Behavioral Macro

Mark Dow's microblog, analyzing global macroeconomic and market issues, often through the prism of our cognitive shortcomings

Cash Hurts—but so does Crash: Market update

A friend of mine from London (a currency-oriented macro guy) with whom I regularly exchange ideas asked me my views this morning. I’ve posted my side of these exchanges before. Here’s the latest:

I think the story with gold/silver is the same one we’ve been discussing since May 2011. The fever peaked (with the parabolic silver spike), and now we realize that (1) monetary easing isn’t as powerful as the markets had been thinking and (2) all the “tail-risk reasons” for owning gold and silver are melting away. And it is still a crowded trade amongst the macro tourist crowd that hate US monetary policy, but, when you read what they write, clearly haven’t understood it (e.g. inflation, higher yields, US-is-Greece, pick your variant). Think Einhorn, Loeb, Paulsen, Dalio (though Dalio’s not a tourist), etc.

In short, the monetary tables are now turned: it’s not Bernanke who needs an exit strategy, it’s them.

The framework I finally got around to laying out in June last year goes through things factor by factor. It seems as relevant now as it was then—at least to me.

More broadly, I am bullish, structurally. Growth will be mediocre, with scope for upward surprise only in the US—and even this would be modest. Plus in the US we have to slog through a fair amount more of fiscal drag. Growth everywhere else is not great, and in Europe it’s downright terrible. There is not enough lipstick in the whole Sephora chain for the PIIGS, and I expect more downside surprises—both with respect to depth and duration, but at least the surprises should now be of a lesser magnitude.

We will likely have risk hiccups out of the Old World, but the end game there (re-memberfication of the euro—I know, not a word) will be further out in time and only after years of economic contraction bring radical political alternatives more solidly into the mainstream. For now these forces are still dancing around the fringes.

But, for the medium term, I think low-ish but steady global growth is good for equities. Notice below how the amplitude of the surprise index swings post-crisis has been contracting. Textbook disaster myopia. Bottom line: People will need to take risk. Multiples should expand. Dividends are still a draw. Cash hurts.

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I have been long equities (admittedly a little slow in jumping back on after getting off end-December) and short gold and silver. I haven’t needed to trade much. I took down equity risk on Friday for the first time in a while. I don’t like what I see in the European indices of late and if gold and silver accelerate further to the downside (which is my base case) the old correlation to equities would likely come back, dragging equities down along with the shiny stuff.

The equity market is loaded enough with “late purchases” that it wouldn’t take a huge story to generate a shakeout. A hard fall in precious metals could catalyze such a story. What would that story be? It really doesn’t matter much; we market participants always reverse engineer something plausible whenever we see sharp price action.

I am holding core long positions, now partially hedged with European “stuff”—in addition to the precious metal shorts. I hope we get a selloff in the next month or so, so that I can increase equity exposure. I suspect I am not alone in this, which of course complicates my odds of being right. If the selloff in precious metals accelerates too much I will probably trim some futures and sell some puts against a good part of the rest. But sooner or later—who knows when?—we are going to get a whoosh-type selloff in precious metals for the reasons outlined in my framework, so it’s very unlikely that I would take my exposure to zero. In my dream sequence, I am hoping that the market will let me keep my long equities, short precious metals positioning for the bulk of this year if not longer.

  1. markdow posted this
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