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Oil rising

The time of electric cars is dawning and the whole International Automobile Fair in Frankfurt was all about electric cars as well as autonomous driving. The demise of the fuel driven car has been discussed and the government are pushing for ever stricter environment standards.

China, United Kingdom are already discussing the end of the combustion and the beginning of the e-automobile era.

At the same time there is different narration. Saudi Arabia is planning the biggest IPO with Aramco coming. Clearly allow oil price would not be a great news for such a high profile IPO.

The oil production in the US is strong reaching nearly highs registered in 2015 and highest level in more than 40 years.

Despite production cuts by the OPEC the global oil production as reported by the Energy Intelligence Group reached the same levels as 2016 and is expected to continue growing in the coming years.

Oil price weekly (WTI future continuous)

CL1 2017-09-27

Source: Bloomberg

The oil price is suddenly and mostly unexpected by the most investors higher. There is very little indication that the consumption increases. The imbalances of the last years appear to be working out slowly particularly as strategic holdings by the governments normalise.

The price development looks very much like the price chart of the emerging markets. It might be difficult to call for USD 80 on oil on fundamental ground or any data that is currently available. Charts like to follow patters and if history is any guide and emerging markets oil may appreciate stronger than most anticipate.

There is little indication why the price of oil is increasing and breaking higher. However, listening to the market is important to see the early signs of change. Oil is currently indicating that it might move higher. The market anticipates fundamental improvement.



Black swan

It has become very fashionable to speak about black swans in the recent years since the now so famous book showed how powerful black swan events can be. Since it has proved very difficult to predict it is not impossible to flag or indicate any real future black swans. Especially the one least expected. Just the probability of event is by definition minuscule.

I tried to refrain from this futile exercise but nonetheless it is very tempting to try and at least flag some events which have the ability to develop into the initial spark which could bring the next big market correction.

Here three ideas which are rather obvious but somehow have been neglected.

German election. The clarity is stated by numerous recent polls that the winner will be CDU/CSU and the second biggest party will be the SPD. However, there is a very little debate about which coalition is the most likely and what market impact it may have. What if CDU/CSU will not find common ground with SPD for a grand coalition? What about SPD, die Linke (the left party) and die Grünen (the green party) will be able to gain 50% of total votes? What about if no coalition will be achievable and a minority government in Germany will need to go through daily grind of politics?

The markets are very complacent about the outcomes.

A week after the German election there is the planed Catalonian Vote of Independence. Spain intends to use all the legal avenues to stop the vote. The avenues are clearly numerous but it may kick-off a continued struggle in Europe about the stability of EU and the future of the EU structure. Poland and Hungary are already a burden which may gain additional support from an independence struggle of Catalonia in Spain.

Markets do not see it as a real issue.

Weather has been hitting the newswires in the recent weeks and month with ever larger issues and financially bigger damages. The recent events are clearly Hurricane Harvey and Irma currently followed by Maria. At the same time the magnitude of earthquakes intensified as well as the occurrence with the latest hitting Mexico City.

Past earthquake may offer some illustration of the events. On September 21, 1999, when a 7.6-magnitude earthquake struck Taiwan, killing almost 2,500 people and causing billions in damage, the stock prices of major U.S. tech companies, including Apple, Dell and Hewlett-Packard, plunged. The industry had become so concentrated that American companies half a world away were paralyzed by the lack of crucial parts.

An earthquake in Asia or California could see this scenario repeated. The markets are not discounting this highly unpredictable event which nonetheless is likely.

Delving into the geopolitical events around Russia and North Korea would add to the list of black swans. The markets have their own way dealing with predictability and fear. Possible the most interesting event was the last launch of a North Korean rocket and the markets did not blink. Markets react only to surprises but the launch was not a real surprise.

Markets are calm waiting for the next surprise.

SPX und VIX 2017-09

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It has been a while since Emerging Markets were the darling of the crowd. There were various names for the various regions, BRICS, Asian Tigers etc as the roaring economies inspired investments. Now most of this is gone. Financial crises broke the case for EM investing and since 2009 emerging markets investing was mired in continued challenges.

Emerging Markets have been generally associated with growth, inflation, investments and strongly expanding population. Additionally, opening of the economies added to the appeal. Not to forget fast growing consumer, new economic structures and price advantages which were supporting the exports to develop countries.

Since 2009 global growth was slow and continuous reason for debate and concern. Inflation turned into deflation as pricing power vanished with growth. Central banks were concentrating on supporting economic growth at any rate. At the same time inflation appeared to be a wishful thinking as it vanished not only in the developed countries but also started to fall dramatically in Emerging Markets in general. The 2% inflation target which appears to be somehow a magical number was the line in the sand for central bankers to fight for. So far illusive.

Emerging Markets shared the same fate as value investing or commodities.

Now the Emerging Markets appear to have found a new life line. Not that there is apparent change in the economic fundamentals. The strength in Emerging Markets equities appear to be seeping through as investors look for new avenues to invest.

Suddenly the commodities appear to be supporting the return of Emerging Markets and inflation expectation begin to rise in the developed markets.

Clearly there is no just one reason for the return of Emerging Markets. Some large markets like Brazil appear to be stabilising and the political and economic environment supports stocks. Energy prices are stable to slowly growing supporting numerous smaller and larger countries like Mexico. China grows as expected between 6% and 7% as the exact number is rather a concept. Finally the local consumer in the EMs did not vanish over the recent years. Countries like India did see continued growth in middle class and the average income. The same happens in all the Asian countries from South Korea to Indonesia.

MSCI Emerging Markets

EM 2017-09

Source: Bloomberg

The self-healing process appear to have been accomplished. The Emerging Markets rallied from the low of 2016 back to the same highs seen in 2012 and 2014. This is now a very pivotal level. Relative performance in comparison to MSCI World in Euro bottomed in late 2016 just after the US presidential election and outperformed the Developed Markets in 2017.

To make the bottoming process perfect Emerging Markets need to rally above the resistance levels created in the years 2010 -2015. This could herald the end game in the 10 years of financial crises. Back to normal.


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VIX indicator

Volatility as investment style and asset class begun a stellar career as and when investors discovered its positive hedging properties against an equity market dislocation during 2008/2009 equity market rout. The popularity grew over the years and new investment styles and strategies where developed.

One of the more successful strategies which attracts investor’s attention and assets, is centred on various ways to short volatility.

As volatility has a profound tendency to return to the mean any bout of higher volatility generally can be used to short the respective volatility index most prominently the VIX in order to profit from mean reversion. At the same time the shape of the forward curve adds to the appeal of the strategy. It is mostly in contango.

Shorting the VIX future was extremely profitable as the following chart shows.

VelocityShares Daily Inverse VIX Short-Term ETN

XIV 2017-08-23

Source: Bloomberg

As the strategy becomes ever more popular there is a growing number of strategies and funds which try to replicate the historical success and collect assets.

This popularity leads clearly to an ever rising short position in the VIX futures of various maturities. The strong short bias is clearly connected with the demise of the corresponding long strategy in the VIX and other volatility strategies. As long strategy in volatility loses so the short strategy wins. The original purpose of hedging against the market event becomes obsolete and the technical curve trading gains.

CFTC CBOE VIX Futures non-commercial net total/futures only

VIX and futures 2017-08-23

Source: Bloomberg

Extremely low volatility has been a continuous feature of the recent equity market advance. It has puzzled investors particularly as the various risk factors multiplied. Stable and gradual central bank policy is deemed to have contributed to the environment of low volatility. The widely cited absence of investment opportunities in the world of low nominal interest rates and the continued investment rush into equities might have supported this tendency.

However very few focus on the possibility that a direct investment in volatility, here VIX, may depress the volatility measure and partially decouple it from the equity market development. The more investors short the futures the more they depress the volatility. This may clearly impair the ability of volatility measures to continue its well documented ability to indicate and/or warn against any market related stress.


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The verbal war between North Korea and USA moved into a new phase last week. The usual reaction to political and economic stress is to look for safe haven which could protect from any financial fallout. Traditionally Swiss Franc and Japanese Yen alongside the German government bonds offered this safety. Just wait a moment! Japanese Yen?

The Korean peninsula is only 300 Miles from Japan and US forces are located in Japan. Thus Japan could become a prime target for any military intervention from North Korea. This somehow makes it difficult to understand how Japanese Yen could suddenly be the safe haven currency like in the past.

Nonetheless markets follow usual patterns and the patters are like habits. They die hard. Despite changed geopolitical situation and the resulting tension just couple of mile away from Japan it is still seen as safe.

The new player in the safe haven game appears to be the crypto currencies. Especially Bitcoin. As the tension intensified so the price of bitcoin increased. After the July correction the Bitcoin in US-Dollars surged to new highs. Especially the last week it rallied strongly as allegedly Korean, Chinese and Japanese investors turned to digital currencies for safety. This appears to be logical. The currency can be transferred globally on the flick of the finger and it is replicated/stored on countless machines globally. It makes the currency utterly independent form a single country, regional tension or global turmoil.

Bitcoin in USD

Bitcoin 2017-08-14

Source: Bloomberg

The independent set-up as well as the global reach make the crypto currencies an ideal instrument to store value in difficult time. Obviously such developments and trends would enshrine the crypto currencies as long-term reliable store of value. If the really can live up to this expectations may be seen if and when a real crises hits. However in the meantime there is rising conviction and acceptance. All that is needed to create and maintain a fundamental value for such virtual currencies.


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It has been a great libertarian idea that Bitcoin could be established as independent currency which could be used globally outside of the central banks’ systems and governmental control. It had all the flows from the start which clearly made Bitcoin unacceptable for global transactions.

Bitcoin had unintended consequence. It begun a new quest by banks, independent fintech companies, governments and above all central banks. The idea is simple. The technology behind Bitcon, blockchain, can be used for a government and central bank controlled crypto currency.


This idea and the dawn of crypto currencies do have the ability to reshape the world not even envisioned by George Orwell or the creators of sci-fi films. The crypto currencies based on blockchain technology could permit the governments and central bankers to exert a full control over all financial transaction and money movements.

This idea is further promoted by the current discussion if physical money, notes and coins, have to be phased out. Electronic payments and finally crypto currencies would take their place. The formal discussion targets criminals and makes people believe that once physical money is gone, crime can be controlled and combated more efficiently. At the current moment the criminals are even able to trick central banks to transfer money to illegitimate accounts.


Anyone who bothers to look at the current credit card fraud, electronic money transfer fraud and direct successful cyber-attacks on banks will realise that crime is part of the cyber age and that criminals have discovered more than one way to thrive in the cyber world. This means that removing physical money would not really impact the criminals.

Control can be exerted with crypto currency. Investors and ordinary tax payers will become fully transparent allowing insight into the behavioural side. Every payment can be verified and followed. The total control over the tax payers freedom will be possible.

The ultimate idea is to create a system which can survive without boom-and-bust cycles. The utopian phantasy depicts financial world with no crises and full macro and micro control of the financial systems.

Banking system as we know it today will stop to exist. Commercial banks will not be necessary to process payments. Accounts could be held directly with the central banks. Investments could be facilitated directly from central bank account via digital connection between two parties without the need for one or numerous intermediaries.


Let us follow this utopian idea till the logical end. Brokers could become obsolete as the electronic platforms based on blockchain could verify the owner of the assets and the purchaser. The transaction would be secure and virtually free of charge. Banks and credit card operations could be largely phased out. The software based on central bank account keeping could easily transact the volumes of payments.

Our financial system would change for ever. Financial sector will do anything to survive and thrive in this environment. Thus not all the efficiencies of the blockchain technology and the crypto currency will come to fruition.



Fed against markets

Now the equity and bond markets are very content in predicting economic demise and the next downturn. Some strategists are very eager to predict an even bigger demise in equities. Some Like RBS are saying sell all equities and hide. The only place to hide could be gold or bonds as properties are already highly priced globally.

Bank of America believes that we are already in recession


Bonds are not really an alternative investment. European yield curve is mostly in negative territory with Japan finally following the European example and falling below zero along the yield curve. Here investor is basically guaranteed to lose money when invested.

Federal Reserve employs enough economists and researcher to publish an incredible wealth of economic papers. It even publishes its own GDP approximation to see if the recession already arrived. The Wall Street claims this is all to no avail as the Federal Reserve appears to miss what the financial markets already know. The recession is here.

GDPNow calculates quarterly GDP basically life and appears to be well correlated with the quarterly GDP number published. Following the latest release it appears that the economy is well and GDP even rising toward 2.5% growth in the current quarter.


If the Fed is wrong a real restructuring of the Fed would be necessary as it is already demanded by some market participants. If the Fed is right and the market wrong the reorganisation of the markets would be the consequence. We shall fallow the upcoming publications on the outcome of the tug of war.

Now there is some more attention as some strategist recognise that there is something amiss.


Markets after all may not always be right. They are prone to numerous behavioural traits which may now come to hunt them.


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Chinese economy talking

There is continued barrage of news and information why this market needs to go down and that it is at risk from China economic slowdown. China is the culprit which is commonly understood to be over-debted and heading for a major economic disaster.

History is a good guide to ponder. In 1990 Japan collapsed and is mired in economic challenges since. The Fed funds were at 9.75% and inflation above 5%. US exports to Japan in 1990 were 0.8% of GDP. Today exports to China re around 0.7% of GDP. China’s economy has relatively the same size compared to global economy as Japan back in 1990. The size will change as chine continues its devaluation policy.

China is clearly in a transition. A very swift transition and a transition which possibly has not been experienced by any other country in this magnitude and speed ever before. Industrialisation and industrial production are approaching saturation. The growth levels need to slow down.

Now is the time of the consumer. This is a time when services will gain economic importance and industrial production will lose relative value.

Transition is not easy and transition is mired in traps and trepidations. It is never smooth and it need to be understood and accepted.

At the moment investors are having issues with the current transformation. China was and is the production hub for the world. We all get used to view China as a fast growing economy based on industrial production feeding the world all the cheap goods which the consumer in the industrialised countries long for. From Apple phones to clothing.

Now China changes to the global consumer. Chines cities are populated by millions of consumers who now turn their attention to electronics, better food, healthier living and entertainment.

This clearly changes the economic dynamics of the country and will do so for years to come. The following chart shows major changes. Investor are worried about the slow-down in manufacturing (black line in the graph). At the same time PMI services (red line) are very strong and positive. Today the new published number shows a 6 months high.


Caixin China Manufacturing and Services PMI

China PMI 2016-02

Source: Bloomberg

This graph shows clearly the divergence between the perceptions of industry focused China and the reality. Services are winning ever bigger share of the economy and appear to me grossly underestimated by the global Investors.


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On the first days of the year it is an interesting exercise to look into the murky crystal ball and try to figure out what could go wrong in the coming 12 months. Following I will attempt to single out couple of low probability events which none the less have a great impact on the markets.

Surly not many investors did expect that the year 2015 will be the year of central banks which surprised us too many times. But will 2016 also be a year when central banks will surprise us positively but hopefully not negatively. Surly central banks will remain in the spot light.

  1. Federal Reserve could reverse the interest rates increase which it fought for nearly a year to advertise and implemented finally in December.
  2. ECB will be forced to increase its efforts to fight inflation as weak Euro and QE did not make it happen. Not to mention if Euro should strengthen.
  3. The last 2 years were greatly impacted by falling oil prices. Despite strong expectation that the global economy will follow soon, very little happened. The falling oil prices were not driven by exceptionally weak demand but by exceptionally high supply. The balance between supply and demand in 2016 could shift gradually leading to higher energy prices. Oil could rebound back toward 60 USD.
  4. Current rising tension in Middle East have been largely neglected as economic influence. There has been a general consensus that tension in this region could potentially lead to higher energy prices. An open conflict between Saudi Arabia and Iran could actually lead to higher prices. This would additionally support the scenario 3. On the other hand defence spending globally could lead to government spending beyond expectations. Government spending in Europe increases dramatically as European countries try to cope with security issues ranging from terror threats to refugee crises.
  5. Security issues, Middle East and refugee crises are a leading political subjects in the upcoming US election. A surprising outcome could see Mr. Trump winning the election which would impact US and global developments well beyond the 2016.
  6. Many of those developments would have a profound impact on the global currencies. Investors are focused at US-Dollar strength. This could however be the great surprise if US-Dollar weakens toward 1.20 or 1.30 against Euro
  7. Looking for particular spot on interest rates surprises. Negative interest rates are not a surprise any longer. The only surprise could come from other countries like Japan or US. Japan continues to print money and QE has been intensified with the new announcement in December 2015. If Federal Reserve would need to lower rates during 2016 a new scenario could materialise which would drive rates especially on the short-end of the duration toward zero or even into the negative territory.
  8. Finally equity markets could return very positive performance for 2016 in. Not easy to see but a confluent of events could bring what investors do not expect. Most expectations are focusing on weak commodities, strong USD, no inflation, central banks running out of bullets, China economy slowing down or even imploding, high yields seen as harbinger of disaster upon all the commodity sector. All those worries remain and impact the financial markets currently. If those worries do not materialise equities will receive the much needed breathing space.

It will be a very interesting year 2016 and in December I shall review all those possible surprises.


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Unexpected events change often the fate of the world and financial markets. Investors’ expectations are currently even stronger anchored then before. Especially central banks do have the tendency to move markets. Either by design or chance.

The recent ECB decision might have been one of the occasions where a well laid out path had to be altered. The alteration had some short-term unintended consequences. The long term consequences are more predictable.

The simple alteration make the predictability of the outcome even more perilous as the anchored expectations have been directly impacted. The unhinging of expectations had a very violent and profound impact on the financial markets.

ECB continues to print money as before. The QE continues and was even extended till March 2017 with a possibility of further extension. This was the good news. The market expected more. A bit like addict who needs a new impulse to take him to a new level.

Now even lower rates are a bit in doubt. The Swiss experience may not be realised after all. The inflation is not here to be seen but economic dynamics are improving. Even credit action in the European Union is picking up. Over all some more QE paired with better fundaments are not a bad combination.

However, the subsequent market reaction did change – at least in the short-term – the general picture treasured by so many Investors altered. Weak Euro, weak energy and by definition also weak commodities leading to a weaker Emerging Markets and weaker Emerging Market currencies.

As the subsequent charts show the Euro suddenly does not play by the rule. It begs the question is it just a short term aberration or fundamental change. Stronger Euro has been related to stronger oil and commodity prices in the past. The unanswered question is which is the fundamentally leading variable.

Euro vs. Oil daily Chart

Euro Oil 2015-12-09

Source: Bloomberg

JP Morgan Emerging Markets Currency Index vs Thomson Reuters Commodity Index

EM FX 2015-12-09

Source: Bloomberg

Relationships do not break overnight. The following days and weeks will show if the relationship actually fell apart. This would cause some major changes to the strategic asset allocation. However, if the relationship remains the implication will be even more interesting.

Either the Euro will need to weaken again or the commodities will rise. If this happen it is very much likely that EM currencies and EM equities could follow. This would clearly be also a large surprise to the markets.


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