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“You Know Sergio?”

-Smirnoff Ad

You know Janet?  Heavy set, thin lady … dovish, kinda hawkish … super conventional, mostly ZIRP-y …  hyper Bullish, but also a pretty Bearish ... (dehydrated, but super healthy)

Ahh …. the life of a central planner charged with equivocating in all messaging while simultaneously smoothing volatility by providing the market with absolute certainty.   

(If you’ve never seen the Smirnoff ad above, check it out, it’s good)  

If there’s been a voice of non-prevarication in recent years on the policy side, it’s probably been Stanley Fischer – FOMC vice-chair and former head of the Bank of Israel (and not to be forgotten – the 1st central banker to raise rates and pursue policy normalization coming out of the recession)

Here’s my hack theory on Fischer:

You know how when people get old they get to the point a lot faster.  What is lost in tact is made up for in unfettered insight –   a kind of unadulterated, politically quasi-correct truth serum.   Little kids don’t know better, old people do but don’t care anymore. 

While I think Greenspan has probably lost it,  I think Fischer’s entered still-coherent, old-dude, truth serum prime time. 

Consider some of his more recent quotables: 

  • Fischer On Forward Guidance:  "if you give too much forward guidance you do take away flexibility ….we don’t know what we’ll be doing a year from now. It’s a mistake to try and get too precise ….you can’t expect the Fed to spell out what it’s going to do...because it doesn’t know."

 

  • On Fed Forecasting Credibility:  “Year after year we have had to explain why the global growth rate has been lower than predicted.”

 

  • On Patience & Policy Lags:  “We tend to underestimate the lags in receiving information and the lags with which policy decisions affect the economy …. Those lags led me to try to make decisions as early as possible, even if that meant there was more uncertainty about the correctness of the decision.”

 U Know Sergio? - Fed cartoon 04.30.2015

 

Back to the Global Macro Grind...

 

You know Bergoglio? … from Buenos Aires?  … the guy who has all the streets shut down in NYC on Thurs/Fri while we’re trying to get through a stacked schedule of meetings in the papal party zone?

Pope Francis has shouldered the charge of change and evolution at the Vatican.  Raised in Argentina during recurrent LatAM hyperinflations and currency devaluations, the Pontiff could probably also produce some positive P&L in the current Global Macro chop. 

Argentina offers a convenient and relevant case study in interconnected global macro and its derivative impacts, so let’s stick with it:

Argentina Currency Crisis:  In an attempt to quell recurrent hyperinflations, Argentina adopted a formal currency board in 1991 – which means they held a dollar (& gold) against every peso in circulation and stood willing to exchange the two one for one.   The goal of a currency board, in effect, is to import another country’s monetary policy – in this case Argentina wanted to displace the lost credibility of its own central bank by importing the legitimacy of the U.S. central bank and its monetary policy with the goal of re-anchoring inflation expectation.   

The regime was stable and successful for a decade before collapsing spectacularly in late 2001. 

Why?

Brazil (not Argentina).  The flow of impact can be sufficiently captured in the following way: 

Brazil Currency ↓  -->  Argentine Currency (relative to the Real) ↑  -->  Exports to Brazil (largest trading partner) ↓ --> Argentine Growth ↓  --> Argentine Unemployment ↑/Budget Deficits ↑ --> investor angst over Argentine growth/deficit ↑ --> Argentine interest rates↑/ability to tap credit markets ↓/ability to service debt↓ --> currency board abandoned/Peso devalued  --> Argentine Peso ↓

In other words, Brazilian fiscal and monetary policy and the government budget constraint ultimately manifest in the massive devaluation of Argentina’s currency.

What’s the point:

  1. Interconnectedness:  Global Interconnectedness is real, dynamic, and non-linear – when a particular set of circumstances will reach a critical state and catalyze a “phase transition” in an asset class or macroeconomy is not always obvious
  2. Macro Bread Crumbs: The ability to forecast and front-run 2nd and 3rd derivative effects of Growth/Inflation/Policy/Currency phase transitions remains the wellspring of non-consensus macro alpha. 
  3. Re-Runs:  Hmmm … This Brazil slowing, Real currency collapse movie feels familiar.   

Timing markets and front-running major macro inflection is our job – it’s also hard and requires dynamic risk management.   While maximizing macro alpha necessitates an active management strategy - particularly when volatility is percolating - it’s not for everyone. 

Last week, I extolled the merits of The Mom Test and its unique ability to bring clarity to an investment thesis.  Some readers rightly pointed out that while I described the merits of “the test”, I didn’t actually offer an answer to it.

Here’s the laymen, common sense, sleep-fine-at-night, largely passive management frame-up: 

What if I told you:

  1. We are 76 months into the current expansion (the mean & median over the last century are 59-months and 50-months, respectively. Meanwhile, Fischer’s Fed, is forecasting above trend growth through 2018 – implicitly forecasting the longest expansion ever)
  2. Global growth is slowing currently and given global leverage and demographic dynamics, slower for longer will remain the prevailing reality
  3. Policy has proven to be impotent in printing sustainable real growth and the capacity for another large scale and sustained easing and asset purchase campaign is low.
  4. The market is up 186% off the 2009 lows – it’s been a great run, maybe there’s some modest runway left but the expansion is certainly in its twilight. 

Would you:

  1. Raise some cash
  2. Downshift equity beta exposure
  3. Allocate to long-duration fixed income on pull backs
  4. Buy stocks that look like bonds and/or equities with solid free cash flow yields, relative inelastic demand and pricing power – particularly with a fundamental catalyst, negative sentiment and elevated short interest
  5. Or, my Moms answer:  Buy a bigger mattress?

Active management and the pursuit of peak alpha is cool.  So is “sufficiently simple”. 

Bluish, whitish collar …. Long and Short … sophisticated but sufficiently simple. 

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 2.07-2.21% 

SPX 1 

VIX 19.98-26.51
USD 94.41-97.11
Oil (WTI) 43.65-47.82 

Gold 1125-1155

You Know Hedgeye?

Christian B. Drake

U.S. Macro Analyst

U Know Sergio? - z CoD Smirnoff Trade