Making “educated” bets on central bank outcomes, economic releases or elections is a hiding to nothing. Repeat after me. “I have no edge”. None of us do when it comes to events that are outside of our control. When it comes to investing, the only things we can influence is our entry and exit points. The entry points are vital because it establishes the framework we have predetermined, the approximate risk versus reward. The exit proves whether we were right or wrong. The rest is broadly out of our control because you cannot influence the markets’ reaction to news. You can make your best estimate of the outcome but that is it. The only certainty is price. Where you get in and where you get out and that can only be determined post the event. Public market investing sounds like an awful business model when I put it like that.

All we can do is look for anticipated asymmetric pay off structures. Given the current polling, I have no clue whether the UK will stay within the Eurozone. I think they should stay but that isn’t relevant. What I suspect is that the risk versus reward of asset markets is heavily skewed in favor of weakness. The SPX is within 2.0% of a one-year high, credit remains tight and carry trades are buoyant. Risk premium being priced into asset markets is not reflecting the level of risk. Sovereign bond markets have adjusted to the growing risk of Brexit and increasing evidence that the US employment outlook and the longest cycle in US history may have peaked but equity and credit markets have not. They will this week.

All year we have advocated that we are stuck in a broad trading range for the USD, stocks and credit. We are back at the top of the trading range for stocks and therefore we are short. Our belief that Brexit risk is not properly priced is something that just reinforces our view. All the headwinds we have spoken of all still exist: weak global growth, poor profitability, ineffective central bank policy, rich US equity valuations, slowing China. Yet when I speak to investors about selling here, the response I get time and time again is that the market is short and we are going to break out. Selling strength and buying weakness must improve your risk v reward. However, the average trader finds this difficult because it requires you to swim against the tide. Short markets can squeeze higher but only fundamental improvements force new price paradigms. This is not one of those times. From where I sit, the outlook for profitability and growth is deteriorating while asset market pricing is asymmetrically skewed the other way. The risk v reward of being short is outstanding. We will add 20% to our short stock position.

My crystal ball cannot predict the outcome of referendums so we will be covering all short risk strategies before the 23rd. By then, I feel that asset markets globally will have adjusted to reflect the potential for a binary Brexit outcome. A recent survey I saw showed that the consensus for the pound if Britain chooses to leave was 1.30 and 1.50 if they stay. So if the outcome is binary, shouldn’t the market reflect this by providing the same symmetrical outlook i.e. 1.40? That is my best guess. Euro will also weaken going into the vote as proxy trades are established. USD strength will be broad based (ex-yen), global stocks, credit, EM and all forms of carry will fall this week.

Fed is a non-event. Expect a repeat of Yellen’s speech in Philadelphia. Besides the FOMC meeting on Wednesday, several other Central Banks will be meeting this week. On Thursday, the Bank of Japan will convene, and later that day the Bank of England and the Swiss National bank. Expect nothing. Furthermore, Mr. Draghi will speak on Friday. Several countries will release CPI numbers this week; the UK on Tuesday, the Eurozone and the US on Wednesday, and Canada on Friday. Beside that data, we will also see Japan monthly Industrial Production on Tuesday, Unemployment numbers from the UK on Wednesday and from Australia on Thursday.

 

Paul Krake
Founder, View from the Peak
IND-X Advisors Limited

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