a global macro investment newsletter by Neil Azous Morning Edition | August 30, 2019 Risk-Adjusted Return Monitor CROSS-ASSET FOREX FIXED INCOME EQUITIES COMMODITIES THEMATIC PAIRS Poland WIG NOK/SEK German-Eur Schatz Poland WIG Palladium EU Long Value EU Cyclicals vs Defensives Saudi Tadawul USD/MYR South Korea 10-Yr Saud Tadawul Wheat None EU Long/Short Momentum * Highlights the largest overnight positive and negative risk-adjusted returns across 160+ market proxies Summary & Views Contents Collection Of Thoughts To Prepare For Post-Holiday Trading Summary & Views Top Observations . Global Fixed Income – German Buxl Remains Key Driver Tracking Portfolio . Can You Spot the Outlier Asset? Economic Data . The 2015 Analogy . US Small Caps – Russell 2000 Index . Trump Owns the Machines…They Just Don’t Realize It Tracking Portfolio Admin – Schedule Tracking Portfolio Twitter @sbstimestamp The next edition of Sight Beyond Sight will be delivered on Tuesday. There will be no Bloomberg MCRO <go> delivery on Monday in observance of the US holiday. Any updates to the tracking portfolio will be sent via Twitter (@sbstimestamp) or Links Bloomberg (MCRO<go>). Subscribe Now! Newsroom View Archive Permissions/Reprints Connect Twitter @neilazous Today’s edition is a collection of thoughts. They are in no order of importance. It has served us well over the years to write down our thoughts or conversations we had this week with risk takers we respect. The views laid out in Wednesday’s edition of Sight Beyond Sight have not changed. Global Fixed Income – German Buxl Remains Key Driver In the August 19th edition of Sight Beyond Sight, we described how the German Buxl had been the primary driver of global fixed income for the past several months. Although German growth, either realized or expected, is at recessionary levels, we believe that the stronger driver of lower yields is supply/demand related, not fundamental. As a reminder, the ECB can only purchase bonds above its deposit rate, which is currently -0.40%. Therefore, unless there is a rule change, the German Buxl is currently the only German bond that the ECB will be able to mechanically purchase in its upcoming QE program. Every other part of the curve is trading below the deposit rate. There is €117bn outstanding of German bonds longer than 20 years. The ECB already owns at least 33% of them and will likely own many more – rivaling the amount that the BOJ owns of the Japanese bond market – after conducting another QE program. Conclusion: The bid-tone in the very long-end of the German curve should remain firm until the ECB releases details of its easing package on September 13th. Also, shorting the long end of US fixed income outright or via a steepener position is ill-advised until then as well. NY Fed President, John Williams, is one of the top three most important voices at the Fed. Williams has made it clear that he has a strong concern regarding US interest rates diverging too far from international ones. Said differently, Williams is afraid of a stronger US dollar. This thought process is labeled the “convergence” trade in global fixed income, and is why the US long bond has followed the Buxl lower in yield. A key example of this “convergence” is the US fixed income market. Despite constructive data on aggregate this summer, the US has experienced its second “bull flattening” in history during an easing cycle. The leaders of this bull flattening were the 10yr and 30yr US Treasury bonds. The only other time this occurred was in 2008 when Lehman Brothers went under. While things are certainly difficult globally, we do not think it is as bad as when the financial system came to a halt in 2008. Regardless, the US bond market feels like a financial crisis because of ECB mechanics. Can You Spot the Outlier Asset? Last Friday, the trade war was escalated by both China and the US. Nothing formally has been walked back, and tariff increases are expected to go into effect this weekend. Last Friday, Dollar-Yuan (USD/CNH) closed at 7.1315. Currently, it is trading at 7.1485. Last Friday, gold (XAU) closed at 1526. Currently, it is trading at 1526. Last Friday, December 2020 Eurodollars (EDZ0) closed at 98.725. Currently, it is trading at 98.715. Last Friday, the 2-10-year US nominal yield curve closed positive. Currently, it is trading at -2.5 bps. Last Friday, SPX closed at 2847. Currently, it is trading at 2945. One of these assets is an outlier. We will give you two guesses which one and the first guess does not count. Rareview Macro LLC | Soundview Plaza, 1266 E. Main Street, Suite 700R, Stamford, CT 06902 Page 2 Copyright © 2019 Rareview Macro LLC. All Rights Reserved. The 2015 Analogy China devalued the yuan in August 2015. The US dollar relative to the yuan (USD/CNH) appreciated 3.56% that month. After a delayed reaction, SPX fell 11% over six days. However, from August 26-28th, SPX bounced 6.39%. On the last day of the month, August 31st, SPX dropped 0.84%. On September 1st, SPX fell 2.96%. This month, USD/CNH appreciated 3.47%, or similar in magnitude to the August 2015 devaluation. This week, SPX has bounced 3.07% (using current pre-market bid in futures). The parallel would be a sell-off today and a larger sell-off on Tuesday. US Small Caps – Russell 2000 Index There is an old saying that the market is most volatile at the top. We attempted to determine if that is true now. The average true daily range (ATR) in the Russell 2000 Index (RTY) this month is 1.39%. RTY has moved more than 1% in either direction on 15 of 21 days, or 71% of the time. The ATR over a rolling 21-day period (i.e., one calendar month) in August has been the fourth-highest this century. The others were in 2000, 2008 and 2011. Currently, the ATR is slightly higher than the periods during the fourth quarter of last year, and the second half of 2015, but approximately the same. Two of these periods – 2000 and 2008 – were during bear markets. The other three – 2011, 2015, and 2018 – coincided with a bear market, but further losses once this condition was reached tended to be about 20% on a peak-to-trough basis, not the more than 40% seen in the other periods. The average peak-trough drawdown for these five periods was 37.84% with a minimum decline of 26.4%. We remain mindful that small caps continue to be the weakest market on an absolute and relative basis despite the benefit lower yields provide to many walking zombies. Rareview Macro LLC | Soundview Plaza, 1266 E. Main Street, Suite 700R, Stamford, CT 06902 Page 3 Copyright © 2019 Rareview Macro LLC. All Rights Reserved. Trump Owns the Machines…They Just Don’t Realize It For the last several years, many founders of firms or CIO’s have complained to us that it is too difficult to beat the machines. The argument is that machines have the input of information already released, and markets are no longer a discounting mechanism, only reactive. We believe it is more acute than that pedestrian view. President Trump has mastered taking advantage of algorithmic trading and key members of his Administration – Navarro and Mnuchin – are learning how it works too. During the Presidential Election, Trump used social media to his advantage better than any opponent. It did not matter what the issue was or what side of the issue Trump came down on. What mattered is that Trump controlled the headlines and took both sides of the issue. The media outlets syndicated him talking out both sides of his mouth continuously, in the process drowning out the truth or anything Hillary Clinton had to say. The same thing is happening now. Here is a good example. “WHITE HOUSE MULLS RICK SCOTT IDEA TO CUT TAXES BY AMOUNT RAISED IN TARIFFS THROUGH U.S.-CHINA TRADE WAR” Investors respond two ways to this headline. We have put those responses in two columns below. The column on the left is for winners. The column on the left is for losers. No Rationalization Rationalization Required There is no rationalization. Traders trade price. If the Rationalization is required. This thought process keeps S&P 500 goes up driven by machines that are reactive, investors underweight or is reasoning to remain short it is prudent to follow their lead. and fight the machines. If the US is going to do a deal, how can the US cut a tax if there are no tariffs or if the tariffs are ratcheted down? Is it because the US now has a balanced budget, and the Federal Government has extra cash lying around? No, the 12-month rolling average of US federal budget deficits is currently running at $80 billion per month. If there is any truth to tax cut? If the answer is yes, is that not further evidence that the Administration is not going to reverse their stance on China soon? Or, is this another acknowledgment by the Administration that Americans will be hurt by tariffs? Here are two other examples this week from President Trump: 1. The President said Chinese officials had called "twice" over the weekend to discuss trade talks with his Administration. He would not say whether he personally spoke with his counterpart Xi Jinping recently, and the Chinese Minister of Commerce twice denied any knowledge of phone calls over the weekend. 2. Trump said US-China trade talks scheduled for Thursday 'at a different level.' Aides denied the weekend comment.