week’s ECB meeting is important despite the fact that there won’t yet be an agreement on how to tweak the current asset purchase program. Even though its too early for an agreement, we should be able to see progress towards a consensus of how the ECB plans to tweak the program in terms of duration, magnitude and composition of the asset purchases. In addition, the ECB could cut rates and go negative 20 basis points on its deposit rate.
The current rules don’t allow the ECB to buy government bonds with a lower yield than its deposit rate, so a shift to a negative deposit rate would open up the universe of bonds available to be purchased. All of this is…you guessed it, Euro bearish.
Each week, I use this commentary to focus you on the aspects of last week’s news and market action that I believe to be the most critical; and I eliminate everything else.
Last week is a perfect example of why I have a job and this commentary exists.
There is a lot of noise in the markets each week which have absolutely no impact on trading decisions. I will admit that the gin fizz element of today’s markets makes forecasting of a market’s direction challenging to say the least and trading the markets as the Fed determines the timeline and magnitude of its first rate hike will be tricky.
I much prefer to drink my bourbon neat and I would certainly prefer to trade free markets. However, it’s important that you ALWAYS “Trade the market you have, not the one you want.”
I prefer bourbon, but gin fizzes are here to stay. Luckily I’m not allergic to raw eggs.