Recap : Thoughts on Macro Ideas from the Ira Sohn Conference

Commentary:

Excerpts of speaker presentations taken from various online sources. I will summarize those first before expressing my own views. But first off – it’s kind of interesting that there were so many macro speakers this time, isn’t it? I wonder if it’s because everything thinks interest rates are going up and trying to figure out how the macro will evolve. Or maybe it reflects the fact that few assets are substantially mispriced here.

Novogratz wants to go long the Brazilian Real. He said “It’s so bad, it’s good,” The Brazilian real has been one of the worst performing currencies over the past five years. The country’s equity markets have been hit very hard over the same time frame. Business confidence is at a low. Brazilians have sustained a decent level of growth via credit. With that context, he’s betting that the odds that President Dilma Van Rousseff won’t get re-elected. And if that’s the case, Brazilian assets could be poised for a big rally. “The bet is a really simple one,” he says. “The election dynamic is going to shift between now and the election and the probability of Dilma winning will go lower.” He predicts she will lose and if that happens, you’ll see “a major rally in Brazilian assets.” But if she wins the presidential election, the Brazilian market could be in for a “long, long dark period.”

>>> As a general rule, I strongly dislike bets based on political changes. There are exceptions certainly, but it is almost impossible to measure what the NET impact of the political leadership is. In many cases, the currency will trade strong or weak based on underlying economic dynamics that are only marginally affected by the near term politics. One can make a strong argument that the Real is here simply because it is strongly exposed to commodity prices, and China is shifting its growth model away from capital expenditures. Furthermore, the currency remains strong vs most PPP metrics, flawed as they are. As I noted yesterday, going long due to the carry in this low vol environment may be good for a trade. But the backdrop does not seem sufficiently attractive for a long term investment.

Shumway wants to short China’s Currency. He’s riffing on China now, showing shadow banking’s grown quickly and that a lot of it’s come even when projects don’t have returns. He says shorting the CNH is a way to short China’s currency. “Our view is they have limited options within China to deal with their slowing growth.” Shumway says he thinks expected growth in China is overstated and that China will devalue their currency. In 1994, he says, China devalued their currency right before a big growth phase.

>>> Usually, when long/short guys start putting on macro trades AND publicly announcing them, that is a sign that the trend is near the end. The growth points Shumway made are all pretty well understood and priced in – they key difference is that he thinks China will devalue because they have been overstating their growth. The problem with that view is that China’s trade balance, which can be verified via trade data with other countries, continues to be quite positive. Also, their FX reserves continue to grow. And if China does devalue in an attempt to goose growth despite running a trade surplus, we can be pretty sure there will be repercussions via US and EU tariffs on Chinese goods. It will be a lose-lose, and for all we know, CNY/CNH could strengthen as assets are repatriated in that scenario. Having said that, Gavin Davies noted that a liberalization of China’s capital controls could be a key catalyst for weakness.

Gundlach wants to short US housing. Gundlach is going to focus on the housing market and the “deleveraging myth.” He says “single family housing is overbelieved and overrated.” “Housing market has been supported by great volume of cash transactions,” he says. “This is not exactly indicative of the organic growth in the market from a real buyer’s perspective.” New home sales are “remarkably weak,” he says, while adding new home sales are “flat on their back just as they were at the depths of the recession and falling anew once again.” Housing starts have “plateaued,” he says. One of the things the bulls like to point to is the “ubiquitous affordability chart.” But Mr. Gundlach pokes holes in that as well. “It doesn’t really represent what is going on in the financing markets,” he says. “If affordability was so great, why was the interest rate rise last year responsible for such a huge drop off in sales?” he asks. When interest rates ultimately rise, “you’re looking at a rather bleak picture of affordability,” Mr. Gundlach says. Fannie Mae and Freddie Mac are looking to be wound down by politicians. “One thing I do believe for sure, if you wind down Fannie and Freddie…then mortgage rates will go up. That will certainly impact affordability in a negative way,” he says. He’s now talking about the dynamics between renting or buying homes. Renting has become “massively more appealing,” he says. And that covers people across the age spectrum and across the country. “This is a generational preference,” he says. “Young people were shocked and scarred” by the financial crisis. Baby Boomers have a great deal of residential real-estate wealth compared to their income. He describes baby boomers as “cash poor, house rich.” The home-ownership rate is near decade lows, and Mr. Gundlach thinks it will go lower. “Housing starts are not going to rebound,” he says. “I am going to make the bold statement that during the rest of my career we will never see a year of 1.5 million housing starts again.” And in the grand finale, Mr. Gundlach recommends people should short XHB, the S&P home builders ETF.

>>> I’ve been noting weakness in housing for some time, so I broadly agree with those views. (Though I will concede that the data is likely to better at least temporarily in the next couple months) The table I put up yesterday shows that in Sacramento, only 12% of Millennials in 2012 own a home, vs 19% of Gen Xers in 1990 and 25% of the Baby boomers in 1970. I think that highlights another reason why consensus expectations of housing demand returning to ‘trend’ is wrong – and why trend growth is lower than consensus expectations. But having said that, the housing market seems very bifurcated. Demand for homes > $1mm is very strong. Homebuilders seem to be increasing the median values of the homes they are selling, which will allow them to perform. For buyers with good credit and capital for a down payment, purchasing remains preferable to renting in may parts of the country. So despite my general agreement with those views, I disagree that shorting XHB is the right way to play it. Receiving LT fixed rates or buying agency mortgages (if the GSEs go away and mortgage rates go up, refinancing will slow even more) seems like a better bet.

Zach Schreiber, CEO at PointState Capital wants to short WTI crude oil. He starts out by saying he is making a big bet that crude oil is going lower, “much lower.” He’s urging people to short WTI crude, and then partially offset that position by going long Brent. He also notes that he’ll make the case for going long some of the U.S. refiners. “There’s $33 billion that’s net long WTI,” he says. “Now, if you’re long, I’m sorry for you, but this could make you feel comfortable. At least you have friends.” Or that could make you scared, he adds. “I’m sure that will be a smooth exit when all those clowns try to get out of the Volkswagen,” he says. He cites geopolitics and economic reasons to be nervous about crude. Oil supply growth won’t slow at these prices, either, he says. “We don’t think U.S. production will slow meaningfully until crude oil prices go below $80 to $85 a barrel,” he says. Odds of a disconnect between WTI and Brent prices are “very, very high,” he says. On the disconnect between WTI and crude, he says the competitive advantage is large, is likely to get even larger and more durable than the market believes and the oil-refining stocks currently discount. Ultimately, crude has gone from landlocked mid-continent to policy locked in the gulf coast, he said, which is one of the main reasons why he’s so down on crude prices. “U.S. crude is being drilled for by the same cast of characters that oversupplied the natural gas market,” he said. “We just saw this movie. Why should we expect a different outcome.” Schreiber posed the question of why oil prices globally hadn’t moved lower given the surge in North American production. He said interruptions in oil supply from the Arab Spring and events in Libya have “almost completely negated American production growth on a barrel-for-barrel basis.”

>>> I agree with the analysis but am not sure about the trade. 5y forward WTI contracts are already trading ~$81 a barrel, so the market is already discounting Schreiber’s expectations for the marginal cost of production. In addition, with spot prices at ~$100, the annualized negative carry of ~$4 a year is fairly punitive. And if you were to try to do the trade at the front of the curve, it would be SIGNIFICANTLY more expensive due to the backwardation. Dec contracts are ~$5 below spot, so on an annualized basis, the short could cost you -10% a year if the curve is unchanged! Schreiber does make a good point about the amount of speculative longs, however. CFTC data shows that managed money longs in WTI are near all time record levels. The problem is that it’s kept making new record levels for some time now. I’m not sure why it is – maybe new regulations are forcing some players to change their declared classification, but it does seem that particular data point is less relevant. Finally, being short WTI here is akin to being short all those geopolitical risks. That may be a fine risk to take, but the market is priced such that one has to PAY to be short those risks. To conclude – Schreiber seems to be betting that WTI prices will fall toward its marginal cost of production sooner than the market – which may work out, but the risk reward seems unattractive given current market prices.

Paul Tudor Jones discusses when to short bonds. Jones presents his topic of choice: “macro manic-depressive trading in a volatility-compressed world.” Jones says life has been tough lately for global macro managers. He says no interest rate volatility also means no volatility in foreign exchange and called for “central bank Viagra.” Jones talks about coming rate hikes in the U.K., U.S., Europe and Japan. “We’re all patiently waiting on these economies to reach escape velocity and central banks to react,” he says. He says Friday was “one of the greatest days I remember in macro trading” because of the market’s reaction to the strong U.S. jobs report. It was “the strongest economic data we have seen in five or six years,” he says. “You had everything you wanted for fixed-income to get killed…And yet at the end of the day, bonds closed up.” “It just goes to show that what’s obvious in macro is obviously wrong,” he says. Jones says his model shows that “nothing is going to be happening in fixed income” for the first seven months of this year. He noted that historically, yields start moving higher about 3 months before the first hike. Given that he thinks the FOMC will hike in July of 2015, he thinks you are not supposed to try shorting fixed income until April 2015.

>>> Hard to disagree with anything there. Shorting negative carry or momentum instruments will always require good timing. Note that applies to equities also.

Notable:

  • RBA : Status Quo
  • AU Trade Balance declined to 731mm vs 1bn exp and 1.3bn prev
  • US Services PMI improved to 58.7 vs 57.8 exp and 57.6 prev
  • JPM guided 2Q FICC trading revenues down 20% YoY. GS: On average, we lower 2Q14 EPS 4% to account for an average yoy FICC trading decline of 12% and equity trading decline of 7%. We also model a prolonged period of FICC pressure given a lack of macro catalysts, and lower our 2015/16 EPS 2%/1% on average. We also revise select price targets.
  • Results of the Fed’s Senior Loan Officer Survey yesterday include:

  • Fitch says peripheral ratings upgrades are possible – Fitch Ratings says some recovery in eurozone periphery sovereign ratings is possible in a benign scenario of economic recovery and declining debt ratios.
  • Europe’s “bad banks” are benefiting from a rush and PE and hedge fund money seeking assets throughout the region; banks are suffering smaller losses on the sale of non-core portfolios and some have even been able to book unexpected profits. ~EU200B worth of funds have been raised to bid on distressed assets being sold by Europe’s banks. FT
  • Russia wants to destabilize the southern and eastern regions of Ukraine with an insurgency. The resulting chaos and de facto civil war will enable Moscow to proclaim Ukraine’s May 25 presidential election as illegitimate – Moscow Times.
  • More Chinese cities are rolling out measures to bolster the local housing market. A number of cities have unveiled steps that ease home purchase rules. “By relaxing the rules, local governments are effectively reversing a near-five-year-old policy of reining in China’s frothy property market” – Reuters/CNBC

Upcoming Data:

  • Tue: NZ Unemployment, Australia Retail Sales, China HSBC Services PMI
  • Wed : UK RICS House price balance, Australia Employment
  • Thu : BoE, ECB, Canada Housing Starts, US Jobless Claims, RBA Minutes
  • Fri : Canada Employment, Brazil Inflation, USDA Ag Report
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One thought on “Recap : Thoughts on Macro Ideas from the Ira Sohn Conference

  1. Nice recap of a few non-consensus calls. As for your 2 cents – you seem to disagreed with all the calls, so might as well spare us that…

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