Some things I think, I think - Post-Brexit edition

- Donald Trump will (continue?) to do better than expected

Yes, in many ways he’s a very flawed candidate and he’s exceptionally unpopular one.  His opportunity lies in Secretary Clinton’s weaknesses as a flawed campaigner with her trust/honesty issues (whether they’re perception or real, is irrelevant) and a popularity level that’s in the Trumpian realm.  They’re literally the most unpopular candidates to run for President – they key for each, might just be avoiding appearing in the press in the final week!  In all likelihood, the favorable demographics and Mr. Trump’s weaknesses should be enough for Secretary Clinton to win, assuming she gets enough of those young voters who stubbornly only turnout to vote for President Obama, to the polls! That said, I wouldn’t expect a majority in the popular vote or much of a mandate despite the claims otherwise. 

- Limits of monetary policy and R*

One of the more thought provoking things that Our Man has read recently is this essay from San Francisco Fed’s John Williams that came out just before the staff of various Central Banks met at Jackson Hole.  In it, he argues the world has changed (and the neutral rate of interest is lower), thus monetary policy needs to change and that monetary policy is not the only answer.  Suggested changes on the monetary policy side include a higher inflation target, or replacing inflation targeting with a flexible price-level or nominal GDP targeting framework.  Both of these suggest a lower-for-longer (maybe forever) since with inflation (and GDP) undershooting existing targets (and thus increasing the distance to future targets) the pressure to increase rates diminishes further.  As for what lower-for-longer/ever means…well, there are some thoughts on that below. 

- People’s QE

It may go by a different name, and under many different guises, but it’s coming to a country near you…soon!   With monetary policy at close to its limits, and rising populist sentiment in numerous countries around the globe, the stage is being set for “People’s QE”.  What does Our Man mean by “People’s QE” – think massive fiscal spending, supported (directly, but possibly indirectly to get around legal issues) by an aggressive Central Bank QE program.   It will be done differently across countries, but the most successful will by those countries that realize “infrastructure spending” in the 21^st century while not yet well defined likely doesn’t mean the same as it did in the post-World War 2 period!   Our Man’s sneaking suspicion is that Britain, with the readymade excuse of Brexit and seeking global competitiveness, will do it best with a mixture of old school infrastructure spending (bridges, roads, etc), new-style infrastructure spending (start with internet/cellular connectivity, but who knows what else, maybe it’s drones, etc), education (especially in very pro-Brexit areas) and healthcare (updating hospitals, from the bricks and mortar to processes/etc). 

- Regulation 

 Despite all the talk in the political realm, Our Man rather suspects that increased scrutiny on Banks and Financials (post-08) was the start of a trend rather than a one-off, and wouldn’t be surprised to see Technology and Healthcare cos next in the regulatory firing line. 

- The market will either be much higher or much lower within the next 12mos

Our Man just can’t tell you which but is pretty sure it ain’t going to hang around here.  The downside case is the clearest with investors able to take their pick of potential issues, including China, slow growth, falling Earnings/high valuations, Europe and the Euro, Brexit, etc.  The upside case is more complicated, but linked to negative rates (and the prospect of negative or low rates for some time).  At a certain level negative rates make sense; it’s an acceptance that we can’t afford our debts, and thus pricing the interest rate at the level at which we can amortize them.  If this is true, and as yields turn negative and assets fall in real terms (with central banks adding money to prevent nominal falls), then the answer is to buy duration, and stocks are exceptionally long duration instruments.  So if you think negative yields are here for the long-haul, you want to be buying stocks…hand over fist.


Portfolio Update 
Our Man’s felt that the market is sitting at the edge of the binary path for a couple of months now, and so he made some changes to the portfolio earlier in the third quarter.  Out have gone all the commodity-related positions (Gold, Silver, and Gold Miners) which have generated exceptional profits year-to-date, but are stretched following their strong runs and vulnerable to dollar-strength.  Into the portfolio have come some (levered) market equity positions, in particular as Our Man’s Technical book saw a tentative buy signal – expect to see more, if the market’s price action suggests much higher highs ahead.  The Currency and International positions remain unchanged, though the Argentinean equities are nearing the end of their (so far successful) investment horizon.  Our Man full expects to sit here, not doing much, and let price determine whether some of these positions are sold or are joined by substantially more equities.

Portfolio Update

This is an unexpected update and due to a sore neck that Our Man claims is from looking at the soaring markets, it shall be a brief one. Somewhat to OM’s surprise, Mrs. OM has decided that he should be in charge of a more substantial part of their LNW and as such has suggested he take over the rest of their assets in the market. Thankfully, such generosity of spirit does not come with a ban on the words such as Japan, bubble, Minsky, credit contraction, deflation and Treasuries that Our Man has a tendency to throw around, and so unfortunately you will not be spared his ludicrous ideas.

As with all things in life, while the move almost doubles the size of the portfolio it also comes with some downside; in this case, it’s that these assets while predominantly in cash also contain a number of securities, some of which cannot be sold at the current time (due to the constraints that Our Man operates under). However, this is but a minor detail and the assets are expected to be co-mingled and the portfolio reshaped to reflect Our Man’s views immediately.

The timing also allows Our Man to use the moment to introduce some of the new ideas that he’s been considering. The most notable of these is by adding some medium-term high quality bond exposure to the portfolio, by adding some risk exposure to the book but by limiting the directionality of the portfolio by adding a substantial exposure to medium-term downside equity protection (through puts).

It goes without saying that the performance and exposures will include these assets, the moment they are co-mingled within the portfolio. As noted, the incoming assets are primarily in cash but also include the following:

- 1 TIPS Bond

As someone who prattles on about deflation, it’s unsurprising that OM will sell it immediately.

- 2 Intermediate Term Bond funds

Our Man expects to sell one (which holds 40% in pass through mortgage securities!), and substantially increase the size of the other Fund (VBIIX), which holds both Treasuries and Corporate bonds and (ironically) was amongst the list of potential bond funds that OM had been looking at.

- 4 Equity positions

These are positions that OM expects to be restricted from adding/removing from the portfolio (or in 1 case the commission would make it pointless to do so). While none of these names fall into the ideas that OM was considering investing, and add directionality to the book, they also make up a relatively small part of the book (OM estimates <4% style="">

- L THRX (OM doesn’t believe that it will be restricted)

However, it is a position that Our Man knows reasonably well, having done a stock pitch on the name just under a year ago while he was a loafing student, and having encouraged Mrs. OM to purchase it when she was considering adding exposure. Ironically, the stock trades today at almost the exact price that Mrs. OM entered the name (read what you will into that, about OM’s stock-picking ability!) and Our Man is secretly quite pleased to be inheriting this name. The sizing is a little large (6.5% of total assets, estimated), but OM is comfortable with the downside given the heavy equity put-hedge that he intends to apply.

Other portfolio moves that will be made, concurrently:

- TLT

So far Our Man’s exposure to long-end Treasuries has been through a specific bond; with the need to add to the Treasuries position in order to take long-end Treasuries back up towards 40% of the book, TLT will be added to the portfolio.

- Put Options (SPY and Financial Firm/ETF)

Our Man is largely constrained in expressing his negative views on things except via options (especially since he has no understanding why people with time horizon >1week would invest in Short/Ultrashort ETFs, and have the magic of simple mathematics working against them)

During December, we’ll look a little more closely at what Our Man suspects and fears could happen in 2010. Suffice to say, that it’s not likely the most bullish of views and this is reflected by a heavy put hedge on the portfolio. Our Man intends to buy Dec-10 options on the SPY, with a couple of different strikes (one close to at the money, one out of the money) and to do so now (rather than later/in the New Year) as he’s somewhat more skeptical of a strong run into year-end (potentially in the face of weakening data) than most.

In addition, there will also be a longer-dated option on a Financial Institution/ETF reflecting the belief that the “Credit Crisis” is in hibernation rather than over, and spread to prime mortgages, Option-ARM recasts (rather than resets) and CRE weakness will raise further issues for financial firms in 2010.

The premium is likely to be 2-3% of the total assets.

- GLD

The Gold position has proved the hardest to decide what to do with; while Our Man would like to add to it (to retain its % of NAV in the book), it seems like it will be somewhat impractical to do so. This a function of the gold price (now $1,170-ish), OM’s desire to run a ‘mental’ stop under the 50%+ of the existing position once it goes through the $1,200-$1,250 barrier, and given the constraints imposed (OM would not be able to trade in it again for at least 1-month). If the last issue wasn’t applicable, Our Man would double the position and continue with his original plan, but given its presence (and the pace at which Gold is moving!) OM is currently leaning (very frustratedly) to forsaking on adding to the GLD position and instead running that mental stop underneath a far smaller part of the resultant position.