We're bullish. Are you? Since the lows seen in late August, we had been playing it safe. Risk, as we call it, most commonly refers to equities and the carry trade. We're now bullish risk in general, and we've many reasons for that. We'll talk about some of them in today's snippet. The bull is out, and you'd better stand aside especially if you're short.
We said on 7 September that risk was squeezing, and that we wouldn't be aggressively positioning ourselves in either direction. That turned out well. A few days after, we wrote that risk had broken out but we weren't yet convinced that bulls were in control. Again, that paid off well.
Between 9 September to the end of that month, there was one critical event that everyone and their pet dog was intently eyeing. You guessed it right, the September FOMC meetings. The uneventful events dearly spooked the markets, creating a lot of volatility on the surface, and eventually led to risk falling hard with most global equity indices re-testing their respective lows in August or even trading below them.
But were we surprised? No one bit. If anything, this year's narrative from the Fed should have adequately taught us not get hopes up too high, higher than the point underlying asset prices were implying. We're not going to banter retrospectively here, but this is an important point we wish to reiterate.
Certain markets lead others, and it all depends on where the broad market is trading at. The vicious selloff in August, climaxing with an unforgettable day now known as "Black Monday", was heralded by many waves of liquidations and momentum hedging. In such conditions, we're always looking beyond the surface - beyond what price action on say the SPX or aussie-dollar.
By focusing on lesser watched markets, markets that are much larger than the stock markets of the world, it is totally possible correctly second guess beyond the tape. There's a lot of precedent that equity markets are amongst the last markets to rally out of a correction.
And second guess did the so called smart money do very well. One good example was how implied volatility on SPX options weren't printing new highs (inverse to stock prices) when the second leg of the correction unfolded. That hinted that most of the hedging had already been done, and whatever selling left in equities was probably done by technical players which had little to do with why the global markets corrected in August.
Risk driven by the dollar
For our well documented view on this, read the snippet on our thoughts orbiting the future trajectory of the Fed's policies. In short, a weaker dollar be the trend for the medium term as 2015 rate hike expectations continue dwindling. The long dollar trade is still prevalent in the FX sphere, and has room to normalize further. In a $5trn/day market, even a blip in sentiment driven by important events can have huge effects on other asset classes just as we've seen. For reference, as of Friday's close, Fed Funds interest rate futures implied an 8% chance of an October liftoff.
Yes, the FOMC events did add a tricky dynamic, and their disappointment in September sure didn't help. But the gist was that there was not much selling left in the tank. Markets just didn't want to head lower. The weaker of global stocks indices, such as Germany's DAX (not helped by the massive VW emissions scandal), and most EM equities, did print lower lows but we didn't really buy those signs. Our proprietary indicators were signaling a divergence between where risk should have traded at, and where it was actually trading - markets were oversold both technically and mathematically.
Key levels lie close ahead
On to where we currently stand, markets are at key technical levels on the charts. Fundamentally, nothing has changed, literally, so there's nothing to talk about here. Between the markets we watch, emerging currencies (EM FX), the carry trade (FX carry), and implied volatility look to be the strongest. EM FX has seen very strong buying against the U.S. dollar, this has intensified after last week's release of the September FOMC minutes.
The more broadly followed FX carry has also outperformed developed market equities such as the SPX and Nikkei. Bond yields are still in a down trend in the medium and long term. Gold and the other precious metals have shot up and cleared important technical resistance levels, possibly indicative of a big shift in hawkish sentiment.
How we're playing this
We've been long equities since the middle of last week. We're also long the Aussie dollar against other selected currencies. We were long gold but got shaken out too early in hindsight. Our gross exposure is on the heavy side. We're obviously betting on direction here. There are certain markets we prefer over others and will be capitalizing on both the continuation of the re-risking trade besides others.
Again, we're fully willing and ready to flip sides on a turn of a dime, as and when the markets tell us we should. We aren't in love with our positions, you should never be.
But until then, we're not fighting this bull. We're riding it.