China Won’t Roll Over Until Liquidity Tightens

China Won’t Roll Over Until Liquidity Tightens

This year on October 18th The Communist Party of China will kick off their 19th National Congress and set the leadership for the next five years.

It’s an extremely fragile time for incumbents. During this Congress a group of party representatives will review a report from President Xi on what has been achieved in the past five years as well as what he believes the party should work on going forward.

If they like what they see, Xi and his administration will stay. If not, then it’s onto the next guy…

President Xi has done well for the Chinese people, at least on the surface. (Nevermind the megaton debt bomb that’s bound to explode at some point.)

He’s been able to somehow navigate the country through the Mundell-Fleming Trilemma without setting off a full blown banking crisis. And he has the positive growth numbers to point to as evidence.

GDP growth has been humming along in the 6-7% range with uncanny consistency.

Chinese GDP Growth

President Xi absolutely loves power and the last thing that he wants is an economic meltdown before this important Congress.

So what can a power hungry politician do to guarantee his seat for the next five years?

Well he can turn on the liquidity taps.

If you’ve been reading Macro Ops for awhile you know that the single most important fundamental to markets is liquidity. Nothing else comes close, which is why the investing legends like Soros, Druck and PTJ kept a close watch on how central bankers and government officials used the liquidity spigot.

In China’s case, Xi has made sure that spigot has been running at full bore going into the end of the year. Year over year loan growth to non-financial companies has been cranked up to near 16% — the highest levels seen in nearly 5 years.

China Y-Y Loan Growth to Non-Fin

All of this extra credit creates a huge wall of demand that creates a bunch of economic activity and elevated prices.

This liquidity injection is the reason why China A-shares have caught a nice rally over the last three-months.

We’ve been on for the ride during the entire breakout because we watch liquidity like a hawk. One of our own Chinese liquidity indicators has been signaling looser liquidity conditions since mid-2016. And right now it’s actually hitting new all time highs!

Liquidity AS

Yes, China has a bunch of long-term debt problems that will inevitably lead to a blow up. But with liquidity conditions this strong it’s suicide to play for the implosion. We need to wait until liquidity tightens up before we see any real financial stress.

And our guess is that won’t be happening until President Xi has secured his presidency for the next 5-years.

If you aren’t monitoring liquidity conditions around the world you’re really missing out on an extremely effective market timing tool.

We check liquidity conditions on a monthly basis in every major market.

Click here if you want to see how we monitor U.S. liquidity.



The Gold Bugs Were Wrong

Operator Tyler here.

The Gold Bugs were way too early on their inflation call.

Ever since the start of QE, countless Austrian economic gold bugs have been warning about a tidal wave of inflation that will debase our hard earned savings. Their fear mongering is what sent gold up to nearly $2,000 an ounce.

Gold Futures

But the inflation never came. The gold bugs were wrong. And anyone who bought into their narrative has had to suffer through a 5-year bear market in gold.

What did the gold bugs overlook that made their prediction so far off the mark?

The labor market.

Economic stimulus can only create inflation if the labor market is tight.

When policy makers try to rev up the economic engine they do so by influencing demand. Tax cuts, QE, rate cuts and government spending are all trying to do the same thing — increase buying power. The more money people have, the more goods and services they can buy.

Now just because there’s more buying power doesn’t mean prices automatically go up. If the economy is recovering from a recession (like it has been since 2008), producers can keep up with this new demand by hiring on a ton of cheap workers. People are willing to work for cheap because they’ll take anything they can get. They just want to be employed. In econo-speak this is what we call a “loose” labor market.

As long as labor remains cheap, inflation stays subdued.

When the economy finally reaches capacity, producers can no longer hire for cheap. Everyone who wants a job already has one. In order for a company to poach an employee from another company they have to offer a ton of money. This is what’s called a “tight” labor market.

Tight labor markets create wage or cost push inflation. Since producers have to pay more for workers they hike their prices to offset the increased costs. These higher prices get passed down to the end buyer creating inflation.

For the last 4-5 years slack in the labor market has counteracted loose Fed policy.

Ever since 2013 all of the potential inflationary impacts of loose Fed policy have been absorbed by the loose labor market. That’s why inflation hasn’t shown up. Instead we got a goldilocks economic environment – modest growth and low inflation.

We’re still in this same modest growth, low inflation environment but with one key difference — the labor market has tightened significantly.

In a tight labor market, the amount of job openings are high, while the unemployment rate is low. This is exactly what we’re seeing now. Total nonfarm job openings are hitting a fresh high.

While unemployment is flirting with its lows.

Unemployment Rate

Companies want employees more than people want jobs. That means employers are going to have to fork over a ton of cash to fill their open slots. Wage hikes means higher prices are right around the corner.

Now’s the time to watch out for the inflation that the gold bugs have been looking for all along.

With a tight labor market, the economy has a much higher chance of overheating and sparking inflation. Serious inflation hasn’t happened for a long time in the U.S. so we have to go all the way back to the 1960’s to see a similar situation.

Back in the early 1960’s JFK took the reins of a sluggish U.S. economy and injected it with a fresh wave of stimulus. These policies worked and the unemployment rate began a nice downtrend — the economy improved.

In 1963 after Kennedy was assassinated LBJ took over. He inherited a true goldilocks economy similar to the one today. Unemployment was in the 4-5% range and inflation never got above 2%.

But instead of letting off the stimulus pedal he stepped on it even harder by pouring money into the Vietnam War effort.

Since the economy was already at full capacity with a tight labor market, all of this extra stimulus began to push prices up dramatically. The inflation rate skyrocketed and remained high for nearly 30 years.

The unemployment and inflation charts from the 1960’s look eerily similar to present day data.

Unemployment is right around that 4-5% level, exactly how it was when LBJ took office.

US Unemployment Rate

And the inflation chart looks similar too.

US Inflation Rate

If the 1960’s data is any useful guide, that means we have soaring inflation right around the corner…

What gives us even more confidence in this analog is that President Trump will have no reservations about keeping his foot firmly on the gas pedal.

Trump ran on job creation. He’s even alluded to the fact that if things do get overheated he’s still going pedal to the metal. He repeatedly talked about getting “tired of winning” while on the campaign trail. Actual quote below:

We’re going to win so much. You’re going to get tired of winning. you’re going to say, ‘Please Mr. President, I have a headache. Please, don’t win so much. This is getting terrible.’ And I’m going to say, ‘No, we have to make America great again.’ You’re gonna say, ‘Please.’ I said, ‘Nope, nope. We’re gonna keep winning.

With that attitude, the last thing he’s going to do is “tighten the fiscal belt”, nominate a bunch of Hawks into the Fed, and risk an economic slowdown.

He’s going to fill the FOMC with doves, cut taxes, and try to push through large government funded infrastructure projects.

All of these will tighten up any remaining slack in the labor market and send unemployment down into the 3s just like in the 60’s.

Trump won’t care about the potential impact of runaway inflation. By the time it really starts to become a problem, he’ll have ended his first term and it will be the next guy’s problem.

Investing in this type of economy requires special attention.

A lot of investors will be caught offsides once inflation starts to rear it’s ugly head. Almost all professional money managers today have little to no experience in managing assets through an inflationary environment. We don’t have much real life experience either. But what we do have is a solid framework for how to invest in inflationary environments.

This framework is called the Investment Clock.

The Four Phases of the Investment Clock

Using the investment clock framework we can see that we are exiting the Recovery phase. The economy has improved, unemployment is low, and life is pretty good for most Americans (or at least much better than what it was in 2009).

But now the macro tide has changed and we’re about to sail directly into the Overheating phase of the economic cycle.

Navigating this cycle isn’t difficult if you have the right tools and you know where to look. In fact, it can be one of the most profitable environments for global macro traders like ourselves.

In last month’s Macro Intelligent Report, sent to our premium subscribers, we laid out in detail where our investment dollars are going. Right now we think oil and gas stocks are primed to pop higher as commodities benefit from the impending inflationary tail wind.

And in next month’s MIR we’ll be discussing in more detail how rising inflation will affect fixed income and agricultural stocks. (Hint: Bonds are the last place you’ll want to be.)

The plan is to initiate some brand new positions at the start of October to take advantage of our view.

To learn more about how inflation affects markets, check out our Trading Handbook here.


  • The gold bugs were wrong in 2012.  
  • Economic stimulus only creates inflation if the labor market is tight.
  • Now that the labor market is tight, there is a high probability of rising inflation in the future.
  • Commodities tend to perform best in this environment.



Archimede's Dollar Smile

Archimede’s Dollar Smile

Give me a place to stand,
and a dollar that’s trending,
and I can move the world
~ Archimedes

Archimedes, the Greek tinkerer, knew of the US dollar’s importance to global macro well over 2200 years ago, decades before Fed Chair Yellen was born. A man ahead of his time.  

If you’re one of the very few who read my work then you know that I refer to the dollar as the world’s fulcrum.

This is no exaggeration. The US dollar is that important to global markets.

The deeper you get into the global macro game the more you realize nearly every trade is a derivative of a long or short dollar position.

Long Brazilian equities? You’re short the dollar.

Long airliners? You’re making a macro call on oil and thus the dollar.

Long volatility? You’ve got an embedded dollar call there.

Short inflation through duration? Then you’re long the dollar.

The dollar is important.

Why is this?

Short answer is the dollar is the world’s reserve currency. It’s what commodities and goods are priced in for global trade, and it’s the dominant global funding currency. The dollar is pervasive and it’s everywhere which is why the Fed swings the biggest stick of them all.

If you can figure out the path of the dollar then you’re starting from an advantaged point in assessing where the other major macro trades are headed.

It’s always my starting point when analyzing any market.

That’s what I’m going to spell out quickly here today. We’re going to run through some basic models for thinking about the dollar and then we’ll jump into the bearish thesis, the bullish thesis, and conclude with where in the argument I sit.

And just to make clear my current biases. Our team at Macro Ops has been short the dollar against AUD, CAD, since June 27th, until this last week when I closed out for profit.

I took these trades with the belief that they were countertrend moves. I was in the cyclical dollar bull camp but was bearish over the intermediate term, with the expectations of a 10% pullback due to technical, sentiment, and macro reasons.

Now that the move has played out, I need to update my view.

Some dollar models.

I’ve shared a more in depth piece on the way I think about FX that you can find here. In it, I hash out Soros’ arrows and the core/periphery model.

Today we’re going to talk about the “dollar smile” concept put forth by Stephen Jen of Morgan Stanley because it’s relevant to our conversation.

The theory is simple. It states that the dollar tends to outperform when the US economy is very strong (on the left side of the smile) or very weak (right side). And it does poorly when the US economy is just muddling through (middle of the smile).

Dollar Model

Why is this?

Well the logic is straightforward.

The US trades at a  “safety premium” relative to other countries.

Some might snarl at that and there’s a lot of gold bugs who think the US government’s debt blowup is imminent. But the reality is that relative to the rest of the world, the US has one of the most dynamic economies, highly liquid markets, (relatively) stable governments, decent rule of law, and again, we’re the world’s reserve currency.

When the US economy is performing well, investing in the US is a no brainer. And since well over 80% of the moves in the FX markets are due to speculative flows, this fact matters.

And when the US economy is very weak, the dollar performs well because it gets a safety bid. Money gets pulled back from overseas to within safer borders.

Most international funding is done in USD dollars. And when volatility increases and markets are perceived as more risky, these dollar loans are called back and Brazilian Reals or whichever, get converted into USD to cover the dollar debt thus putting upward pressure on the dollar.

But when the economy is in the middle of the “smile” and just muddling through, the dollar tends to perform poorly… why?

Well, the primary reason is that mediocre growth and low inflation is bullish for risk assets because it keeps the Fed steady and prevents them from raising rates too quickly.

So a steady Fed keeps interest rates low. These low interest rates suppress volatility and pushes investors further out the risk curve in search of returns. They go overseas to high growth emerging markets to play in their fertile fields.

Low growth and low rates lead to speculative outflows from the US which drive the dollar down relative to where the capital is flowing to.

There’s a reflexive relationship in these FX flows that starts to dominate.

This is because currencies make up the largest pie of the total return picture when investors put money into foreign markets.

So when speculative capital leaves the US because of low rates and slow growth, and then flows into, say, Latin America. It depreciates the dollar while appreciating the Latin American currencies. This drives up the total return of those investments in these EMs which then attracts more speculative flows (ie, reflexivity).

Here’s a short snippet from Soros on the mechanism.

To the extent that exchange rates are dominated by speculative capital transfers, they are purely reflexive: expectations relate to expectations and the prevailing bias can validate itself almost indefinitely… Reflexive processes tend to follow a certain pattern. In the early stages, the trend has to be self-reinforcing, otherwise the process aborts. As the trend extends, it becomes increasingly vulnerable because the fundamentals such as trade and interest payments move against the trend, in accordance with the precepts of classical analysis, and the trend becomes increasingly dependent on the prevailing bias. Eventually a turning point is reached and, in a full-fledged sequence, a self-reinforcing process starts operating in the opposite direction.

This is why currencies tend to trend for long periods of time once they get going. See the seven year USD cycle below.

Dollar History 7-Year Cycles

Strong US growth = outperforming dollar. A very weak US economy = strong US dollar. And a muddling US economy = weak dollar.

I should point out an important point that I’m not sure Stephen Jen mentioned when he introduced this concept. But all of this is relative. We don’t care about the US’s economic growth on an absolute basis. We care about its economic picture relative to that of the rest of the world’s (ROW).

If the US is muddling at sub 2% growth but emerging markets are a dumpster fire, like they were following the GFC just up until this last year, then that’s still dollar bullish.

The idea is that investors have to perceive risk to be low and the reward to be well above the US’s premium, in order for capital to leave our beautiful shores and invest in a Chilean poultry producer.

The chart below shows this dollar smile relationship at work. Blue line shows the US’s growth relative to the rest of the worlds (ROW) and orange line is the USD.

US Growth and the Dollar

It works because if growth in the US is strong relative to the ROW’s then it means that the Fed is likely leading developed markets in raising interest rates. This makes the US real interest rate spread more attractive. And vice versa when the US is performing well below the ROW.

And as Soros said, the “expectations relate to expectations” that drive FX trends far from their “fundamental equilibriums”. This is why we always need to be trying to understand the markets expectations around future relative growth and rates.

Once we understand the embedded expectations we can compare them to the likely outcomes and see if there’s a divergence between the two.

If there is, then we can identify potential catalysts that would reprice these expectations to be more inline with reality. And then we have a trade.

The dollar bull market that began in 2011 was driven by strong relative US growth (seen in the chart above) and the Fed signaling tighter monetary policy relative to its developed market peers.

This created a reflexive loop which kicked off in 2014. Stronger growth and signaling of tighter policy drove the dollar higher along with US equities. This brought in further speculative flows and kicked that reflexive process into gear.

US Vs ROW Relative Equity Momentum

But by 2016 market expectations for US outperformance and tighter relative monetary policy began to exceed likely outcomes.

Long dollar positioning had become crowded and the trend extended.

Europe and emerging markets on the other hand were recovering from very low bases and horrible sentiment, as well as benefitting from improving global economic growth.

This set up a reversion in expectations.

The market began repricing the Fed’s rate path lower while pricing in tighter monetary policies for other DM central banks.

This  caused the huge unwind in the dollar, which is currently the greenback’s worst year on record (chart via Bespoke).

The market is now overweight the eurozone and emerging markets while underweight the US.

And expectations are high for Europe and EMs, while neutral for the US.

Most Favourable Profit Outlook

There have also been signs that DM central banks have been coordinating policy and using forward guidance to move exchange rates, letting FX markets do the heavy lifting for them in their monetary policy goals.

Learning from 14’-15,’ where diverging monetary policy drove the dollar higher and risked pushing the global economy over the edge. Central bankers started managing expectations in order to subdue the dollar while the Fed moves to become the first to begin reducing its balance sheet.

I wrote about this signalling by the Game Masters (the central banks) in a Brief that went out July 24th. For reference, I’ve included the excerpt below.

Basically, Brainard stated how a country with a large existing trade deficit (ie, the US) should choose to tighten its monetary policy in a way that puts the least amount of pressure on its currency (the USD) and its exporting sector.

The opposite is true for a central bank of a large surplus region (ie, Germany/ECB), which should tighten in a way that helps bring its economy into better external balance.

Lael argues that tightening by increasing the policy rate has a bigger impact on the exchange rate than tightening through balance sheet reduction. Therefore, the US should tighten through balance sheet reduction while the ECB should tighten through interest rates. And if the two coordinate, they can reduce the potential for instability (ie, large china yuan deval or a blowout in Italian yields).

Now what’s currently happening in the land of central banks?

The Fed has recently come out as dovish on hiking but signalled it intends to start letting its balance sheet runoff. And other major central banks, like the ECB, have come out surprisingly hawkish, indicating that the beginning of rate normalization is upon us.

I believe this is a large reason the dollar has sold off. Most countries are better off with a slightly weaker USD and tighter local interest rates, than they are with ever diverging rate paths and a strengthening dollar leading to tighter global liquidity.

Everybody is focusing on interest rate spreads and dollar debt — which do matter, just less so at this time —  while failing to factor in the new intentions of central bank coordinated policy. The CBs don’t want a repeat of what a stronger USD did to global markets in 2015. They’ve wised up (a little bit at least).

The price action of DXY definitely seems to be confirming this, finishing near its lows for the week and breaking through a significant line of support. The chart of DXY below is on a weekly basis and I think it falls down to at least its 200-week moving average (the blue line) and likely even a bit further before finding a significant bid.

The last nine months we’ve been in the middle of the dollar smile curve. The US economy has been muddling through while the ROW has rebounded off its lows and DM central banks have played catch up to the Fed.

This is what the bear case for the US dollar is based on, that we’ll continue to stay in the middle of this curve.

Here’s a summation of the thesis from Nomura.

And Mark Dow also summed up the case well, writing:

On balance, a weaker USD. The US shifting to the balance sheet from rates as the front-burner tool, and global CBs ‘catching up’ to the Fed are the major drivers. EUR, AUD, EM all good. The positioning/psychology in the USD doesn’t strike me as too extreme, so USD weakness doesn’t have to be dramatic.

The question that I’m most interested in when looking at the dollar now is: How long is this ROW outperformance and DM central bank catch up likely to last relative to what is already priced into markets?

EM Sovereign Rally

And it’s here’s where I have trouble buying fully into the continuation of the dollar bear thesis.

When looking at credit spreads and EM debt, you can see that risk is increasingly priced out.

That means that the embedded expectations are high.

This tells me there’s an exceedingly narrow path of outcomes that the future needs to meet for this trade to continue to work.

Secondly, and maybe even more importantly, it appears the low growth, low inflation narrative has been fully adopted, not just by the market but also by the Game Masters themselves.

Fed President, Bill Dudley, said this in a speech recently:

While some of this year’s shortfall can be explained by one-off factors, such as the sharp fall in prices for cellular phone service, its persistence suggests that more fundamental structural changes may also be playing a role.  These include the increased ability of prospective buyers to compare prices across different sellers quickly and easily, the shift in retail sales to online channels of distribution from traditional brick-and-mortar stores, and the consequences of these changes on brand loyalty and business pricing power.

A finance friend of mine recently attended an investors conference where the main subject was inflation. And he mentioned that this was the first time, in the many years he’s attended, where the crowd wasn’t expecting higher inflation.

The Low Level Of Inflation

Instead, everyone was talking about how the phillips curve is dead and how technology has brought on a new secular trend of permanent low inflation, with much thanks to Amazon.

This popular narrative is priced into all areas of the market. And it has been somewhat true up until recently.

But I chuckled when I heard this because for the first time in a long time I’m seeing data that says inflationary pressures are building and higher prices are right around the corner. I covered this in our most recent MIR.

The market is pricing in a much lower hiking schedule than the Fed’s already shallow projected path (see chart below). Fed fund futures aren’t pricing another rate hike until June of next year.

Expectations For Fed Tightening

With inflationary pressures building, it seems to me that there’s a large possibility that the market is on the wrong side of the inflation trade. And therefore, is on the wrong side of the dollar and EM trade, as well.

And if we do enter an inflationary environment, do you think Europe will be able to stomach a repricing of rates higher, better than the US?

Count me as skeptical.

Interest Rate Spread and EUR USD

However, there are a few outcomes where the dollar bear case becomes more likely and they’re centered around the Fed.

With the recent and unexpected departure of Fed vice chairman Stanley Fischer, the Trump administration now has five Fed seats it can fill should it choose to replace Janet Yellen.

There’s a lot of speculation that Trump will install loyal puppets and we’ll return to a dollar crushing era similar to that of the Nixon-Burns partnership of the 70’s.

This is possible and I don’t have an edge in predicting who the President will choose, so I’ll have to react to that when the time comes.

But I do have a hunch that we’ve hit bottom in the Trump Presidency and that things are likely to improve from here (at least somewhat).

With the divisive influencers out of his cabinet and former Marine General Kelly now effectively steering the ship, it seems to me that we’re seeing and hearing less from the Commander in Chief, especially on Twitter, which is a good thing.

And with all likelihood of positive economic policies such as tax cuts and infrastructure spending priced out of the market, it seems like an opportune time for some positive surprises to the upside in the US.

Plus, the recent devastation from hurricanes Harvey and Irma are likely to quell infighting within Congress, at least for a little while…

The US appears ripe for a period of positive expectation revisions.

US Dollar and Citi Economic Surprise Index

The way I see things currently, is that for the dollar bear case to continue to play out, a large number of things have to unfold to match the expectations that are priced into markets.

  • Volatility needs to remain low
  • Investors need to remain in risk-on mode
  • Inflation needs to remain low
  • The Fed’s hike path needs to come down to meet the market’s expectations
  • DM central banks need to continue to signal tighter policy ahead
  • The US needs to continue to muddle through while the ROW goes on a tear

All the dollar bull case needs is just for anyone of these things to not happen.

The dollar bear case needs to walk a shaky tightrope to continue to play out while the dollar bullish case can spawn from any number of outcomes.

In addition, when you throw in the Fed’s likely coming balance sheet reduction (likely to start this month) and the Treasury’s cash normalization — which due to the debt ceiling debate being moved to December, now won’t be happening until early next year — you have some large liquidity drains that will begin to open in the coming quarters.

Draining liquidity leads to the repricing of risk. And with risk priced out of current markets (especially credit markets) there’s the likelihood that this repricing will become jet fuel for the dollar.

The good folks at Nordea Markets have covered this more in depth, and you can read about it here.

The longer dated EURUSD basis swaps are beginning to price this in, while the near market is not.

EURUSD Basis Swaps

As of right now, I put the odds in favor of the dollar bull thesis.

I don’t know when this dollar selloff will end. Though positioning and bearish sentiment are reaching extreme levels.

US$ Valuation and Trade Weighted Index

I’ll be patient and wait for higher inflation numbers. Then see how the Fed responds.

I’d also like to see sentiment become more negative on the dollar than it is, but I’m not sure we’ll get that.

I continue to use the late 90’s analog for the macro environment and have found it extremely helpful to understanding the possible outcomes for today. It’s far from perfect but helpful, nonetheless.

So, of course… strong convictions, weakly held.

The trading game is not about forecasting, being right, or showing everybody how smart you are… It’s about making money.

I’ll be quick to rerate my probabilities if new disconfirming evidence comes in, such as inflation falling further or Trump replacing Yellen with Alex Jones.

Until then, pay attention to the dollar smile and look for comparative growth relative to expectations.



Where Oil Prices Are Headed

Oil has been in my “too hard” bucket the last six months. I couldn’t identify any catalyst that could drive it out of its trading range. I mostly expected it to chop around which has turned out to be the case.

But I figured it’s time I revisit oil and see if there’s anything on the horizon that could ignite a tradable trend in the near future. With many US E&Ps selling for what appears on the surface to be cheap, along with the oil and gas servicing industry trading at historically low relative values to the oil price; now seems like a good time to dig in.

To kick things off I’m going to share the framework I use to view the energy market. And we’ll then use that as a guide to understand the current environment.

To begin, I analyze every market from three vantage points. These are:

  1. Macro: This is the big picture supply and demand fundamentals of the market, along with the attributable macro/liquidity factors that drive them.
  2. Sentiment: I want to know what the market is thinking, what the dominant narratives are, and how the players are positioned.  We want a finger on the pulse so we can understand the expectations embedded in price.
  3. Technical: What’s the tape saying? I note areas of support and resistance and where the path of least resistance might lie.  


A useful model for thinking about supply and demand in oil, or any cyclical market, is to view it through the lens of the capital cycle which often moves in lock-step with the debt cycle.

In doing this it’s key to remember that we’re more interested in what the supply and demand picture will look like in the future (ie, 18-24 months down the road). The fundamentals of today are already reflected in price and we always want to be forward looking, but use present day data as an input in our framework.

Using the lens of the capital cycle or investment cycle framework, we’re concerned with how past, present and future investment (CAPEX) is going to affect future supply as well as the macro variables that drive demand.

The chart below from the book Capital Returns illustrates how the capital cycle works — I’ve written more about this process here.

Here’s a note from the hedge fund Bridgewater laying out the various stages of this cycle.

1) In the first phase, a pickup in commodity-intensive growth causes a global surge in demand for commodities to outstrip supply. As demand pushes up against capacity limits, prices rise.

2) In the second phase, high prices caused by the supply and demand imbalance induce large amounts of capital expenditure. As prices rise, margins for commodity producers widen and profits increase. These producers, flush with cash and looking at high prices, invest in profitable opportunities to expand production. There is a massive investment boom. This acts as a support to growth and inflation as capital expenditure accelerates.

3) The third phase is typically marked by a slowdown in commodity demand that occurs when the original growth that sparked the cycle fades and high prices incentivize reductions in demand growth, by encouraging substitution and efforts to improve efficiency. Simultaneously, the investment boom begins to bring new supply online, demand/supply imbalances ease, and prices stabilize. Thus, high prices help set in motion the increase in supply and reduction in demand that eventually lead to the turning of the cycle.

4) In the fourth phase, there is a supply glut. The balance between demand and supply swings sharply in the other direction, as production is much greater than demand. This phase is typically characterized by large price declines.

5) As prices fall, margins for commodity producers are squeezed. And, in the fifth phase, producers respond to low prices by slashing investment and in some cases shutting down production permanently. This decline in supply eventually brings the market back into balance, as the low investment deteriorates capacity, sowing the seeds for the next cycle.

Four of these long-term oil investment cycles have played out over the last century (chart via Bridgewater).

Let’s breakdown the current cycle by stage so we can see where we sit.

Stage one: The current oil investment cycle began in the early 2000s. There were three primary drivers that spawned a pickup “in commodity-intensive growth”. These were (1) the beginning of a cyclical bear market in USD (2) extremely easy monetary policy by the US Fed following the collapse of the US tech bubble which sent capital flowing out of the US and into emerging markets in search of returns and (3) accelerating growth in China that led to booming demand for commodities sparking a reflexive emerging market growth story.

This growth story in the periphery led to a large pickup in demand which pushed up against capacity limits causing oil prices to rise.

Stage two: Rising prices caused by the large supply and demand imbalance meant widening margins and greater profits for producers of oil and gas. Increasing returns on capital attracted new investment into capacity and an investment boom was started. The Fed’s loose monetary policy along with a falling dollar made capital cheap and readily available which led to more borrowing and more investment into future capacity.

All of this investment acted as a short-term boost to demand/growth which further led to rising commodity prices (a reflexive growth story).

Stage three: It began following the GFC in 09.’ This led to a slowdown in commodity demand growth.

The old economic adage, “the cure for high prices is higher prices” applies to this stage.

High oil prices incentivized new technology to lower extraction costs (ie, fracking) as well as lower consumption (ie, greater vehicle fuel efficiency).

This led to the unsustainable situation where we had high oil prices with lots of new supply coming online (from both fracking and conventional sources) while demand growth was falling due to more efficient vehicles and a tepid global economy.

Stage three was extended by large Chinese credit injections into its economy along with massive centrally planned commodity intensive investment projects. At one point, around 2010, China comprised something like 60+% of the worlds annual commodity consumption — which is larger than any share of demand by a single country in history.

Stage four: In 2014 China’s growth began to slow. Also, the Fed began to signal the beginning of the end of its easy monetary policy. This led to diverging expected rate paths between the US and ROW which kicked off a bull market in US dollars. And since oil is priced in USD, a higher dollar means oil becomes more expensive on a relative basis to the rest of the world. This leads to lower demand and is why the two move inversely to one another. At the same time, new production capacity was coming online as the result of investments made years earlier.

A supply glut plus a rising dollar led to the collapse of oil prices in 2014.

Stage five: Falling oil prices led to compressed margins and lower profits for commodity producers. At the same time, tighter US monetary policy and a rising dollar led to tighter liquidity in emerging markets which sent the reflexive growth story into reverse. Oil producers responded to the lower prices and tighter liquidity by reducing costs, cutting investment and shutting down unprofitable production.

This is where we find ourselves now.

Low oil prices have led to draconian level reductions in CAPEX. Remember, lower CAPEX today means lower supply in the future. Take a look at the chart below, showing global CAPEX in oil and gas.

Global oil and gas investment, as a percentage of GDP, has collapsed from a cycle high of 0.9% in 2014 to just 0.4% today.

That means CAPEX into future capacity is now less than half of what it was just a few years ago. This makes it one of the largest capex reductions to global oil and gas capacity in history.

Knowing that, it’s hard to imagine a future (next 1-3 years) where we don’t enter an extremely supply-constrained environment which would send oil prices much higher.

But one of the things that’s delaying this imbalance from showing up in price is US shale producers pumping at a loss and only being kept alive by cheap financing. Read the following from the FT:

As one Oklahoma oil and gas man I know says: “There is still unlimited capital, and as long as that is true, you can grow anything. If the companies had been forced to live within their cash flow, then their production would go down. Then they would have run into a death spiral where nobody would want to invest in them.” The shale companies struggling with sub-$40 or sub-$50 oil prices were also able to live off the excess inventory of drilled-but-uncompleted (DUC) wells that had built up during the boom years.


As our Oklahoman says: “There were thousands of DUCs that had not been taken account of. The companies could just complete and connect those to offset the declines in production from older wells.” Along with the sunk-cost inventory and cheap refinancing, the US E&P companies made real advances in the use of geoscience to find new oil in already-known fields. They also drilled longer lateral holes, and made more effective use of fracking techniques. So productivity went way up in places such as the Permian Basin in Texas.

While fracking has placed a temporary ceiling on oil, it’s only going to last as long as financing remains available (ie, rates low).

But this doesn’t permanently change the longer-term supply and demand picture. Here’s Jeremy Grantham of GMO on why:

After 1999 the costs of finding new oil started to rise very rapidly. By today, in my opinion, the price needed to support the development of new oil reserves has risen to at least $65 a barrel. This rise from $16 (in today’s currency) constitutes a second paradigm shift in oil. Less is found each year in smaller fields and is more difficult and costly to extract.

  • U.S. fracking oil is a small resource, under one and one-half years of global consumption. It will soon run off and show the underlying implacable rising costs of finding ever-diminishing pools of new oil.
  • Existing oil wells deplete faster than they used to because enhanced technologies squeeze more into the early years. Over 5 million barrels a day out of a global total of 95 a year now needs to be replaced every year. Half a new Saudi Arabia!
  • Today’s draconian cutbacks in exploration almost guarantee another sharp price spike in the next two to four years.

Another short-term factor that’s been weighing oil prices down are high levels of inventory which have been papering over the supply gap.

Over the last two years, a steep futures curve incentivized the increase in storage capacity. This is when higher future prices make it profitable to buy oil now and store it to sell at a later date. This steep curve led to a glut in inventories within OECD countries, and with the US nearly maxing out its storage capacity.

But over the last year the curve has started to flatten. This is leading to inventories being drawn down which is bullish for the oil price down the road. You can see the curve/inventory relationship on the chart below showing the WTI 12M futures price over spot, along with the year-over-year change in US inventories ex. SPR.

Another factor that muddies the macro picture is that we’re in the early stages of a major technologically driven secular change with the rise of electric vehicles (EVs). This will eventually have a major impact on the price of oil, the only question is when.

Transportation is by far the largest source of oil demand, comprising over 55% of global consumption with passenger vehicles making up about a quarter of total demand.

Increasing fuel efficiencies and the rise of hybrid and pure EVs spell trouble for high cost oil producers. And there are a number of countries that are trying to accelerate this trend to greener tech through policy and regulation.

For example, the UK and France have formalized plans to ban fossil fuel vehicles over the next two decades.

The US’s CAFE standards are forcing auto makers to produce ever more fuel efficient cars. And China, the largest market for EVs last year, is aiming to be the largest maker of lithium-ion batteries as well as increase the number of hybrids and EVs on its roads from 2M by 2020 up to 7M within a decade.

And while the transition to EVs will eventually remake the energy market — not to mention have cascading and long-term geopolitical impacts — I’m suspicious of the speed at which this secular shift occurs along with its near-term (over next 5 years)  impact on the price of oil.

Currently, EV’s make up a tiny fraction of the total auto market. Just last year there were only 750K EVs sold around the world which is less than 1% of the new-car market and only 0.2% of the total market.

The IEA is forecasting demand for oil to fall by 12% in OECD countries over the next decade. But it’s expected to grow by 19% in non-OECD countries over the same period and where by that time, over 60% of global oil demand will come from these developed markets.

So even though the fuel intensity of global growth is declining, the aggregate level of demand will continue to rise, at least into the foreseeable future.  

So the macro backdrop for oil can be summarized by the following:

  • We’re in the fifth stage of an oil investment cycle (ie, capital cycle)
  • A record amount of global oil and gas investment has been cut over the last three years which is going to lead to a highly supply-constrained environment sometime in the next 1-3 years
  • This phase is being drawn out by low interest rates and cheap financing allowing unproductive producers to stay in business
  • The global credit cycle is also being extended by China’s credit injections which is propping up demand and is likely to continue into its November Congress
  • The short-term supply glut has been exacerbated by a steep curve which led to record high inventories. But over the last year the curve has begun to flatten bringing inventories down with it
  • The rise of EV’s will eventually reshape the energy landscape but that future is still a ways off

As one analyst was quoted in the FT, “The Permian is preventing high prices today, but ensuring high oil prices tomorrow. The low prices are holding back investment in most of the world, and that is storing up a significant problem in meeting demand in the future”


For sentiment I like to track things like speculative positioning in COT, open interest and commercial hedging, fund flows and positioning data, and the futures time spread, along with other more qualitative factors like news flow and popular narratives.

And when looking at sentiment I’m looking for signs of extreme consensus. Instances where it appears there’s dominant narrative adoption and positioning is one-sided. Like Kovner said, we want to look for a “consensus the market is not confirming. I like to know that there are a lot of people who are going to be wrong.”

And right now, I’m not seeing any evidence of extreme or consensus sentiment in the oil market.

There’s some anecdotal evidence of the bearish oil narrative gaining adoption along with some notable longtime energy bulls being forced to close up shop. But these aren’t near the extremes that are indicative of a major trend change.

You can take a look at the COT chart below via FreeCOTData as an example. Specs were extremely bullish at the beginning of the year but have since tapered off to more neutral-bullish positioning.

I can foresee a scenario where oil prices stay low for a good deal longer causing a number of E&Ps to go belly up which would lead to the “Rise of the EVs” or “Death to the Combustion Engine” narrative gaining adoption. The Economist’s most recent cover is an example of this narrative becoming more popular.  


I’ve found the late 90’s analog to be useful for today’s market. There’s a number of similarities (an extended core driven equity and dollar bull market marked by an EM and commodity crisis) as well as many differences (ie, definitely lacking the euphoria of the late 90s amongst other things).

Analogs have no predictive value whatsoever but they’re still useful for getting a sense for what’s possible and what’s happened in the past under similar circumstances. This analog helped us catch the short dollar trade that started a couple months ago.

With that said, the tape is following a similar pattern to its path in the late 90’s, early 2000’s. The chart below shows the oil price in monthly bars.

The way the macro data looks with a short-term supply glut persisting into the near future eventually leading to a large supply deficit in the next 1-3 years, plus the neutral to bullish sentiment and positioning, I would not be surprised to see price action largely mirror that of the early 2000s.

This would mean that oil would continue to chop around in its range. And there’d be a higher probability of it moving lower than higher over the next 6-months.

The potential 18-month H&S topping pattern in crude suggests this scenario may be starting to unfold.

My base case has the US and global markets moving into an illiquid environment around the end of this year/ beginning of next. This will reverse the fall in the dollar and kick off the final leg of the dollar bull market.

A rising dollar will further tighten global liquidity. And it’ll send oil and other commodities lower, with crude falling back to somewhere in the $30-$40bbl range.

During this time credit spreads will widen and financing for unproductive frackers will evaporate.

Sentiment will turn very bearish and adoption of the rise of EVs and other oil bearish narratives will become popular.

This will play out until the bull market in USD ends and a new commodity investment cycle begins.

In short, I don’t believe oil will start a major trend over the next six months and therefore isn’t worth trading at the moment. The fact that it’s been unable to rally out of its range to the upside while the dollar has been shitting the bed suggests the short-term supply glut is still weighing on the market.

And since I believe the recent weakness in the dollar is going to reverse in the coming months, I think the path of least resistance for oil remains lower.

I think in the next 1-2 years, long oil will make for a great trade. This will happen once this capital cycle fully completes and that will be when rates rise, credit spreads widen and financing dries up leading to the last of the unproductive producers to come off line. Then we’ll enter a multi-year severely supply-constrained market which should coincide with the start of a new bear market in the US dollar.

This is currently my base case for oil. It’s just what I view to be the most probable path at this point in time and I’ll be quick to flip my script should some new evidence, like war for example, change the outlook.

To learn more about our investment strategy at Macro Ops, check our Trading Handbook here.



A Corn Soybean Spread Trade

A Corn/Soybean Spread Trade

The following is straight from Operator Jose, a member of the Macro Ops Hub.

The Corn to Soybeans Ratio is very important to American farmers. In normal conditions, it’s a key factor that helps them decide how much Soybeans or Corn they’ll put into the ground. Both crops compete for the same acreage area. I like to think of it like this:

Farmers have a portfolio, but instead of money, they have acreages. There are two assets they can choose to invest in. Either Corn or Soybeans. This key decision is ASSET ALLOCATION. Whether they want more exposure to Corn prices, or prefer holding more Soybean bushels, depends on many factors, but price is a big one.  

Farmers can check, even months prior to the harvest, how much money they’ll receive for every bushel they pull from the ground. This is done by evaluating the relationship between the Corn and Soybean futures that’ll be trading by harvest time.

Here´s the long-term relationship for the front month futures:

Soybean Corn Ratio

The ratio is Soybeans over Corn. Whenever the ratio is over 3, farmers get 3 times more money for every Soybean bushel than Corn. Sometimes the ratio goes crazy due to weather risk and supply imbalances, but in normal conditions it shouldn’t be over 3.

Whenever the ratio is over 3, farmers plant a heck of alot more Soybeans than Corn. And by the laws of supply and demand, this will eventually cause the ratio to go down as Corn becomes scarcer relative to Soybeans.

The best way to play this relationship is through a spread trade. You can use one contract of Soybeans per two contracts of Corn. This means you’ll have 5,000 bushels of soybeans and 10,000 bushels of corn on a notional basis.

If we’re bearish on the Soybean/Corn spread, meaning we think corn prices will rise relative to soybean prices, we’ll need to short one contract of Soybeans, and go long two contracts of Corn. If bullish, meaning we think soybean prices will rise relative to corn prices, we do the opposite — buy one contract of Soybeans and short two contracts of Corn.

Soybean Corn Chart

You’ll notice that this chart is very similar to the previous spreads chart, but the Y-axis is now quoted in points instead of in a ratio. Every point on the Y-axis is worth $50 per the spread trade.

The reason we use a spread instead of playing the commodity straight up is to hedge weather risk. Weather is THE principal risk factor in grain commodities. Weather produces a largely asymmetric effect: while bad weather alone could completely destroy a crop yield, good weather by itself won’t produce a bumper harvest. Good weather is just one factor involved in a successful growing process. By taking the spread we’re strictly betting that Corn futures will do better than Soy futures no matter the other general conditions. Weather risk is partially hedged.

I´m bearish on the Spread. Here are the fundamentals that support my theory:

The chart below shows how the Soybean/Corn ratio went over 3 last year when farmers planted too much Corn relative to Soybeans (Soybeans became scarce and therefore fetched a higher price). Since December the ratio has been falling.

Soybean Corn December Ratio

The ratio didn’t do much in February and March other than consolidate. But at the end of March the USDA released the Prospective Plantings report. This report shows how many acreages farmers intend to commit between Corn and Soybeans. The keyword in this report is “Intention”. Following our portfolio analogy, the farmers are telling you the percentage of their portfolio they’re willing to invest in Corn or Soybeans.

But keep in mind that the grains aren’t in the ground yet. These farmers can change their planting intentions. There’s currently a small portion of Corn being planted right now, but there’s still time to switch acreages in later stages. Farmers aren’t forced to stick to what they reported in the prospective planting report.

On March 31st the report was released showing a decline in Corn acreages of 4% and an increase in Soybean acreages of 7%. Less Corn supply means each kernel is worth more. And more Soybeans means each is worth less. This confirmed my bearish bias on the spread. All that was left was price action to follow.

What do you think the big funds did on the day of the report? They shorted 11,000 contracts of Soybeans… and went long 20,000 contracts of Corn… a big 10,000 spread trade.

Amazing! It was almost like forecasting the future….

Here´s a chart with the Net Contracts position of Managed Money in the Soybean market. Notice the downtrend. They are finally net short!

Net Positions of Managed Money On Soybeans

The spread went from around 230 per bushel to 168 — a 27% move in 7 days. Report day was the biggest red candle of almost 30 points.

November Bean December Corn Spread

I believe there’s still downside potential to this trade. Price has retraced almost completely since the day of the report, and as I said, I don’t think the market has fully discounted a big soybean crop this year. And if you check the long-term historic spread, there’s still downside potential.

I am short the New Crop Spread ZSX17- 2*ZCZ17 (Short 1 November Soybean Future and Long 2 December Corn Futures.) These are the futures at harvest time when the market should be overflowing with Soybeans relative to Corn.

To learn more about how we trade at Macro Ops, click here.



Is The Dollar About To Break

Is The Dollar About To Break?

A couple of my favorite quotes from legendary trader Bruce Kovner are:

What I am really looking for is a consensus the market is not confirming. I like to know that there are a lot of people who are going to be wrong.

As an alternative approach, one of the traders I know does very well in the stock index markets by trying to figure out how the stock market can hurt the most traders. It seems to work for him.

If you can figure out how the majority of the market is positioned and where the most consensus trades are, you can do very well by opportunistically fading the herd. This is playing the player and trading at the second level… a skill that’s vital to long term market survival.

Fading crowded trades is a great strategy, especially recently.

For example, our oil short went against near record long speculative positioning as noted in the COT report. Our long bonds trade went against speculative positioning as well and has been very profitable.

Since markets have lacked volatility and benchmark indices have gone vertical over the last few months, money managers have been desperately chasing and recklessly crowding into trades. This has resulted in a lot of one sided positioning that traders like us can continue to take advantage of.

Looking around global markets there’s one obvious trade that would make a lot of people wrong and hurt the most traders. That trade is the ole’ greenback.

Let’s look at the evidence.

The chart below shows speculators are max long the dollar against broker dealers. This is an extreme reading. When you see COT positioning at this level of divergence, it’s almost always the dealers who win out. The market doesn’t pay a bunch of speculators so easily.

BofA’s monthly Global Fund Manager Survey was released this week. The chart below shows that a large net % of respondents are saying the dollar is overvalued. This survey has a pretty good track record of noting short-term reversal points in the dollar.

It’s been a long time since there was a large and violent forced selloff in the dollar. That means dollar longs have grown complacent and many of them are probably leveraged. When there’s been mostly one way moves in an asset for a few years, it creates a situation where positioning, leverage, and complacent beliefs are like piles of dried, kerosene-soaked kindling. They’re just waiting for a spark.

Take away talk of the border adjusted tax and combine it with other global central banks like the BOE and ECB looking to end their easing cycles, and you have the potential for a ripe and violent reversal… or a dollar bonfire if you will.

Is The Dollar About To Break

USD price action is setting up in what looks like a textbook head and shoulders pattern. We could see a break below the neckline this week.

Now we don’t think this is a major reversal in the dollar here, it’s only short-term. But it’s still very playable.

There are a number of ways to get short the dollar since it directly and indirectly affects the pricing of many other assets (ie, emerging markets, oil, gold etc).

But in order to find the optimal dollar short trade, let’s again look at market positioning — using COT data and the BofA Fund Manager Survey —  to see how other players are long dollars directly or synthetically.

The chart below via shows the 5-year percentiles for Net Speculator positioning. The instruments in red on the right are those that speculators are net short and vice versa for those in green on the left.

ZB, the bond futures contract we’re currently long, is essentially a synthetic dollar short position.

The 10-year yield and USD have moved in lockstep fashion over the last two years. This means that the potential for a dollar selloff looks good for our long bond positioning.  

The next instrument — 6B —  is the British Pound futures contract. Looking at the graph below from the Fund Manager Survey, you can see that respondents are historically net short the euro, pound, and bonds.

Like the dollar, both the euro and the pound have been forming inverse head and shoulders and are close to closing above their necklines.

We took a crack at going long the pound (FXB is the ETF alternative for the pound and FXE is the euro ETF alternative) a few months ago but closed our position for scratch as it failed to carry through. I’m willing to take another stab at it and perhaps the euro as well should we see price break those necklines.

If you’re interested in seeing exactly how we play these coming currency moves, take a trial of the Macro Ops Hub. Hub members get alerts to our exact entries, exits, and position sizes of both our model portfolios. Membership comes with a 60-day money-back guarantee. Check it out for 2 months, and if you don’t get your money’s worth, we’ll return it right away. Click here to learn more.



Optimism and Complacency

A Dovish Hike and a Third Step Before a Stumble?

The following is an excerpt from our weekly Market Brief. If you’re interested in learning more about Market Briefs and the Macro Ops Hub, click here.

The Fed hiked on Wednesday as expected, bringing the Fed Funds rate to a whopping 1%. The market, with its rose colored glasses in full effect, interpreted the hike as dovish.

In reality the meeting was neither overly dovish or hawkish. The Fed stuck to its playbook of hiking rates and muting expectations going forward. Their infamous dots still project two more planned hikes this year and three more the year following.

Nautilus Research published the following chart noting market action following the third rate hike in a tightening cycle.

The “3 steps and a stumble” theory was put forth by late trader and market guru Marty Zweig (he wrote a book worth reading titled Winning on Wall Street). Zweig noticed that the market has a tendency to considerably underperform following the third rate hike in a hiking cycle. Here’s the following from Nautilus.

The SP500 has endured significantly below average results from 1 to 12 months after  3rd rate hikes in 11 events back to 1955.  Note that 6 (more than half) of those hikes occurred within a year of a major cyclical top for stocks (1955, 1965, 1968, 1973, 1980, 1999).  However, the market defied that relationship on the last occurrence in 2004 by rallying for 3 more years… When looking at all hikes – note that hikes are generally bad for stocks, somewhat bad for the US Dollar, and bullish for 10yr yields and commodities.

Yale economics professor Robert Shiller, of CAPE ratio and “Irrational Exuberance” fame, noted the similarities in sentiment between the current market and that of the late tech bubble (an analog we’ve discussed quite a bit).

In a recent Bloomberg article Shiller said, “They’re both revolutionary eras, in the tech boom it was a new era of prosperity brought on by the internet now it’s a ‘Great Leader’ has appeared. The idea is, everything is different.” But no matter how you cut it, Shiller says “The market is way over-priced… It’s not as intellectual as people would think, or as economists would have you believe.”

Going off of the chart below, it’s safe to say we’re transitioning from the greed to euphoria stage. Take a look at magazine covers and article headlines and it’s easy to see that the market is entering a new level of optimism and complacency.

Optimism and Complacency

As we progress further into the latter innings of this cycle, and as expectations become more and more dependent on a narrowly defined and exceedingly optimistic future, it pays to remember the following from the book Ubiquity: Why Catastrophes Happen (bolding is mine):

In this simplified setting of the sandpile, the power law also points to something else: the surprising conclusion that even the greatest of events have no special or exceptional causes. After all, every avalanche large or small starts out the same way, when a single grain falls and makes the pile just slightly too steep at one point. What makes one avalanche much larger than another has nothing to do with its original cause, and nothing to do with some special situation in the pile just before it starts. Rather, it has to do with the perpetually unstable organization of the critical state, which makes it always possible for the next grain to trigger an avalanche of any size.

(Note: There will be eleven(!!) Fed members speaking this week. Who knows what kind of tone they’ll take, but it should make for an interesting week).

The above is an excerpt from our weekly Market Brief. If you’re interested in learning more about Market Briefs and the Macro Ops Hub, click here.



George Soros The Way Ahead Lecture

A Review Of George Soros’ “The Way Ahead” Lecture

The following review is straight from Operator James, a member of the Macro Ops Hub.

With my TV broken for the last several months, and a useless repairman backed by a company going out of business, I’ve had a lot of time to devote to learning and thinking. Recently I realized I need to dig into fundamentals and decided George Soros was the best place to start. Thankfully there’s plenty of his speeches and lectures online (along with a lot of ‘Soros is the devil’ articles and something about him being a Nazi).

Soros’ “The Way Ahead” lecture series from 2010 is very interesting. It covers his theory of reflexivity and how it applies to financial markets. The lecture contains some interesting ideas that have yet to happen, but seem to apply to the near future. You can watch the lecture below. To follow are my quick notes and thoughts on the material presented.

7:00 to 8:00 – Back in 2010 Soros felt the financial crisis was not the end. He expected another crisis within a year or two. Obviously that didn’t happen. But he explains that he didn’t see the recovery from 2009. I’m not saying a crisis is around the corner, but we should never lose sight that one could be.

9:00 to 9:30 – Eventually the US won’t dominate the world as it has in the past. If Soros is right, a new paradigm will emerge. There will likely be many potential opportunities to profit during the shift. As a 13th generation American, I’m saddened by the short-sightedness of our leaders, but a new world order is not the end, but rather an opportunity.

12:00 to 17:50 – Soros discusses the concept of central and periphery currency flows.

20:30 to 21:00 – After talking about global financial regulations needing a force with teeth, Soros mentions how the system is currently constructed to give rise to ‘financial protectionism’ that could disrupt the global markets.

40:40 to End – Soros discusses many points in the last few minutes of the lecture. The overriding theme is: what happens after the dollar rises and puts developing countries in a bind? The world does not seem to trust American leadership anymore and that could spell trouble for US debt and dollar dominance. My intention is not to say that the following will absolutely happen, but rather to game scenarios to see where things may land. Ultimately, how do we profit from these events should they happen? I will try to encapsulate as many points as possible:

  • If the USD continues to advance higher, will the other powers (including China) want to operate under the Bretton Woods arrangement? Soros’ suggests the world should move to an SDR basket as a reserve currency. But could this realistically happen? I doubt the current US administration would be willing to sit down with the Chinese and allow a new world order where the dollar ceases to be the reserve currency. After all, USD reserve currency status provides certain advantages to the US government (e.g. greater debt spending because foreign governments are willing to buy in).
  • Would it be in China’s best interest to join an SDR-like arrangement? With all the poverty still racking their country, I doubt they’d want to give up their manufacturing advantage by becoming the reserve currency. Maybe they think they can do better than the Americans and prevent the hollowing of their rust belt. But of course I should mention that America can still produce a lot. I see it everyday. However, I also happen to know by dealing directly with the Chinese that they’re skeptical of automation (plant automation is my profession).
  • Around 46:50 to 47:00 Soros concedes that if Obama fails to prevent a double-dip, the population could become susceptible to populism. We didn’t have another dip in asset prices, but the folks in the places that voted for Trump didn’t see it that way. Shortly before the election I interviewed an engineer who worked for the steel industry in western PA. He told me he was looking for a job because a lot of plants had shut down and he knew he was next. This is a common story that illustrates that the people that voted for Trump did not care about stock prices.
  • At 48:50 Soros mentions that China will need a more open society if it wants to be considered a developed country. This point makes me wonder whether a crisis will serve to open China up, or makes it more isolated. This is something we’ll have to wait to see.

These are just my own thoughts on the lecture. I would love to hear yours as well. Please feel free to respond in the comment section below. Thanks!  

To learn more about our investment strategy at Macro Ops, that includes wisdom learned from Soros, click here.



SPDR Bloomberg Barclays High Yield Bond ETF

Hawkier Fed, Drowning Oil, and Insiders Jumping Ship

The following is an excerpt from our weekly Market Brief. If you’re interested in learning more about Market Briefs and the Macro Ops Hub, click here.

The Fed is going to hike this Wednesday. They’ve made that clear. But why the complete reversal in tone since their last meeting?

The answer is obviously because of the Fed’s unspoken third mandate — putting caps on bubbles. This is something it’s historically been poor at. But Yellen and team have commented in recent weeks on the market’s seemingly lack of concern over economic and political “uncertainty”.

Charts like the one below are evidence of this:

So the Fed’s gonna hike. But the real question is, do they talk dovish following this week’s hike as has been their modus operandi? Or do they increase their hawkish rhetoric out of fear that the market and expectations are running away from them?

I don’t know, but we’ll find out shortly.

We nailed the breakdown in oil. Our option play in Vol Ops should pay out nicely.

Now we just need to see if oil experiences another v-bottom reversal at its 200-day like it did the last two times, or if the third time’s the charm and she trips off the cliff here.

What happens to oil will have big implications because it’s wagging the tail of credit (see nearly identical chart below). If oil turns lower, then credit will continue lower and we’ll see spreads begin to widen and defaults increase.

SPDR Bloomberg Barclays High Yield Bond ETF

Not to mention what a lower oil price will do to S&P earnings over the coming year. The rebound in oil prices have been a big boon to earnings and revenue growth over the last year. The chart below shows expected forward earnings for the SPX, Energy and SPX ex-energy.

If oil prices roll over from here then expect that blue line to come crashing back down. And the green line showing S&P companies ex-energy doesn’t look a whole lot exciting either.

Indicators are pointing South for the credit cycle. The chart below is a prime example of an end of cycle liquidity suck. Falling liquidity = falling demand = falling growth = asset prices adjusting lower.

The 12-month, 3-month and 1- month change in bank lending (an aggregate of business, consumer, and real estate loans) growth is rolling over and looks like might actually start contracting later in the year.

This liquidity tightening is happening all while sentiment and retail participation is markedly picking up. The chart below shows soft data (dark blue) which is various business and consumer sentiment survey data compared to the hard numbers (light blue) which report actual data on the economic state of our country.

Large divergences between exuberantly optimistic soft data and the actual hard numbers as shown in the chart above don’t have a history of working out well for those giddy individuals.

My call last week for a coming market retrace still stands. The divergence between breadth and credit is still there (has actually widened more). I suspect the market levitates for the next few days and starts selling off into the end of the week.

I’m not calling a top here, just a retrace. The highs haven’t been made on this market yet. It has some more room to run. But expect things to start getting a lot more bumpy…

The above is an excerpt from our weekly Market Brief. If you’re interested in learning more about Market Briefs and the Macro Ops Hub, click here.



Uncertainty Is Good For The Stock Market

Uncertainty Is Good For The Stock Market

The following is an excerpt from our weekly Market Brief. If you’re interested in learning more about Market Briefs and the Macro Ops Hub, click here.

Here’s an interesting question: Is the Trump administration’s erratic policy and governing style bullish or bearish for stocks?

Lately, I’ve read a number of analyst notes talking about how the current political uncertainty spells trouble for the stock market. They all include the line “…if there’s one thing markets don’t like, it’s uncertainty about the future.” I think that’s lame thinking.

I would argue that this “uncertainty” is bullish for equities, at least over the short-term.

I say this because this “uncertainty” is feeding into the Fed’s rake hiking decisions. Remember the hawkish tone coming from Fed members back in December? That seems to have been reversed since Trump took office and started significantly shaking things up. Fed members have cited the uncertainty over future fiscal policy as a key reason to err on the side of caution in raising rates.

FOMC member, Neel Kashkari, wrote a post this week explaining his reasoning for voting to keep rates steady at last month’s meeting. The whole post is worth reading (link here). but here’s Kashkari’s concluding remarks:

We are still coming up somewhat short on our inflation mandate, and we may not have yet reached maximum employment. Inflation expectations remain well-anchored. Monetary policy is currently somewhat accommodative. There don’t appear to be urgent financial stability risks at the moment. There is great uncertainty about the fiscal outlook. The global environment seems to have a fairly typical level of risk (though that can change quickly). From a risk management perspective, we have stronger tools to deal with high inflation than low inflation. Looking at all this together led me to vote to keep rates steady.

Fed President James Bullard, also cited fiscal uncertainty in a speech he gave this week saying “It is unlikely that fiscal uncertainty will be meaningfully resolved by the March meeting… We don’t have to move. We have a lot of fiscal uncertainty. Why not wait until that is more clearly resolved?”

So Trump’s unconventional governing style is creating uncertainty over the future which is making the Fed step back from its rate hiking path. This is supportive of equity prices over the short-term. The breakouts this past week in many of the indexes seem to confirm this.

This creates the unusual situation where a more steady governance and a clearer picture of future fiscal policy would likely lead to faster rate hikes and thus be a net-negative for markets.  

The Fed conducts a Senior Loan Officer (SLO) Report every quarter. In this report they survey roughly 60 large commercial banks and up to 24 large foreign banks with branches in the US. The survey is intended to provide a quarterly update on credit availability and demand as well as developments in lending standards. It’s a good barometer of the overall credit market and provides us useful insight into how the credit cycle is developing. Read more