Thursday, December 31, 2015

Year in Review

More for my reference than anything else, here's a list of what I think are the most significant events of 2015, in no particular order, on the global scale as well as in my own personal life. I like lists.
    • FX and monetary policy
      • currency regime shifts: Switzerland unpegged its Swiss franc (CHF) from the euro (EUR) and China loosens its Chinese yuan (CNY) peg to the USD - free floating currencies are crucial adjustment mechanisms for economies, especially those with diverging prospects and thus divergent policies. Unless the peg is removed (or relaxed), a strong dollar and weak euro means a strong CNY and weak CHF, which isn't always desirable. Global divergences are wreaking havoc on currency markets and central banks are being forced to react.
      • Fed raises rates for the first time in nine years: this is important as it affects the price of virtually everything. We will see 4 rate increases next year if all goes according to plan, which of course it won't.
    • oil collapse continues: from $53 to $37 per barrel and no one's sure if we've even found a bottom yet. In the medium term (1-3 years from now) oil prices will probably be higher than they are today, but in the meantime, we will see a massive transfer in influence, power and wealth from producers to consumers. This throws another dimension of complexity into the geopolitical uncertainties (below), especially for countries like US, Saudi Arabia (de facto leader of OPEC), Iran and Russia as they wrangle in the Middle East.
    • debt crises in Greece (bailout), Puerto Rico (no bailout), Ukraine (restructuring) - these three events actually have very little in common and their individual significance is quite small. However, they may be the forerunners of bigger fish to come (perhaps Brazil?) as global growth mediocrity persists.
    • civil wars in Syria, Yemen, Ukraine continue: proxy wars for US/EU/Saudi Arabia vs. Russia/Iran. Part of the picture is ethno-religious, but the bigger part is energy security. Much of the current issues are about securing a direct and convenient geographic link between consumers (EU) and producers (Russia and the Middle East). A Russia-Iran alliance could effectively create a gas cartel; however, Syria/Turkey/Ukraine are (in)conveniently geographically positioned between Russia/Iran and their clients in the EU (and thus the rest of the West). Furthermore, Saudi refusal to cut OPEC production has directly hurt Russia/Iran who are dependent on high oil prices. Resource-dependent countries stake their livelihood on economic access to their trade partners and guaranteeing this access sometimes means crossing sovereign borders, with tanks (or drones) if necessary.
    • international terrorism: Al Qaeda's Charlie Hebdo attacks in Paris; ISIS attacks in Beirut and Paris. Now that it is clear that their reach is global rather than merely regional, perhaps we will see a more forceful and coordinated response in the Middle East.
    • domestic terrorism and unrest: Tyrone, Ferguson unrest, Charleston church shooting, Freddie Gray protests in Baltimore, Colorado Springs Planned Parenthood, San Bernardino. Public opinion on racial and gun issues is reaching a breaking point; however, there is probably very little that policy can do. Gun laws that mainly target new guns/owners aren't exactly useful if there are already millions of unregistered untracked guns. Extreme pessimism here is probably warranted.
    • US foreign policy: thawing of relations with Cuba and Iran alongside a cooling of relations with China and Russia. I'm not sure what the strategy is here.
    • formation of trade blocs as a form of regional protectionism: this year we saw the creation of three disparate regional trade alliances: 1) US/Japan's Trans-Pacific Partnership (TPP) vs. 2) China's Asian Infrastructure Investment Bank (AIIB) vs. 3) Russia's Eurasian Economic Union (EEU). Trade and protectionism are increasingly being used for political aims rather than purely economic ones.
    • refugee humanitarian crises: compare responses to Syrian migrants from EU/Germany/Turkey/Saudi Arabia/Canada/US. The tensions between expanding welfare states alongside the opening of borders expose modern liberal hypocrisy. This will be a huge source of friction as lack of coordination pushes costs onto other countries (classic case of externalities). 
    • EU rise of radical populist over mainstream centrist parties: Greece (far-left Syriza), Portugal (anti-austerity Socialists), Spain (rise of far-left Podemos and Catalan separatist parties), UK (Cameron renegotiating EU membership terms), France (far-right Le Pen polling first place for 2017 elections). Increasing skepticism about the viability of the Eurozone and to a lesser extent, the European Union, will persist if these populist nationalist parties continue to be elected. It is hard to convince people to buckle down and work hard towards a common good if your neighbors have a different language/culture and your leaders are constantly emphasizing that fact. Even more importantly, it is fundamentally impossible to have a monetary union without a fiscal union.
    • US rise of radical populist over mainstream centrist candidates: rise of Donald Trump (and to a lesser extent, Bernie Sanders), resignation of John Boehner. It's not just Europe; it turns out that we're having our own brand of ridiculousness on both sides of the aisle.
    • unusual weather: January nor'easter, California drought, Nepalese and Hindu Kush earthquakes, Texas-Oklahoma-Utah floods and tornadoes, strongest hurricane (Patricia) in the Western Hemisphere on record, El Niño - climate change is real. Pretty soon we'll be surfing instead of snowboarding in the Northeast and getting our wine from England instead of France. 
    • science: there's water on Mars. NASA astronaut candidate applications are open - submit yours now. We are almost definitely currently in the midst of an ongoing Holocene mass extinction event - go see the polar bears and pandas at your local zoo asap.
    • signed my first apartment lease: previously, I had only informally sublet from friends
    • went to a lot of breweries, wineries, cideries, meaderies
      • breweries: Threes, Captain Lawrence, Other Half, Long Trail, Drop-In, Otter Creek, Fiddlehead, Magic Hat, Queen City, Zero Gravity, Prohibition Pig, Trapp Family, Napa Smith, Bronx, Allagash, Sly Fox, River Horse, Gun Hill, Vault
      • wineries: Paumanok (eastern LI), Quintessa, Artesa, Saintsbury
      • cideries: Nine Pin, Woodchuck, Woodside (eastern LI)
      • meaderies: Maine Mead Works, Urban Farm Fermentory
    • my first major injury: grade 3 complete tear of my MCL, luckily made a full recovery without surgery thanks to PT. I learned that healthcare advice (like all advice) can differ drastically from practitioner to practitioner. In that sense, they're more like economists than scientists.
    • fitness firsts: sprint triathlon in Staten Island (1/4mi swim, 12mi bike, 5km run in 1:13), NYC century (100mi bike in 12hrs), cyclocross bike race at Sly Fox Brewing, marathon in Honolulu (26.2mi run in 4:32)
    • sports: missed out on indoor soccer, but did kickball (we won our league!), outdoor soccer (scored 2 goals!), participated in the East Coast Spikeball tournament (didn't pass qualifiers, but hopefully will next year)
    • bikecamped to Poughkeepsie (roughly 100mi), camped in Clarence Fahnestock State Park
    • traveling: India (Mumbai, Aurangabad); Amsterdam (albeit only 24hrs); Russia (Moscow, St Petersburg); LA (kayaking/camping in the Channel Islands, my first national park); wedding and wine in Napa; sailing in Baltimore; eating and drinking in Portland (Maine, not Oregon); hiking, roadtrip, surfing, running, paddleboard and scuba in Hawai'i (and hiked Haleakala, my second national park)
One of the most eventful years that I can remember. I can't imagine 2016 (due to reversion to the mean) being more eventful but you never know. Life can surprise you in that way.

Monday, October 5, 2015

some macro pitches

Long Mexico (EWW)

·          It's sold off hugely due to oil (it's an oil producer), but it's overdone since the government fully hedges its oil exposure (rumors are that the gov't sold futures near $100, basically locking in that price for its oil sales for the medium term). This should preserve gov't finances for this year at least.

·          In the long term, as Chinese labor gets richer and therefore costlier, more manufacturing should localize and move to Mexico to take advantage of its cheaper labor force (a MX auto worker cost 20% of his American equivalent) and its infrastructure and trade ties with the US and the rest of the world (Mexico has the most FTA free trade agreements in the world after Israel).

·          Thus it's levered to the strong US recovery, albeit with a lag.

·          Capital inflows and foreign investment are growing, with Mexico privatizing and selling off its oil assets for the first time in decades (auction results have been a bit disappointing however, need to watch this closely).

·          Auto manufacturers have announced plans to start plants in Mexico (including German car co's such as VW, BMW, Mercedes and Japanese car co's like Toyota, Honda, Nissan). This will also be supportive for the currency, which has been a victim of the indiscriminate Latam selloff since oil prices fell late last year.

·          MXN been used a liquidity proxy as one of the most liquid EM FX and has deviated too much from fundamentals. Lower cost of carry vs. other FX like BRL.


Short Brazil (BZF)

·          Perfect storm of several factors: stagflation (recession at the same time as high inflation of 9.5% vs. 4.5% target), too much debt/deficit yet they're at a bureaucratic impasse to pass budgetary austerity measures, no political support and significant political uncertainty, BCB is conflicted and already has very high rates (raising would mean deeper recession but less inflation and stronger currency), BoP deficit and choice of impossible trinity trade-offs means weakening FX, CB FX swap interventions are ineffectual

·          Classic case of Dutch Disease, in which a country's over-reliance on natural resources creates upward pressure on its domestic currency, reducing the attractiveness of the country's exports from other sectors, such as manufacturing. This creates a feedback loop in which non-resource sectors fail to attract investment or jobs, and the country becomes even more reliant on natural resource exports. For the past decade, however, the commodity price boom has hugely beneficial for those who have depended on its high prices for economic prosperity. However, like all good things, the commodity super-cycle has come to an end.

·          Many countries have dealt with Dutch Disease by nationalizing and saving its export revenues, usually through a sovereign wealth fund. This is not something that Latin America has done, however. Unfortunately, much of the wealth from these export surpluses were squandered through gov't handouts rather than investment and infrastructure.

·          The result is textbook reforms: this will be a painful adjustment to better fit reality: they need to be able to provide value-added goods and services and not rely on nat resources. 

·          Political realities are tough: President Dilma might get impeached, FM Levy can't pass a budget, 90% budget is non-discretionary


Long China/Asia (ASHR, GXC, GMF, AAXJ)

·          China is becoming more regionally active. Carrot and stick, China has a lot of carrots. Unlike the US, China is extremely pragmatic and morally agnostic, having no qualms with working with Muslim or authoritarian states if they have something that China wants. Willing to spend and invest huge sums, exceeding US foreign aid.

·          $100bn Asian Infrastructure Investment Bank (AIIB) is China's vision of a "new world order" led by Asia with China on top. This would supersede the post-Bretton Woods status quo of US-led IMF/World Bank/ADB/TPP international financial system. This could channel $20bn/yr of foreign investment into Asia, which would boost GDP, equities and currencies. Prominent proponents include Larry Summers and Hank Paulson have criticized the administration's stance towards AIIB, which many US allies have joined. Bernanke says it's because the US blocked a 2010 IMF agreement to shift 6% of quota/voting rights to EM.

·          CNY is now fairly valued. Bernanke emphasized that AIIB and CNY internationalization is mostly a symbolic and nationalist prestige issue rather than having any large practical economic implications.

·          For example, China-Pakistan Economic Corridor (CPEC): part of the Silk Road. It's a series of 50 projects totalling $46bn to connect Gwadar Port in Balochistan, Pakistan with Xinjiang, China. This creates a new, direct route for China to import oil from the Arabian Sea, bypasses the current much longer and less secure route which requires ships to pass through the Indian Ocean, the Strait of Malacca and the South China Sea, which are all geopolitical hotspots for China.

·          ASEAN-China Free Trade Area (ACFTA) - largest FTA in the world in terms of population (3rd largest in NGDP).

·          China has "FOMO MOMO" momentum driven by fear-of-missing-out sentiment, real estate bubble, difficult transition from I to C, healthy consumer, "middle income trap", costlier labor. On other hand, capital stock per capita is low.

·          Asset prices and specifically, stocks, have implicit support from PBoC. Governor Zhou Xiaochuan said: "most enterprises raising capital through the stock market are real-economy enterprises, and this helps the real economy to develop".

·          China has the 2nd largest stock market cap in the world and half of the 10 biggest companies in the world are now Chinese. This isn't reflected in major indices & benchmarks, so funds are underallocated.

·          Lots of tools: RRR and lending rates are still quite high and have room to fall, inflation is 2 p.p. below target, which gives PBoC further room to ease. $1 trillion (which is 10% of GDP) in fiscal infrastructure spending was accelerated in a fast-track approval process in January.

·          On the other hand, real indicators have been all declining, reflecting an slowdown in GDP growth. This is natural and inevitable. The question is if and how the administration will manage it. Furthermore, the stock market has little correlation with economic growth.


Long India EPI

·          Reformist-minded PM, who made a success story of his region when he was governor, is elected in an inefficient bureacratic developing economy with a huge labor force.

·          Highest growth prospects in the EM world, although GDP numbers are a bit strange.

·          Hawkish UChicago CB head who gives mkts relative confidence (for an EM CB head) about FX, esp since inflation is low.

·          There is lots of low hanging fruit such as land sale reform, GST (general sales tax). States are getting more power to run their own fiscal policies.

·          However, GDP numbers are not credible. Nobody knows how they get them. High 7-8% growth, up from 5% in the old methodology.


Long Eurozone equities (HEDJ)

Short EUR (EUO)

·          Don't fight the Fed -> Don't fight the ECB.

·          ECB QE - low agg new net supply due to low fiscal deficits, low liquidity, low public capital mkts participation (only 35-40% of core EZ debt is held by active managers) are actually a plus, this means that portfolio rebalancing effect will be huge and will force banks to sell bonds and lend to corps and households

·          However, low fiscal debt, deficits and structural reform, monetary union without fiscal union, Juncker Plan, which is the EFSI European Fund for Strategic Investments, has been identified as the ONLY initiative in the EZ where aggregate fiscal stance is concerned. It has largely failed due to national self-interest

·          It's all about the banks. They have stopped deleveraging, but they need to lend to the real private economy: i.e. households and corps. Households are borrowing, corps still are not.

·          Euro project means core gets a weaker currency, peripherals get a lower interest rate. Outcome? Core surplus and peripheral deficits without a regional rebalancing mechanism. This means deflation in periphery to improve competitiveness.

·          Core-peripheral divergence - as long as Germany refuses to run a current account deficit, the rebalancing mechanism will be extremely painful for peripherals. Germany already at potential, UE rate very low

·          Chances of a more open-ended QE is likely: in the last meeting, the bond purchase issuance limit was raised from 25 to 33%, and new language was introduced which says to conduct QE to Sept 2016 "or beyond if necessary". On the other hand, core CPI is solid near 1% and they seem happy with this.


Long Japan (DXJ)
Short JPY (YCS)

·          Three arrows is really just 1 arrow: monetary

·          Chances of further QE has increased - unlikely to hit inflation target, weak wage growth, Tankan inflation expectations declined

·          On the other hand, there's been strong household spending and "core core"(ex-food and ex-energy) inflation

·          BoJ has signaled that they may have to get more "creative" in achieving its inflation target. Interpreted this as more ETF and J-REIT purchases. Kuroda has stated that the scale of their ETF/J-REIT purchases is "extremely small". Since economic growth or inflation has not picked up significantly, the likelihood of this has increased.

·          Don't bet on significant fiscal or structural measures

Monday, September 21, 2015

Michael Pettis notes

I heard Michael Pettis speak last week. Here are my notes:

Key conclusions

·         China - we should applaud a sharper growth slowdown, as this would make non-destructive adjustment more likely

o   Low capital stock/capita relative to DM is not a good argument to justify high investment/GDP

o   Watch for SOE privatization, transfers of wealth to households and centralization of power under President Xi Jinping

o   Low chance of further CNY devaluation


1.       EM countries have had two unique problems

a.       Very low savings rate

b.      Private sector does a very poor job of identifying productive investments

2.       Old solution was to push up savings, keep savings in the banking system, and have gov't direct investments

a.       How do you force up the savings rate?

                                                               i.      S=GDP-C

                                                             ii.      Reduce consumption (C) by reducing household income share of GDP

                                                            iii.      Side note: need to distinguish hhld savings from total savings

                                                           iv.      Hhlds in China spend as much as other countries - Chinese hhld savings aren't abnormally high

                                                             v.      Total savings are high because hhld income share of GDP is low

3.       Brazil's model - raises taxes, use domestic savings to fund investment

4.       East Asia / Japan model - raises implicit not explicit taxes

a.       1st tax - undervalued FX

                                                               i.      Similar to a consumption tax on imports

                                                             ii.      Subsidizes tradable goods sector

                                                            iii.      Reduces growth of hhld income

b.      2nd tax - have wage growth lower than productivity growth

                                                               i.      Lowers ULC

c.       3rd tax - financial repression

                                                               i.      Set bank deposit rates extraordinarily low

                                                             ii.      Huge transfer from net savers to net borrowers (SOEs, local govts, producers of GDP)

5.       Old argument in favor of high investment/GDP: China has very low capital stock per capita and this needs to converge with DM

a.       This is nonsense - the causation is backwards

b.      Countries aren't rich bc of high investment

c.       Countries have high investment bc they're rich

6.       China started misallocating investment in late 1990s

a.       NPV was less than cost of investment

b.      This leads to debt levels rising faster than debt servicing capacity

7.       Now China is trying to increase hhld wealth at expense of gov't

a.       Two ways to do it

                                                               i.      Japanese way: transfer debt from private sector to gov't

                                                             ii.      Hopefully, China transfers assets & wealth from gov't to private sector

b.      Turning point was (ex-)Premier Wen Jiabao's 2007 four "un"s speech: China is unstable, unbalanced, uncoordinated, unsustainable

c.       Rebalancing are rarely successful

                                                               i.      Historically, only successful under democracies (US in 1930s) or highly centralized autocracies (Deng Xiaoping), but countries in the middle of the political spectrum have a lot of trouble

                                                             ii.      Xi Jinping needs to become Deng Xiaoping and centralize power in order to pass reforms

8.       Ideal slowdown would be for growth to decrease by 100-150bps a year until end of decade

a.       Try to control credit growth -> Inv falls, C is maintained -> GDP falls

b.      Japan in 1990-2010: while GDP grew slowly, consumption growth was steady

c.       Problem is that this comes at the cost of vested interests

                                                               i.      Anti-corruption is about destroying vested interests which benefit under current policies

d.      1st group of reforms is to reduce implicit taxes - this has more or less happened

                                                               i.      Wages are growing as quickly as productivity

                                                             ii.      FX is not undervalued as much as before, look at trade weighted CNY not just USDCNY

                                                            iii.      Standard trade theory says deleveraging low growth DM should have surpluses against high growth China

                                                           iv.      Imbalances have peaked and there have been small improvements - consumption share of GDP has risen 2-3% since bottoming in 2011

                                                             v.      Financial repression has been resolved

e.      2nd group of reforms is actual wealth transfer - hasn't happened yet

                                                               i.      Hopefully starts end-2015 or 2016

                                                             ii.      Third plenum reforms are all about transfer wealth to hhld

1.       Hukou residency reforms - this will allow migrants to have educational/social services/welfare, which will make them richer

                                                            iii.      March 2015, Shandong province announced a transfer of SOE shares into their pension fund

1.       Unfortunately, not a very efficient transfer

2.       Depends on credibility of the pension fund, which is low

3.       Downside is that Shandong inhabitants prob don't feel richer and thus spend more

4.       One virtue is that because the gov't controls the pension fund, it doesn't lose control of the SOE

5.       SOE profitability goes to hhld, but not control

9.       China needs to give up on the 7% growth target

a.       Best-case scenario: 2013-2023 avg growth is 3-4%

                                                               i.      The faster they slow, the less likely the chance of a destructive adjustment

                                                             ii.      West needs to stop applauding high growth numbers from China - we should applaud a sharper slowdown

                                                            iii.      You can have any growth you want - e.g. US could easily have 10% growth today through a credit boom but would  lead to very painful adj later

b.      GDP target is for domestic political purposes

                                                               i.      If they relax this, XJP can be confident about reform

                                                             ii.      If privatization speeds up, this is good - watch for developments here

                                                            iii.      Only just started the adj process, iron prices could fall further

                                                           iv.      Need to recognize losses so that they can allocate capital efficiently

c.       Bad case scenario: 7% for 2-3y then debt capacity limits are hit and system collapses

                                                               i.      If gov't backs all debt, then debt won't stop growing

                                                             ii.      Banking crises usually allocate losses to hhld

                                                            iii.      In China, C needs to replace Inv, so hhld can't take losses

d.      More than 50% chance of best-case scenario (non-destructive adj)

10.   Composition of state reserves is secret, may have illiquid assets

a.       However don't worry, China can take many measures

                                                               i.      E.g. stop outflows with capital controls or devalue FX

b.      Gov't monetizes inflows, prints and buys dollars

c.       Now capital acct outflows are larger than current acct inflows

11.   Low chance of further FX devaluation

a.       PBoC is opposed to further FX deval - PBoC not going to quickly liberalize/internationalize the FX

b.      FX deval transfers wealth from hhlds to tradable goods sector - opposite direction of the correct rebalancing

c.       FX deval might increase outflows

d.      FX overshooting occurs when there's lots of external debt - China doesn't have much

e.      China is pouring reserves to prop FX

f.        If outflows continue at high levels, then they need another solution

                                                               i.      Re-peg? Low chance, this would be a huge loss of face

12.   The idea that the offshore CNY rate (CNH) is a pure mkt expectation of where CNY will go is WRONG

a.       SOEs have ways to arb CNH and CNY - the frictional cost is <2%

b.      SOE will no longer misallocate bc IR are high

morning market color

Greece - Syriza won 145/300 seats, more than expected

o   will need to form a coalition, likely with previous partners Independent Greeks (10 seats)

o   Syriza is bound to austerity program and committed to implementation - this outcome removes ST risks

o   in the prev election, bonds sold off on a Syriza win; on the other hand, now it's a relief to get Syriza elected

·         Fed - mkt can deal with good news or bad news, but it hates uncertainty

o   Sept 17 meeting gave less clarity than mkts would like

o   futures pricing in 51% chance of no hike this year

o   13 "dots" looking for hike this year

o   US tsy 2y yield peaked at 80bps, fell to 66-68bps after the Thurs meeting, now back up to 70bps

o   Yellen speaking on Thurs - hopefully schedules a press conference for the October mtg, but unlikely

·         HY correlates better with eqy mkts than EM mkts

·         Credit spreads widening out while eqy mkts are stabilizing/up - are fixed income investors seeing sthg that eqy guys aren't?

·         Q3 earning season starts in the next couple of weeks

o   historical trend has been for expectations decline to during the course of the previous quarter, earnings beats this declined exp

o   ^ this hasn't happened this quarter

·         Volkswagen (VLKAY) - admitted that their cars met emissions standards only during tests and not on the road

o   diesel sales are halted - this is ~one-quarter of US sales

o   potential penalties/fines of billions of dollars

o   shares down 20% overnight

·         DAX is still up +11bps despite VW

·         Alibaba (BABA) - share lockup period on 63% of shares is ending, may lead to ST weakness

·         Data flow is focused on the US this week

o   M: US existing home sales at 10am

o   T: US FHFA house prices

o   W: PMI day (China, EZ, US, Japan)

o   Th: US durable goods, new home sales

o   F: US Q2 GDP 3rd revision, UMich consumer survey

Thursday, September 17, 2015

notes from Ben Bernanke

I had the opportunity to hear from (and even ask some questions to) Ben Bernanke last week at a conference. Here are my notes. My impression is that he would NOT hike right now, but you can decide for yourself:

1.       US is doing pretty well

a.       Heart of the recovery will be will be housing sector - housing recovery is only mid-cycle, will continue to provide gains

b.      US is in a virtuous cycle - increased job creation, higher incomes, low energy prices, better balance sheets due to deleveraging, and more wealth

c.       Hhlds feeling good, decent consumer spending

d.      Domestic economy is firing its cylinders

2.       Biggest puzzle is low inflation and wage growth

3.       Potential growth trend can be decomposed into labor force growth and productivity

a.       On productivity growth, I'm a modest optimist

b.      I would expect this to snap back - things that go down will go up

c.       R&D spend is coming back

d.      Mkts are open, lots of credit availability

e.      Low productivity growth means high job creation and low GDP growth

4.       Fed pays more attention to labor force slack than GDP slack

a.       That's why the Fed is considering hiking despite the output gap

5.       Main risks to US recovery are from abroad

a.       Strong dollar

b.      Weakness in trading partners

c.       I was surprised by the recent mkt reaction to China

                                                               i.      Influence of China on US is indirect and small

                                                             ii.      They're entering the classic middle income trap

                                                            iii.      Hitting the limits of its growth model

d.      China is making gradual, deliberate and careful movement towards mkt and reforms

                                                               i.      Avoid rapid capital flows which are hard to control

                                                             ii.      PBoC is not independent, the admin (XJP & LKQ) will always wins against the PBoC

1.       Gov Zhou is very capable and reform-oriented, but nearing retirement age

                                                            iii.      There's different stories internally about why you want to move to a flexible FX rate

1.       Admin wants to ease monetary policy and to strengthen domestic economy

2.       PBoC, on the other hand, emphasizes reform

e.      China influences the Fed significantly

6.       Financial conditions are now tighter than before; lower eqy prices and higher spreads

a.       This weakens the economic outlook in the Fed staff models

b.      Volatility makes the Fed more cautious than otherwise

                                                               i.      Is the mkt seeing something that we don't understand?

7.       An analogous period to now would be Sept 2013 (see chart below)

a.       After the taper tantrum of May 2013, mkts were expecting taper but we didn't do it

b.      Financial conditions were tighter, mortgage rates risen quite a bit, we believed these conditions were not consistent with tighter MP

c.       We are seeing the same thing now

d.      August 2013 labor figures got revised up as it often does

e.      Tapering in December was the right decision

8.       Timing of the first hike has a lot of informational content despite the small size of the move itself

9.       One aspect of today is that we're at zero

a.       Cost of overshooting and going too soon is higher than otherwise

b.      We'd need to come back to zero and we don't really have any reliable tools at zero

c.       Fiscal policy is off the table

d.      Nobody has ever gotten off of zero - everyone finds themselves back at zero

e.      Take Sweden in 2010-2011  - they raised rates from 0.25%->2%, now they're back at zero!

10.   Look at Stan Fischer's comments at Jackson hole

a.       Ultimately we believe in the Phillips curve and that inflation will come back

b.      Lags in policy, takes some time for ZIRP to work

11.   One of the considerations for MP is financial stability issues

a.       Don't fully understand the linkages with MP

b.      MP is too blunt of a tool - SF Fed study showed that in order for the Fed to pop the 2000s housing bubble, would have had to raise FFR 800bps

12.   Yield curve is forecasting very low future FFR, lower than Fed's forecasts

a.       Risk premiums on long bonds are very low and maybe even negative

                                                               i.      Permanent reasons: less fears of inflation, safe haven demand, portfolio preferences

                                                             ii.      Temp reasons: inflation beta may change, hedge value goes down, global savings glut diminishing (China selling tsys, Europe becoming less of a net saver)

                                                            iii.      Negative risk premiums occur when dangers of deflation/disinflation are high, high hedge value for bonds

                                                           iv.      Higher risk premiums will help mkt forecast converge with the Fed's

b.      If the YC flattens or reverts, this is bad news, I hope this doesn't happen


Mkt action in Sept 2013 (vertical line is the Fed meeting)


White is S&P 500

Orange is TLT, the long bond etf

Yellow is UUP, the bullish USD etf

Friday, May 8, 2015

The 29th Day

About a month ago, I won the Listserve. What do you write when you have the opportunity to send an email to over 20k ppl? Being a corny dork (a cork?), I wrote about exponential growth. Here it is:

---------- Forwarded message ----------
From: Andy <>
Date: Sun, Apr 12, 2015 at 4:01 PM
Subject: [The Listserve] The 29th Day

In ancient India, the inventor of chess showed his game to the King, who was so pleased with the invention, the King announced that he would grant the inventor anything he desired.  The inventor sat in silence thoughtfully, then replied that he merely wanted some rice to feed his family. To determine how much rice he would receive, they would use the chessboard as a counter. The inventor suggested that, for the first square, he would receive one grain of rice, two for the second square, four for the third square, doubling each the amount for each successive square. The inventor would receive all the rice on all the squares of the chessboard. The King laughed at this seemingly modest request and immediately accepted, tasking his treasurer with calculating the entire amount to grant the inventor. Weeks went by without hearing from his treasurer until one day, the King summoned his treasurer and asked why there was such a delay. When the treasurer showed him the total sum exceeded the rice count of his entire kingdom, the King was bankrupted and the inventor became the new King.What was the total amount?


18,446,744,073,709,551,615 or 18 quintillion

This heap of rice would be larger than Mt Everest.

There is a pond with invasive water lilies. The water lily population doubles each day and if left unchecked, will cover the entire pond in 30 days, smothering all other life in the pond. Each day, the caretaker of the pond checks the population, and will only take action to cut the water lily population when they have covered only half the pond.

On what day will the pond be half-covered?


The 29th day. This leaves the pond caretaker only 1 day to save the pond.

Exponential growth, or compounded growth, is a very powerful thing. Positive things like savings, investment, networks and technological innovation can bring incredible improvements to one's life, if allowed to compound without interruption. On the flip side, if left unchecked, dangerous things like inflation, debts, diseases or even dangerous ideologies can sneak up on you so quickly that you won't notice until it's too late.

Don't wait until the 29th day.

Friday, May 1, 2015

Two Perspectives on the BRICs

Here's something I wrote for my company newsletter about my travels:


Over the past two years or so, I've been fortunate enough to travel to each of the BRICs: Brazil, Russia, India and China. This group was identified by economists in the early 2000s as the four countries with the greatest potential to become the largest and most important economies in the future. Here were my experiences (no economic charts of GDP, I promise):

The first thing you notice about a country is what you can tangibly detect with your five senses: see, smell, hear, taste and feel. I will never forget the gilded gold surfaces that seemed to cover everything in St. Petersburg like a glimmering sheen, nor the smells of a Mumbai food market blocks away from the world's densest slum. I remember the rich yet simply seasoned broth of a freshly slaughtered chicken caught in the dusty dirt roads of Anhui, China; my bones rumbled by the beating of the African-origin Olodum drums in a street festival in Salvador's historic Pelourinho district. These things stay with you long after your souvenirs and trinkets collect dust in the attic.

But I am getting ahead of myself. Before you even arrive, you must find a (preferably legal) way into the country. I was lucky enough to visit India just months after their modern electronic visa-on-arrival program was launched: I applied online and received my visa confirmation in 18 hours. On the other hand, getting a Brazilian or Russian visa is an exercise in surreal absurdity, which required what I would describe as bureaucratic near-extortion in the case of the latter (in Brazil's favor, I guess it's not unreasonable for the consulate to close without warning to watch their own World Cup matches). I think I'd rather wait for Godot.

The next thing you notice is how much you take language for granted. Some countries are luckier than others: Brazil, China and Russia have high literacy rates, relatively homogenous populations and standardized languages/dialects. Each language has its own sound and rhythm: from the dancing vowels of Portuguese to the syncopated consonants of Russian to the whining singsong of Mandarin. On the other hand, India is a miniature United Nations within itself: each region has a different religion, ethnicity, cuisine and unrelated language. Ironically, this means that English has become the most popular "bridging" language in India out of all the BRICs, which results in surprising ease for English-speakers to survive in India.

Finally, I have to say something about the people. There are endlessly creative and productive ways that the citizens of the aspiring world powers manifest their skills. Of course, you can observe the results of their labor in incredible megaprojects such as China's high-speed train, which has enabled millions of migrant workers to visit their hometowns on a regular basis; and Brazil-Paraguay's hydroelectric Itaipu Dam on the Iguaçu, which generates more power than the entire country of Paraguay consumes. Yet there is also the simple industriousness of the everyday citizen, which can be found by using Uber to hail a Lada driven by an ordinary Moscow resident as well as the sophisticated leather and plastic-recycling industries operated out of Indian slum-dwellers' homes. Take the brutally efficient subway in Moscow and you will never wait on the platform for more than 3 minutes (which is not something I can say in supposedly fast-paced NYC). Despite the vastly different social and economic development models, the BRICs all depend on its citizens for its resourcefulness, from whom I felt a sense of limitless and immense capability.

What you hear in the Western news about the emerging world is sometimes sensationalist or even frightening. Yes, there's poverty, bureaucratic mismanagement and even wars. However, based off my experiences with the people, I have no doubt in my mind that the BRICs are well on their way to becoming the global powerhouses of the future.


And here is Conrad's thoughts on Brazil:


Each bullet pt is a day

  1. I arrive at Sao Paulo, which is kinda like the NY of Brazil. There were some interesting architecture as well...
  2. I had to do some unforeseen work and stayed in the hotel the whole day... I was literally so busy I had to order room service for a burger at 3pm for lunch. It was actually surprisingly good. Then I go eat Churrasco (all-you-can eat Brazilean bbq) for dinner.
  3. Everyone arrives, we go shopping in Sao Paulo and Chico and I get Havainas slippers (a famous Brazilean brand of slippers?). The Havainas chafe my toes. I experience buyers regret. We take the overnight bus to Rio.
  4. In the morning, Andy almost mistakenly sits on a homeless person sleeping in a tarp while smoking cigars at a beach; then we hike up a 2000m elevation mountain to look at the Jesus statue; at night we learn how to dance samba at a night club
  5. We went biking and I had explosive diarrhea- that was an interesting combo, and the first of my epicly bad biking experiences. We then flew to Fortaleza that night
  6. We stayed in Cumbuco (a 2000 person beach town close to Fortaleza) and learned kitesurfing for 3 days. It was very nice and peaceful, and we had very great learning conditions. We all got epicly tanned and burnt. In the afternoon, we go on a sand buggy ride, sand butt boarding and highlining and take lots of failed selfies because we lack the technical expertise... I manage to do work after all this...
  7. After kite surfing, I stay and eat street food while Andy etc go to explore Fortaleza. I try to get Korean fried chicken and fail. I sleep all day and feel happy.
  8. On the last day of kitesurfing, we manage to get up and surf for ~10-20 meters. We go demolish an all crabs meal and then bus to recife
  9. Recife is where we learn how to mountain bike... from Andy... on urban streets because it was so bumpy... and Andy only teaches us what to do after we have spent 3 hrs dodging NYC-type traffic, cycling on highways and riding through potholes and going up and down huge pavement ledges. We are talking about a 15cm wide by 10cm deep drainage systems. A moat between the car traffic lanes and every single pedestrian pavement that we need to somehow vault across each time... We have totally worked in our Havainas- perfect fits and no more chafing. Unfortunately Chico's Havainas breaks. We also contribute to a bike imbalance between the islands of Recife. We eat Churrasco to replenish our energy.
  10. We go to Porto de Galinhas (a beach 2hr bus ride away) and molest seahorses. I drive a manual sandbuggy. I see somebody wakeboarding with a jetski and I am green with envy.
  11. We go to Olinda (lots of baroque/1600s-1800s buildings that then got burnt down by the dutch). We stumble into a school parent teacher open day. I realize that we are going to have to walk up and down steep hills for 3+hrs to look at churches. I become dejected and gloomy. Then I become delirious. We sit down for a beer and then lunch and have good philosophical discussions about goats. I become happy again. Then we fly to Salvador. We bring beer and also try to mix our own Caipirinha's on the flight and learn that domestic flights in Brazil don't serve/allow alcohol. When we get to Salvador, we eat the most epic hotdogs ever (according to Andy).
  12. We visit a market place, learn Capoeira (dance fighting), and watch epic dance shows about Brazilian gods. We go eat Moqueca stew.
  13. We go to a beach. Tuesday night is the designated party night for our region, so we mix our own Caipirinha's and go watch real life Capoeira and party in the streets. We watch a drum group and join a rave.
  14. The rest... is interesting as well. My phone gets stolen. We almost get robbed. I am traumatized. I miss my flight.

Monday, April 20, 2015

Buy and Forget

For those people who don't want to actively manage their portfolios, I usually recommend VT and ACWV to ppl as passive buy-and-hold core holdings for the stock allocations of their portfolios. These are global stock ETFs, which means that they hold basically all the stocks that are publicly trade-able. The main difference is their weighting methodology.

VT is market-cap weighted. That means the stocks held in it are weighted by the size of the company itself. This is the return of the (dollar-weighted) average investor. It is mathematically impossible to always and consistently beat this benchmark (otherwise, you eventually become the market).

ACWV has a higher allocation to low-risk or low-volatility stocks (here we use risk and volatility interchangeably). The correct way to evaluate the worthiness of an investment is to look at return divided by risk (you should NEVER look at solely the return with no regard for the risk). If an investment B has two-thirds the return of investment A but also two-thirds the risk, then you should be ambivalent between the two investments. However, if investment C has two-thirds the return but one-half the risk of investment A, then you should strictly prefer investment C to investment A.

The theory behind ACWV is that ppl are biased towards buying high risk / high reward stocks and structurally overpay for them. When you bid up the price of an asset, you reduce its potential return. Thus, high risk / high reward stocks have their return reduced below what efficient markets would justify.

Why does this bias exist? There are several theories.
  1. The paradigm described above (our analysis with investments A, B, C) is only true if you have access to risk-free leverage. This is obviously not true in the real world. Due to this leverage constraint, investors who have higher risk tolerance, rather than borrowing 50% to buy a 150% allocation of stocks will instead just buy 100% allocation of 1.5x more volatile stocks.
  2. Another theory is that investors solely look at potential return and do not properly account for potential risk. In this scenario, investors will prefer an investment with 1.5x the return but 2x the risk.
  3. Finally, there is theory that investors have behavioral preference-for-gambling and will pay extra for lottery-like binary outcomes. Regardless of which theory is correct, the empirical data confirms that the low-vol anomaly exists.
Thus I think ACWV should outperform VT on a risk-adjusted basis over the long run. Investors should be careful to adjust their asset allocation to take into account the lower risk of ACWV (e.g. rather than a 60-40 stock-bond allocation, a 70-30 or even 80-20 stock-bond allocation might be more appropriate when using ACWV for the stock allocation).

Tuesday, April 14, 2015

Negative Yield Bonds

In theory, negative yields are impossible. Why would you buy something that pays you back less than what you paid? However, this is exactly what is happening across Europe. Almost a dozen European countries now have bonds with a negative yield. What does that mean and how does that come to exist?


The yield is the return received by a bond investor expressed as a percentage of the purchase price. For the sake of simplicity, assume a bond maturing in x years has no coupon and $100 principal, i.e. the bond gives the investor $100 after x years.

If you pay <$100 for this bond, then you will receive a + yield.
If you pay exactly $100, then you get a 0% yield.
If you pay >$100, then you get a - yield.

In effect, a negative yield means you lend someone MORE than $100 with the expectation of only receiving $100 back.


In theory, this bond should never exist. Why would you ever lend more to someone than s/he will pay back? You can keep the cash under your mattress and get a better yield (of 0%) with zero risk! However, this bond DOES exist, and in fact, it is estimated that there is over $2 TRILLION of negative-yield bonds today. For example a 2 year German "bund" (which is Deutsch for bond) has an almost -0.30% annual yield, so you are effectively losing 30 cents annually for every $100 you invest. In fact, Germany, France, Netherlands, Belgium, Finland, Austria, Switzerland, Sweden and Denmark all have negative-yield 2y bonds.

Here is a list of four reasons that I can think of (which is certainly not exhaustive) to justify this situation:


Banks are required by financial regulation to hold a percentage of their assets as reserves with the central bank (you can think of a CB as a bank for banks). Banks can keep their reserves with the CB either in 1) cash deposits or in 2) gov't bonds. So why not keep it all in cash? In normal times, banks receive some interest on their reserves (IOR), just as you would receive interest in your checking/savings account with your bank. However, here's the catch: now some central banks such as the ECB (European Central Bank), SNB (Swiss National Bank), Sweden's Riksbank and Danish National Bank have negative IOR, which is effectively a fee on cash deposits. To a bank that's being charged to hold cash in their reserve accounts, holding negative-yield bonds instead doesn't look so bad.


If the Eurozone monetary union breaks up, there will be 19 new currencies. Countries with stronger economic and fiscal positions will almost certainly have their new currencies appreciate. For example, in this breakup scenario, German bunds, instead of paying you Euros (EUR) which would no longer exist, would probably pay out in newly created Deutsche Marks (DEM). Since DEM would significantly appreciate against EUR, the negative yield would be more than compensated. This is a popular idea for journalists to write about in the media, but since the chances of this are insignificant and the mechanics of this FX redenomination is uncertain (the contracts on which these bonds are written have no clause on the possibility of redenomination), this has the least explanatory power out of the four theories here. Still, it is worth mentioning and it's a cheap bet to take (you pay 0.30% annually for a 2y bund but you have a chance, albeit low, of making double-digit returns if the Eurozone falls apart).

A similar thing is playing out in Switzerland and Denmark, which are not part of the Eurozone, but have historically maintained currency pegs with EUR. When the SNB removed the Swiss Franc (CHF) peg, it immediately appreciated by 20% against EUR in one day. Investors who believe that Denmark will do the same thing with its Danish Krone (DKK) peg can purchase Danish negative-yield bonds for a similar bet.


If you hold a bond to maturity and there is no default, your total return will be exactly the yield at which you purchased the bond. For a negative yielding bond, this means that you are guaranteed a negative total return by holding to maturity. However, if you sell the bond before maturity, your total return will also be determined by your sale price. If your sale price is higher than your purchase price, you will have a positive total return.

An investor who borrows money to purchase an asset with the expectation to sell at a higher price before maturity was termed by economist Hyman Minsky as a "Ponzi borrower". Due to the inverse price-yield relationship of bonds, this means that Ponzi borrowers who purchase bonds must have the expectation that yields will go down. For negative yielding bonds, that means that Ponzi borrowers are expecting them to become even more negative! This might not be so ridiculous, especially if central banks cut their deposit rates even further into negative territory.

Although buying negative-yield bonds may be foolish, there may be even greater fools who are willing to buy them from you later. Hence, the Greater Fool Theory.


Finally, the central banks themselves are buying these bonds in large size. The ECB has committed to buying over $1.2 trillion of assets over the next 1.5y, most of which will be Eurozone gov't bonds. It is willing to buy bonds with yields as negative as -0.20%. Furthermore, there is little sign that gov'ts will pick up bond issuance in any size, keeping supply very tight, as gov'ts aim for deficit targets mandated by Eurozone treaties. Denmark has actually completely stopped issuing new gov't bonds.


Ponzi schemes end when there are no more new investors willing to pay ever-increasing prices to existing investors. This inevitably happens with all Ponzi schemes. However, when the perpetrator of the scheme controls both supply (through official fiscal constraints on gov't borrowing) and demand (through bank regulatory requirements as well as direct outright purchases by the central bank), the scheme can be perpetuated for much longer than you'd think.