Commodities and Bond Yields, tied at the hip – 10 Things you Need to Know

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Must-Read List

1. Lessons from Omaha

2. Convexity Climax

3. Juggernaut

4. Energy Bull Case

“Commodities are starting to revive after a 10-year bear market. Natural resources like energy, metals, and agriculture look set for an extended run, and investors should get on board.

The recovery in commodity prices, Goldman Sachs analysts say, “will actually be the beginning of a much longer structural bull market” that could rival that of the 1970s, when gold rose 25-fold, and the mid to late 2000s, when oil peaked at over $140 a barrel.

Reasons to be bullish are ample. Global economies look poised to revive in the second half of 2021 as pandemic restrictions ease. And monetary conditions have rarely been so easy. The Federal Reserve may keep short interest rates near zero through 2023, while tolerating 2%-plus inflation.

“Commodities are set up for a significant period of outperformance after such a long period of underperformance relative to other asset classes,” says Roland Morris, commodity strategist at VanEck Global. “There is a lot of fiscal and monetary stimulus being applied globally, and the dollar may fall as global growth rebounds. There are supply constraints and new demand drivers for industrial metals from the electrification of the world.”

The Goldman Sachs commodity analysts are bullish in part because of what they see as “structural underinvestment” in commodities, particularly in energy, following a decade of poor returns. While the energy-heavy S&P GSCI commodity index has rallied 66% from its April 2020 low, its total return has been negative 60% over the past 10 years against a 263% total return for the S&P 500 index.”

Barron’s

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A Colossal Failure of Common Sense 2.0, Act or Crash FOMC

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In our global NY Times bestseller*, “A Colossal Failure of Common Sense” – there are two key points the book focuses on – risk recognition failures by the Federal Reserve and the importance of short-sellers in the marketplace.

*now published in 12 languages, over 600,000 sold.

Today, at precisely the same moment – we are once again witnessing key stress points in the financial system which can unravel very quickly. Our 21 Lehman Systemic Indicators are screaming higher. The inmates are running the asylum and the probability of the Federal Reserve breaking out their creative “macro-prudential” toolbox is the highest in years.

What is going on? For example, when five to 15 hedge funds are in trouble, all down 10-40% each in less than 30 days and they command $100B or so of AUM (assets under management) – that´s NOT the problem. The problem is – they are levered about 10-1. So these fellows actually control $1T of assets. And when the margin clerk comes walking by your desk it’s a VERY unpleasant experience on a trading floor. It´s NOT a friendly visit, especially when the risk management team has his back, NOT yours.  You don´t just sell your losers, you MUST sell your winners, nearly “everything must go” to raise precious cash.

Here lies the problem with central bankers. Academics are often clueless about systemic risk, even when it´s right under their noses. The history books are filled with these lessons. Very quickly the Fed will scream ¨there is NO problem, all is well, stay in your seats, ladies, and gentlemen.” After a rude awakening, they realize, “oh, we do have a problem.”

This is when happens when you bail out the bad actors in March, just ten months later the leverage comes back VERY quickly.

Looking forward, U.S. central bankers are no longer Trump constrained, the banking system is strong but the equity market has far more in common with Steve Wynn (Vegas) than Warren Buffett (Omaha). We think the Fed (and SEC) sends a shot over the bow very soon. Our social justice, inequality embarrassed Fed is not happy. They will not taper but they can make serious threats to risk-takers. All the signals are there; we have an explosion of SPAC / IPO issuance, $850B of margin debt or 75% above 2015 levels, the most shorted equities up 75% vs. 16% for the S&P 500 since October (bulls running over bears), record-high call vs. put volume with the little guy leading the charge, SELL Mortimer Sell. The risk-reward is atrocious from a long perspective in U.S. equities. Unless the Federal Reserve acts quickly and decisively, we will crash, the destruction will be of epic proportions. Central bankers have a chance to arrest out-of-control animal spirits, they MUST act now.

Companies Outed by Short Sellers

Enron‬
Wirecard‬
Sunbeam ‬
Lehman‬
Worldcom ‬
Madoff‬
Cendant‬
Tyco

*In a world of state-controlled central bank liquidity, message boards, and leverage; who are we actually protecting?‬ How many Bernie Madoffs, how many Bernie Ebbers will be running around the Hamptons this Summer?

The Problem of 2021 – The Fed’s Macro Pru Risk Tools are designed for 2008, not 1999

In our live chat on Bloomberg, several Institutional Clients are talking up a Possible macro-pru Fed Adjustment, Central Bank Action. Warning, beware…

Bailout Alert: *CITADEL, POINT72 TO INVEST $2.75 BLN IN MELVIN CAPITAL

Comments from Our Live Institutional Chat on Bloomberg

The bailout of Long Term Capital Mgmt LTCM: $3.6B.
The bailout of someone short $GME: $2.75B.

*According to usinflationcalculator.com, that $3.6B bailout in 1998 is equivalent to $5.72B today. The bailout that saved the world was $5B now look at us.. $1 trillion “isn’t enough.”

CIO West Coast: “ I think mkt is really scary when a $13bn hf can be down 40%+ a few weeks into the year and asking for bailouts.”

CIO East Coast: “ Classic Fed, wrong macropru toolbox. What did citadel securities do in revenue? $6.7bn?  I’ll bet 60% of that drops straight to the bottom line. We have an Option vol seller (Citadel) + buy-side (point 72) deploying a Reddit fire hose, comedy”

CIO Hedge Fund NYC: “I remember 1999 well.  I think this is now at least as crazy. The GME squeeze is quite a doozy.  I think the short-selling community is pretty destroyed. “

What Triggered the Bailout? It’s similar to the SoftBank whale gamma squeeze.

A) Large herd of organized players buys large amounts of upside calls on stocks with the greatest % short interest.

B) Option traders getting lifted in SIZE, have (MUST) to buy stock to hedge all the incoming call buyers.

C) As option buyers buy the stocks GME, BB, BBBY etc, this triggers short squeeze as % of the float (actual shares outstanding) is very small, short interest is HIGH. Compared to the 1990s, the options ease of use is 10x more accessible today, cheaper commissions (they are paying, just don’t see it) today as well. Message boards (Reddit), a social element similar to the 1990s. So the options angle triggers more of a gamma squeeze with a larger, more mobilized herd. Next, Elon Musk and VCs pile on the action.

Impact: On Wednesday morning, Nasdaq witnessed two inter-day bearish reversals of 2.7% and 1.8% this week. The VIX touches 200d (27.45) first time since election day. It would later touch 37.

A Bull-Raid on Short Sellers
Think of the 1990s mob taking out famed short-seller Julien Robertson vs. the 2020 mob trying to attempt the same thing, now think Genghis Kahn vs. Atila the Hun innovation, mobilized, organized leverage.

We are Looking at more Macro-pru fix Incentive Fuel for the Fed!!!

Market extremes always force a policy response, oftentimes in Bear markets with March 2020 the shock and awe moment of all time. But what about a colossal bull market perch… covered in froth?

WHAT ARE MACROPRUDENTIAL POLICIES? AND HOW DO THEY DIFFER FROM MICROPRUDENTIAL POLICIES?

With Lehman Brothers in mind, macroprudential policies are financial policies aimed at ensuring the stability of the financial system as a whole to prevent substantial disruptions in credit and other vital financial services necessary for stable economic growth. The stability of the financial system is at greater risk when financial vulnerabilities are high, such as when institutions and investors have high leverage and are overly reliant on uninsured short-term funding, and interconnections are complex and opaque.

For the first time in four years, we are looking at an FOMC without Trump constraints. More importantly, they’re wearing the inequality dunce cap sitting in the corner. After a decade of fueling gross inequality, central bankers are out to prove their innocence as newfound social justice warriors.

The problem, looking over the list of the Fed’s macro-prudential tools – most are bank balance sheet related, that’s not where the problem is. Over the last hundred years, after each financial crisis, there has been a unique metamorphosis, a transformation into another serpent, a far different beast. If the Fed has learned anything, this time the focus must be on stock market leverage, margin requirements, etc. It´s far more 1999 than 2008. If Alan Greenspan could go back in time, what macropru tools should he have used in the dotcom era?

Mobs vs. Shorts
Good one from MacroCharts… In our view, mobs have been taking out shorts for decades, NOW they use tactical nuclear weapons (mob-induced option leverage), vs. more primitive methods in the 1990s.

How Times Have Changed

The bailout of Long-Term Capital Management LTCM: $3.6 billion*
The bailout of someone short $GME:  $2.75 billion

*Fourteen financial institutions recapitalized LTCM with $3.6B: Bankers Trust, Barclays, Chase Manhattan, Credit Agricole, CSFB, Deutsche, Goldman, JPM, Merrill, Morgan Stanley, Paribas, Salomon SB, SocGen, UBS.

The latest buzzword is “macroprudential” as in macroprudential regulation. It’s basically means be more conservative, or save a penny for a rainy day. The idea is to institute laws and rules in order to avoid systematic risk, the risk of the collapse of the entire financial system. Policymakers and their research analysts are warming to the view that regulating in anticipation of collapse is better than after collapse. However, no regulator has ever correctly foreseen a financial collapse, even recognized it as it began under their very noses. Like generals, they always fight the last war. At best they invent new tricks for an old game.

The macroprudential thought has actually been around quite a while, in England, where the term was first coined in the 1970s. It only became less obscure, however, after the Bank for International Settlements took up the banner in the early 2000s. It came truly into its own after the late-2000s financial crisis, or the global financial crisis, in the wake of what in retrospect has been deemed as excessive risk-taking by banks given the popping of the housing bubble in the US.

So macroprudential regulation is an effort to reduce the risks of financial instability. It is viewed as optimally complimentary to macroeconomic policy and microprudential rules for financial institutions.

The important point from this history lesson is that macroprudential policy never evolved out of the collapse of the dotcom stock market bubble. It is a bank or banks-to-markets mindset. Instinctively, it views any risk as curable by treating it as in essence bank risk. So if markets are at risk for non-bank reasons, macroprudential policy may still address it, but that would involve a new mindset developing new policies and new tools.

Now to review macroprudential policy as it currently stands. Macroprudential concern divides into three categories: the agency paradigm, the externalities paradigm, and the mood swings paradigm, with most of the focus on the last two.

In the agency paradigm, principal-agent problems (where one person can make decisions for another, but not always in the latter’s best interests) are the focus. So those who run a bank may care more about their own pay than the best interests of the bank’s shareholders or society at large. Imagine! The fear is that as lenders of last resort, the Fed thereby emboldens bank heads to take undue risks. This is a moral hazard, which in economics means the incentive to increase risk at someone else’s expense. Because of the individual actor’s nature of such risk, the macroprudential policy usually focuses on the other two paradigms.

In the externalities paradigm, the main focus is mainly on pecuniary externality which occurs when an economic actor’s decision affects the welfare of another economic actor. For instance, if a lot of suburban dwellers buy apartments in the city as second dwellings, that can drive up the prices of urban apartments, negatively impacting the ability of young urbanites to purchase apartments. The macroprudential view is that when price distortions caused by lack of perfect competition occurs, policy intervention is the cure. Which is stupid. How can an economist, or government employee, determine perfect competition? What criterion would government hacks use? What prejudices and hidden agendas would affect their determinations? A world where no one is worse off no matter what choices are made by others is a pipe dream. The view seems to be that over-borrowing, excessive risk-taking and excessive levels of short term debt deserve macroprudential regulation because market failures hurt the real economy. Meanwhile the 1987 crash and zero impact on the real economy. But now banks have 52% loans to deposits, the lowest and most conservative in half a century! A classic case of developing a cure for a disease that has gone away.

As for the mood swings paradigm, keying off Keynes’s animal spirits idea, the thought is that there are moments of excessive optimism during which money managers tend to ignore risk. This means that price signals lose value and this leads to systemic crisis. So theoretically macroprudential regulation would curb such optimism. Of course, this is exactly the opposite of the current monetary policy. Ahem.

Thus, the concern over macroprudential regulation is really a fancy way of worrying about when the Fed and other regulators change their collective mind and turn off the money spigot.

So how would a macroprudential regulator monitor systemic risk in the first place? One way is to monitor balance sheets. In the case of large banks, these are superb. In the case of small businesses and individuals, as a result of lockdowns, these are disastrous and too late to repair. Another proposed monitor is to look at interconnectedness risk. But it is safe to say that the economy and markets are highly integrated and making them less so at any point in any way for whatever reason carries with it a high degree of risk.

Other measures to monitor risk include credit to GDP and monetary assets such as M1 growth, but of course, the response to lockdowns of Central Banks has been to inflate those metrics. Real asset prices as a measure of potential systemic risk is a joke given that Central Banks are deliberately inflating them, at least so it would seem if one simply observes their behavior. Stress tests of course have been used and, to be fair, for all their flaws, seem to have had some positive impact.

Assuming that policy geeks can identify risks beforehand, which is questionable (isn’t the definition of a dangerous risk one that can’t be foreseen???), what tools are available to reduce identified risks?

Correcting loan to value ratios might be one, but for the fact they are currently the most conservative in over a generation. And this was done by the banking industry voluntarily. Some CLOs have stepped in where banks have feared to tread, true, but no one views them as globally systemically important (yet).

Another macroprudential tool is controlled through debt to income measures, but by all appearances, as a result of the pandemic, these have been thrown by the wayside.

A levy on non-core assets would restrict banks’ ability to wander too far afield. The counter-argument is this reduces their diversification and thereby increases risk.

Countercyclical capital requirements would restrain desperately risky lending by soon to be troubled lending institutions. However, it is difficult to ignore the irony of governments who would never dream of imposing countercyclical measures on themselves. It was Adam Smith who noted centuries ago that emergency monies borrowed by governments temporarily were never repaid. Still too true to this very day.

Penalties for excessive short term funding, charges on maturity mismatches, penalties for insufficient liquidity ratios, and haircuts on asset-backed securities valuations are further macroprudential tools, none of which have any present relevance to currently overfunded global banks. In the US, banks have $6.6 trillion in deposits that cost 6 basis points to maintain, $115 billion in actual cash, $3.3 trillion in securities most of which government-issued, and about $3.4 trillion in loans. Hard to see the systemic risk there.

Further, more junior capital for banks is a basic macroprudential tool, and has already been implemented.

Basel III is in fact often enough macroprudential in outlook. Capital requirements, for example, have been strengthened, capital buffers are in place.

Pro-cyclical dynamic loss provisioning and time-varying minimum capital requirements are basically fancy names for saving pennies for a rainy day, only in this case the pennies are billions, and, while adjusting for time frames, basically means hoarding cash while you can get it and before you need it. While macroprudential, these measures are also anti-growth and ultimately makes the task of growing out of economic inequality impossible. Besides, after the existential crisis of the late-2000s, banks are if anything too risk adverse, and the pandemic has only confirmed them in their ways.

In essence, then, “macroprudential” just means “conservative”.

The management of systemic risk in the USA is in part institutionalized in the guise of the Financial Stability Oversight Council, created in 2010.

The non-coordination of macroprudential policy and monetary policy is detrimental to both.

While theoretically, they should complement each other, in fact, they are inherently at odds in the very times of crisis each seeks to avoid in opposite ways. Macroprudential regulation is conservative in its essence. Monetary policy in times of crisis is fundamentally a printing press. The one restricts as the other expands.

Current fiscal policy and government backing of loans are together meant to maintain personal spending and reward business risk-taking behavior. How to compliment fiscal policy and monetary policy to macroprudential regulation is more of a mystery than a revelation.

In any case, it may all be besides the point. If the main systemic risk is the current equity bubble, it is hard to see how making banks still more conservative will help.

All current macroprudential regulatory tools are geared to solve the last crisis, not the oncoming crisis. Besides, the easiest way to pop the current equity bubble is to raise initial margin from 50% to 60% and maintenance margin from 30% to 40% under regulation T. One doesn’t need the regulatory and intellectual baggage of macroprudential policy to pop a bubble. It’s not a secret.

The most likely scenario, in our view, is louder discussion of macroprudential regulation with everyone very concerned about what it all means. What it all translates into is good old fashioned jaw-boning asset prices lower, an oft practiced method, that can in fact prove effective in overstretched and overvalued markets such as ours now.

Solutions, Reg T

Two points about ending the bubble macroprudentially: the reason why changing regulation T would pop the bubble is because a mere pinprick pops a bubble! It is true changing reg T isn’t much of a big deal compared to options volumes. Changing reg T, compared to options flows, is a mere pinprick. But that’s all you need to pop a bubble. Secondly, it is empirically the case that heavily shorted stocks are targets in today’s world. That story moderates if margin requirements increase. Again, just a pinprick. What is so satisfying from the Fed’s point of view about tightening margin requirements is precisely the fact that isn’t a big thing. It’s just an adjustment. A second lure for the Fed is that it is easily reversed. A third lure is that if it doesn’t work, there is no immediate major harm either.

 

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Renewable Froth: Memories of the Dot-com Boom

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Party like it’s 1999…

“There’s nothing in this world, which will so violently distort a man’s judgment more than the sight of his neighbor getting rich,”

JP Morgan, After the Panic of 1907

Peak Price to Sales Ratio

Tech in 2000

CSCO Cisco: 31x
QCOM Qualcomm: 29x
MSFT Microsoft: 25x
INTC Intel: 14x

Renewables in 2020

PLUG Plug Power: 52x
NIO Nio Inc: 30x
ENPH Enphase Energy: 29x
TSLA Tesla: 19x

Renewable froth, memories of the dot-com boom.

Price to Sales in Growth Equities

Not only are renewables trading at sky-high valuations, but price to sales ratios in growth stocks as a whole are now above their 2000 peak.

Renewables Quarterly RSIs (Relative Strength Index)

ENPH: 96.8
DQ: 89.8
SEDG: 89.5
PLUG: 88.6

Tech Quarterly RSI 2000 Peak

CSCO: 98.5
QCOM: 97.8
TXN: 92.8
INTC: 92.3

ENPH Enphase Energy

The solar panel manufacturer, Enphase Energy, has a quarterly RSI (Relative Strength Index, momentum indicator) of 96.8, one of the highest readings we could find today. Historically when a quarterly candle is this far above its upper bollinger band (purple) it is hard for a stock to maintain its strength, however, with a quarterly RSI of nearly 97 it’s even more challenging. We see meaningful downside in Q1 for this heavily overbought stock.

Renewables Monthly RSIs

PLUG: 95.3
DQ: 92.5
ENPH Enphase Energy: 88.6
SEDG Solar Edge: 87.9

Tech Monthly RSIs 2000 Peak

QCOM: 98.1
TXN: 93.9
CSCO: 93.4
INTC: 82.7

TXN Texas Instruments Monthly RSI Pop in 2000

Overall, the monthly/quarterly RSIs in the renewable energy space look very similar to tech in the dot-com boom…

Lessons From Cisco

Out of dozens of stocks back in 2000, the highest RSI we could find on a quarterly basis was CSCO at 98.5, only slightly higher than ENPH’s current readings of 96.4.

Despite becoming a very successful company over the past twenty years, now employing over 80,000 people, CSCO is still -45% below its 2000 peak!

The important thing to remember is when equities become this overbought on a long-term technical basis, they are pricing-in DECADES of success. Everyone knows renewables are the future of power-generation, that does not mean these valuations are sustainable in the near-term.

PLUG Plug Power Monthly RSI Above 95

There is unsustainable momentum in high-flying renewable names on a monthly and quarterly basis. When considering we are currently running into month-end / quarter-end, this means January will open with new candles very over-stretched on a technical basis. In our view, this speaks to heavy downside risk in Q1 in the renewable space, RSIs above 95 are very very rare.

RSI Divergence

Any trader experienced with technical analysis will tell you RSI works best when there is price and momentum divergence. As a bearish indicator this means RSI is well BELOW its highs while price is HIGHER. Despite RSI at the highs (blow-off tops) in many renewable and technology equities, this bearish divergence is occurring in the most important equity index in the world – the S&P 500.

S&P 500 Quarterly RSI Divergence

Just like the dot-com peak, the quarterly RSI in the Index has been fading lower for a few years (loss of momentum), while the S&P 500’s price has hit new highs, this is MEANINGFUL bearish divergence. In our view, we are close to a long-term top.

Apple Quarterly Bollinger Insanity

While US equity indexes (and even some non-US equity indexes are over-stretched using quarterly bollinger bands, in some single name equities the over-heating is severe. Namely, Apple and some other volatile tech names like AMD were some of the most extreme examples we could find. Importantly, these all speak to meaningful downside in the first quarter of 2021, especially if we rally into year-end.

Nasdaq Quarterly Bollinger Bands

On a quarterly bollinger band chart, this quarter’s candle is meaningfully extended over the upper bollinger band across US indexes, especially the Nasdaq. Historically, it is hard for equities to maintain their technical strength above this upper band. The nasdaq currently sits 11% above the upper bollinger band, this is the largest spread since the dot-com peak.

TAN Solar ETF Spread Above the 200 DMA
The TAN Solar ETF is now 102% above the 200 day moving average, the largest spread in the ETF’s history. 

The argument in 2019: Big tech is not a 1999 bubble because of underlying profits. Now, we have a whole host of tech, renewable, and EV plays with no profits and a colossal newly minted valuation up-take since October 1st.

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Tesla, the Harry Houdini Quarter

Production, Now You See it, Now You Don’t

The production capabilities Tesla says they now have are much MORE than actual production.

Fremont Model S / Model X 90,000 Production
Model 3 / Model Y 500,000 Production
Shanghai Model 3 250,000 Production

This is on slide 7. They claim 840,000 units of capacity…but actual production and sales are much less.

This means they are underutilizing manufacturing and they cannot say that they are supply-constrained.

One High Bar
“Tesla says its goal of delivering 500,000 cars this year “has become more difficult”: it has to deliver a record 180,000 cars this quarter.” Zerohedge

Unlike the last few quarters, they did not sell out at the end of the quarter.  Warning, inventory grows.  And, satellite images from dealer parking lots around the country confirm this.

Regulatory credits were more than guided.  With their deteriorating share in Europe – where most of these come from, this source of profits should be reduced shortly.

Accounts receivable continue to grow sequentially….which makes zero sense in a business where customers pay before taking cars off the lot.

Outside of the Earnings News

Waymo now has a commercial robotaxi service in Arizona

GM Cruise is applying to have cars without pedals and steering wheels.

It was Tesla that was supposed to have 1 Million robotaxi’s by now.

They are way behind, the current nearly $400B valuation is HIGHLY unsustainable. 

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“Average” Inflation Targeting from Central Banks, Compounds Side Effects

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

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“Averaging” Inflation Does Not Eliminate The Flaws In The Fed’s Policy Approach; It Compounds Them

Larry McDonald with Joe Carson

Federal Reserve has spent over a year conducting a review of its monetary policy strategy, tools, and communication process. The review was an academic re-assessment of an academic experiment called inflation targeting. The new framework of inflation averaging is an extension of the inflation-targeting regime, with a longer timeline.

This decision on inflation targeting moves monetary policy closer to a rule-based framework. A rule-based framework creates the premise that there are no legitimate objectives besides the item being targeted.

Inflation targeting was never supposed to become a rule-based framework. Proponents of the practice argued it would help increase the “transparency” of conventional monetary policy and emphasize the commitment toward maintaining a low and steady inflation environment.

Inflation targeting has never delivered the macroeconomic results that were promised. That’s because it has no practical foundation, focuses on a narrow set of prices that are not entirely market-determined, and creates an uneven playing field between the economy and finance. Inflation averaging will compound the errors.

First, mandating an inflation rate of 2%has no theoretical justification.

There is no such thing as an “ideal” or steady rate of inflation. Policymakers have never offered any empirical evidence to justify a 2% inflation target because none exists.

Research and actual experiences show that an inflation rate too high or too low for an extended period can create imbalances and bad economic outcomes. But that range is very wide.

In the mid-to-late 1990s, reported core consumer price inflation averaged more than 100 basis points above the inflation rate of the last decade, and the macro performance in terms of growth, job creation, and wage gains was far superior.

Policymakers have the freedom to change their operating framework. But any framework should be grounded with solid research and not made up with “alternative” facts to support its use as a policy tool.  

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Second,inflation targetingfalsely assumes there is absolute perfection in price measurement. 

Subtle changes in the prices and quality of goods and services make price measurement at times a “best guess”. Every year government statisticians face new products, changes in old products, shifts in demand, and company pricing strategies.

One of the most complex issues in price measurement is the pervasiveness of item replacements. Item replacement refers to a process whereby government statisticians must select and price a different product because the one previously included could not be found. Previous studies have found that some items are replaced more than once a year and annual replacement rates could be as high as 30% for products.

But item replacements are uneven year-to-year and therefore so too is the judgment component of reported inflation. As a result, price changes that are down or up a tenth or a quarter of a percent from year to the next should be considered nothing but statistical noise. But a rule-based inflation-targeting framework will compel policymakers to fiddle with the stance of policy to account for the noise in price measurement.

How is it that policymakers nowadays have fallen in the trap of placing so much importance on a single statistic to conduct monetary policy?

Third, the Fed’s inflation-targeting regime mistakes indirect measures of inflation for direct ones.

A critical aspect of the design of price targeting is the selection of the price series. The price series must be timely and a direct measure of inflation.

The consumer price index (CPI) is the only direct measure of consumer prices. But policymakers have opted to use the personal consumption deflator (PCE). The PCE deflator is not a direct measure of prices since 70% of the prices come from the CPI. The other 30% is based on non-market prices.

Four of the past 5 years, the core CPI has exceeded the 2% target. The only year it missed was 2018 when it was 1.8%. That small undershoot from the 2% target is not statistically significant and certainty not large enough to trigger a change in the stance of monetary policy.

Over the same 5-year period, core PCE ran nearly 75 basis points below the core CPI rate. Almost all of that difference can be explained by the “invisible” prices, or prices for items that are in the PCE but not in CPI.

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Does it make sense to base policy decisions on “invisible” prices?  

Fourth,inflation targeting lacks balance in anchoring consumer inflation expectations with investor expectations.

The announcement of an inflation target is intended to reduce uncertainty over the future course of inflation and anchor people’s inflation expectations. It is hard to prove that the formal announcement of inflation targeting has had any impact on people’s inflation expectations.

According to the University of Michigan’s consumer sentiment survey, people’s one-year inflation expectations have fluctuated between 2.5% and 3% for the past 20 years, moving above or below the range during an economic crisis or oil shocks. Perhaps people are unaware of the Fed’s 2% inflation target or that “experienced” inflation runs consistently higher than reported inflation.

But investors are readily aware of the Fed’s inflation target. Every little tweak in the Fed’s policy statement on inflation and its impact on official rates triggers almost an instant reaction on the part of investors.

One of the inherent weaknesses of inflation targeting is the inability to balance consumer and investor expectations. That is, as policymakers attempt to simultaneously hit an arbitrary price target and anchor inflation expectations they are inadvertently un-anchoring investor expectations as it eliminates the fear of higher interest rates, encouraging extreme speculation and risk-taking in the financial markets.

Why do policymakers only focus on people’s inflation expectations and not people’s/investor’s asset price expectations as well since both have become unstable at times resulting in bad economic outcomes?

Informal and formal price targeting has been in the Fed’s tool kit for the past 25 years or so. The effects on income and portfolio flows are not similar to conventional monetary policy. At the end of 2019, the market value of equities in people’s portfolios’ stood 3X times workers income, up from 1X times in the mid-1990s.

The shift to inflation averaging compounds the unevenness. That’s because inflation averaging will extend the period of low-interest rates, encouraging more speculation and risk, increasing gains in finance over the economy.

A critical review of the pros and con’s inflation targeting will have to wait for the next crisis. It usually takes three crises before policymakers realize something is fundamentally wrong with their framework.

By then there will be several new academic papers that will highlight the flaws of inflation targeting/averaging, expanding on those that are listed in this article while adding others as well.

After over 40 years researching in the field of economics, with experience on the buy and sell-side of Wall Street, government, and private industry and mostly focusing on financial markets and policy analysis, our long-time friend Joe Carson decided to share his research and opinion on The Carson Report. Please feel free to contact Joe if you have any questions or want to discuss any of his research or opinions. 

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Don’t make it a long dance with the Devil

Warning: Do NOT hold the TQQQ Nasdaq ETF for the Long-Term

Let us be clear, we are discussing the largest casino on the planet earth right now. The 3x Levered, ProShares UltraPro QQQ should come with a surgeon general’s public warning. All one has to do is look at the average trading volume – nearly $5.5B a day for this ETF. It makes the Wynn casino empire’s annual revenues of $6.6B look like child’s play.

We are talking about a borderline scam here? It’s a mathematical fact that this beast is NOT long for this world. Sustainability is the question. It’s a high stakes game of musical chairs, DON’T get caught holding the bag.

TQQQ Total Assets

The TQQQ ETF has lost nearly -35% since the Nasdaq’s September 2nd perch, yet the fund’s total assets have only decreased -16.1% in the same period. This difference is because the TQQQ has seen net-inflows throughout the month of September, the idiots have been buying the dips on this slot-machine with BOTH hands.

TQQQ: “ProShares UltraPro QQQ is an exchange-traded fund incorporated in the USA. The Fund seeks investment results which correspond to three times (300%) the daily performance of the NASDAQ-100 Index.

The popular TQQQ ETF is commonly referred to as a 3x levered version of the Nasdaq. Let’s see how this has played out in action…

Returns: QQQ Nasdaq ETF vs. TQQQ UltraPro 3x Nasdaq ETF

% Return Today (9/24)

QQQ: +0.5%
TQQQ: +1.5%

Makes sense…

% Return Past Month

QQQ: -6.4%
TQQQ: -20.5%

Little more than 3x, but close enough…

% Return Since 2010

QQQ: +520.7%
TQQQ: +6,931.6%

Wait… what?

% Return Since the February 2020 Top

QQQ: +11.3%
TQQQ: -5.1%

Wait… what???

“The scary part of TQQQ is a 10-year chart gives off the impression that a long-term investment is safe.”

What’s Going on?

We must think about the math. If an investment starts at $100 and loses -5%, you are at $95. To get back to $100, you need appreciation of +5.26%. However, if that investment is 3x leveraged, you lose -15%, and instead are at $85. To get back to $100 in this scenario, you now need appreciation of +17.6%. Notice that the 17.6% needed is greater than 5.26% x 3.  

Now, let’s take is up a notch…

Scenario A: Stock XYZ is a non-leveraged stock that falls -33%. The stock needs a +49.25% appreciation to get back to even. $100 would have gone to $67 and a after a +49.25% rally, $67 becomes $100 again.

Scenario A (but 3x leveraged): Stock 3XYZ is a 3x levered version of the same stock. When stock XYZ falls -33%, stock 3XYZ falls -99%. This stock needs +9900% appreciation to get back to even! $100 would have gone to $1 and after a +147.75% (3 x  49.25%) rally, $1 becomes just $2.47!

The Nasdaq 100 Index has NOT seen a -33% drawdown since TQQQ was created in 2010. Once it does, TQQQ’s prior high is likely to NEVER be reached again.”

DANGER: TQQQ UltraPro Nasdaq ETF

ANY financial product that is levered 3x is NOT meant to be held for the long-term. The 10,693% rally in the 3x levered TQQQ Nasdaq ETF from 2010 to the recent peak may NEVER be replicated. The largest drawdown the TQQQ 3x Nasdaq ETF has EVER suffered was -73% from February to March 2020. Although, the -73% TQQQ drawdown was painful, a recovery to new highs was attainable. However, if the Nasdaq had fallen just a few more percentage points and the TQQQ drawdown went past -90%, a recovery back to the highs would have been nearly impossible. The Nasdaq 100 Index has NOT seen a -33% drawdown since TQQQ was created in 2010. Once it does, TQQQ’s prior high is likely to NEVER be reached again.

Long-term Safety Façade  

TQQQ looks great on a 10-year chart, but there is no such thing as a free-lunch in finance. TQQQ’s +6,410.9% outperformance over the Nasdaq 100 since the ETF’s inception in 2010 will not be repeated for a very long time, if ever. This was only possible because since the TQQQ ETF was created, the Nasdaq has not seen over a -33% drawdown… yet.

Keep in mind, the Nasdaq fell -76% from the Dot-Com bubble’s peak to trough. If this were to happen today, the TQQQ would be a penny stock and the 8 billion dollars invested in the fund would be looking around, scratching its head, wondering what just happened.

Unfortunately, the probability is high that inexperienced retail investors lose over -90% of their investment in TQQQ and do not realize they may never get back to an even P/L, regardless of what the Nasdaq 100 Index itself does.

Bottom line: PLEASE do NOT hold the TQQQ for the long-term. If we see anything near -35% drawdown in the Nasdaq, new highs in TQQQ are nearly impossible, the math proves all 3x leveraged ETFs must be traded NOT owned. The scary part of TQQQ is a 10-year chart gives off the impression that a long-term investment is safe…

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Stupid “Rich” Skew in Apple, Greed Breaks Things

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

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Sept 6: What Just Happened over the last Nasdaq 14 days?

1. A Colossal buyer (SoftBank) distorted the price of upside calls on eight stocks.

2. Quants and Robinhood piled on, further distorting markets.

3. Dealers who have been destroyed in recent years (selling vol) holding a small deck, they had to get long more and more stock to hedge upside market risk.

4. As stocks surged, dealers who sold upside calls – must hedge even more as – out of the money options they sold – pick up more delta. Banks buy more stock. Call-put skew reaches record territory on several big-name tech stocks, meaning the cost differential to buy upside vs. protect the downside, reaches all-time wide levels.

5. Nasdaq is nearly 60% 12 stocks, this “three-card monte” game above has a large impact on passive index funds.

6. The original, colossal upside call buyer exits some of their position.

7. Dealers / banks MUST sell stock in size, take off their hedges, sell Mortimer, SELL.

8. Selling brings out more selling, banks take off more hedges as the options lose delta, MORE selling.

9. The little guy / gal gets left holding the bag.

Alert: High and High Closes September 2, 2020
Wednesday, an All-time highest VIX reading on a day with the S&P 500 touching the highest level ever. Of the top 20 occurrences, there were 17 in the 1999-2000 period, and three over the last 7 days. When option traders receive colossal size orders to buy upside calls they have two choices. a) Have your sales force get on the phone to the largest holders of the stock (say Apple and Buffett) and convince them to sell upside calls. b) If they cannot find enough sellers of upside calls, they must buy stock in size to hedge the calls they are selling to the client.
This is taking the street short gamma – likely the largest way all time. As we learned with Lehman, greed breaks things. It’s “high-noon” – the only character missing is Gary Cooper. We are witnessing a battle of wills, high speculation where colossal call buyers are forcing the street to get long more and more stock to hedge their upside risk. It’s the March capitulation selling in reverse. Just the way the street had to BUY downside protection in late March (because put buyers outnumbered call buyers 10-1). Today, they are being forced to BUY upside protection in SIZE (call buyers outnumbered put buyers 10-1). It’s going to break!

Insanity in Options

This post is Part II of New Vol Regime

“As my first boss told me at Merrill Lynch in 1990, ´In options Larry, they show it to you (lush $$ green premium), and then they take it away.´”

LGM

The convexity skew picture on big-name equities like Apple $AAPL has gone parabolically stupid. Let’s keep this simple and draw a conclusion.

“Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Our friends at Citadel calculate, over $1 BILLION of premium spent and upwards of $20B in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years, they noted. We agree someone is playing with House Money, and they’re rolling large.”

Bear Traps Report, August 24, 2020

Apple $AAPL Stock near $130

Jan $180 Strike Calls costs $4
Jan $80 Strike Puts costs $1

*Both options are $50 out of the money, approx data, BUT it is nearly 3x more expensive to buy upside risk in AAPL equity. Downside protection normally costs more than upside risk participation, NOT today. What does this mean?

“The public is trapped long and institutions are trapped long and the snowball that was pushed very quickly up the hill and got big is now at risk of becoming an avalanche.”

Julian Emanuel, chief equity and derivatives strategist at BTIG, Bloomberg

Nasdaq Whale Makes a Splash

One large buyer has made a colossal splash in the market and the scent of greed has drawn thousands of other market participants into the dangerous game. Several clients in our institutional chat on Bloomberg have cited SoftBank as the original size buyer. We have NO IDEA if this is true, just that highly credible clients have made this reference several times over the last week. It’s a high-stakes game of musical chairs, the ultimate greater fool theory moment. The colossal call buyer has thrown meat in the water and drawn in the sharks, but unfortunately thousands of Robinhood minnows at the same time. When the large players’ exit, the little guy and gal will be left holding the bag.

Apple closed near $130, while the cost of speculative upside calls is weighted heavily against the buyer. Someone must have reached out to Buffett today because he can make a fortune in selling $AAPL upside calls. Let us explain.

Very Expensive Upside
Call it extremely unusual activity. We have a higher stock price in Apple AAPL with a much higher cost of equity upside. Equity vol usually explodes higher in market crashes, NOT bull markets. As you can see above, in normal Apple equity bull markets – see all of 2019 – AAPL implied vol has been CHEAP, NOT RICH (expensive) like today! In March and April, near the market bottom – the price for puts was more than 4x the price for calls, today we have done a 180, extreme fear to extreme greed. 

In our institutional client chat on Bloomberg, a hedge fund put on this trade and we are sharing it with permission. 

With Apple stock near $130, think of the January 2021 expiration. The client bought the $200 call and sold the $250 call, 1 x 4, and got paid $3.50 to put the trade on. What does this mean? See below.

Extreme Premium to Extreme Discount
Apple $AAPL is near $140 pre-market on September 2nd. In July, the Street’s 12-month price target was $85, now $116. In March, the price target commanded an $18 PREMIUM to the Apple stock price, NOW it’s close to a $24 discount. In classic 1990s fashion, the mad mob of Wall St. analysts cannot raise their stock price targets fast enough to keep up with the equity price appreciation. That is from 44 analysts, Bloomberg data.

The Trade

Apple was worth $1.5T at the end of July and today she stands tall at $2.2T. In order for the client to lose money* at January expiration, the stock has to breach $270 ($130-$136 this week), which would put the company’s market capitalization very close to $5T, by January 2021, that is a little over four months away.

*The mark to market in the short run can be extremely painful though – if Apple equity soars another 10-20% (Apple is up 50% since late July), that is indeed the catch. AAPL is trading nearly 65% above its 200-day moving average vs. 42% in February’s great bull run. 

Cost of Upside is Insanely Expensive
There are a handful of quant funds pushing around a few stocks (with high impact on QQQ, NDX, SPY) in the options markets. The dealers are getting very nervous.  Last 15 days – Imaging being a large market maker in Apple and Tesla equity options. You make a market, bid – offer, you get lifted and lifted over and over again by buyers to the point where you have raised the price of calls vs puts to multi-year extremes. How short is the Street gamma? VERY.

The Ultimate Lesson From Stan

“So, I’ll never forget it. January of 2000 I go into Soros’s office and I say I’m selling all the tech stocks, selling everything. This is crazy at 104 times earnings. This is nuts. Just kind of as I explained earlier, we’re going to step aside, wait for the net fat pitch. I didn’t fire the two gunslingers. They didn’t have enough money to really hurt the fund, but they started making 3 percent a day and I’m out. It is driving me nuts. I mean their little account is like up 50 percent on the year. I think Quantum was up seven. It’s just sitting there… So like around March I could feel it coming. I just – I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks. and in six weeks I had left Soros and I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to that. I was just an emotional basket case and couldn’t help myself. So, maybe I learned not to do it again. but I already knew that ”

Stan Druckenmiller

When call vs. put skew gets this extreme it can be a solid leading risk indicator.  Join our live chat here, tatiana@thebeartrapsreport.com.

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