Calculating Risks: What's Next After A Bounce?
It’s time for a potential bounce after the worst start for equity markets in history. Am I turning bullish? No way. We may see a very short-term tradeable bounce but on this rally I am adding to the vast array of short positions we have been accumulating as part of our bearish strategy for the first quarter of 2016, since late last year.
Firstly, the bounce. As an active proprietary trader I continually look to where and how I can adjust the positions I and my traders take within the framework of both short-term gyrations and naturally long-term trends. Depending on how strong the longer-term trend is will govern how much I react to short-term gyrations. In the case of the current situation where we have all been short since late 2015, our focus on short-term moves is less so due to our long-held view that 2016 is likely to see a GFC-style event.
Focus too much on the small moves and you miss the bigger picture. And it’s the bigger picture (the larger broad based move in markets) where you make your money. The hedge fund managers like Kyle Bass who made billions shorting the sub-prime mortgage market saw the opportunity, positioned and where undeterred by short-term volatility and bear-market rallies.
So I have a few long positions to profit from a rebound, but our broader short-term positions remain unchanged. They are sitting on healthy profits so I am not compelled to reduce them given that this sell off could be “the big one”.
And this is where readers need to be careful. Very few picked this sell off. But everyone who didn’t has an opinion to buy the dip. From newsletter authors to local economists, analysts and media – all still feeling very comfortable despite more than 10% being wiped off their equity portfolios (on paper since they are not actual traders). There is still a solid array of complacency that everything will be ok.
Short covering rallies in bear markets are the biggest and most savage. Far more so than any bull market move. They tend to give bottom pickers and bulls confidence to stick with their view. These rallies stop the weak bears out, allow complacent bulls to dig their heels in and explains why 95% of traders lose money.
Unfortunately not everything is ok. After this bounce we will see another downleg lower. It might not be until next week or for a few months but like the GFC in 2008, the blatant risk taking forced by zero and negative interest rates around the world will come home to roost. Instead of subprime mortgages in California in 2008, this time it’s much bigger, global and debt laden Government’s and Central Banks have no ammunition left to contain it.
Let’s look at some scary charts and numbers. I showed many late last year to cement the bearish view. Here are new ones to help explain why last year’s charts were important.
Firstly, US student loan debt. This alone is now US$1.2 trillion! I joke around in the office that if you want a guaranteed way of losing money, loan it to Gen-Y and see if you ever get repaid. Student loan debt has ballooned since 2009 as shown in the chart below.
Add to this US Auto Loan debt. Now US$1.1 trillion. Auto sales are running at a rate of nearly 18 million cars per annum all funded by low – almost zero – interest rates. There is a very important point here, retail sales and consumer spending has been very patchy and lacking any real growth – despite oil and fuel prices plummeting. Why? Because consumers are spending money where it can be borrowed. Cash savings at the pump and small ticket purchases are being foregone to allow payments for bigger debts – like cars and student loans.
So when you read the supporting argument that oil prices falling are stimulatory for the global economy – sorry no, not this time. Oil has been falling for 18 months now and it has stimulated squat. Nothing. Trsnports, airlines have enjoyed margin improvement but that’s all.
Just these two items amount to US$2.3 trillion dollars. So we now have a situation where students are driving cars they can’t afford to obtain an education for jobs they can’t get. Sound familiar? US household debt now stands at $14.1 trillion greater than the 2007 high but instead of this debt being concentrated in assets which have a chance with time of appreciating like property, it’s now in consumer loans. Trust me, these things have been securitized and sold to investors who are desperate for any income based returns since central banks have eliminated that possibility from Government bonds with such low rates – like 2005-2007.
This leads to show one of my charts again from late last year. US banks. I noted last year that if the Federal Reserve was truly going to raise rates four times in 2016 and the underlying economy is on solid footing than why when finally interest rates are going up and banks that are most leveraged to profit from that, haven’t rallied? Well since showing that chart in December look how far Bank of America has fallen. 21%! Banks now hold huge amounts of consumer related debt and non-performing loans are on the rise.
To this add the exposure to all the high yield corporate debt (junk bonds) that I have been warning about and exposure to emerging market Government bonds. In Australia it’s no different. Maybe worse, as I haven’t even mentioned the risks within the Chinese credit bubble. Banks here are over exposed to property and consumers that have been mostly funded by debt. Property has been propped up by foreign buying particularly from China. A sudden overnight devaluation of the yuan will reverse this support and the banks will look very expensive, very quickly.
Suddenly those dividends aren’t what they seem. I continue to short rallies on the local banks. The US bank performance gives you an idea of how quickly they could unravel. When I return in two weeks I will explain why they are a ticking time bomb. You have been warned!
Greg is the Head of Proprietary Trading at Gleneagle Securities and has over 20 years of experience as proprietary trader and high level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank. He has been involved across all asset classes including commodities, bonds, currencies and equities right across the globe.
After a 10-year career within the comforts of the large investment banks and research firms he branched out on his own to form his own proprietary trading firm successfully building the business into a multi-million dollar trading operation that turned over a billion dollars a year. This same team now runs the proprietary trading desk at Global Prime, risking their own money in line with the firm's and client's capital.
Greg has appeared on CNBC, Channel 9 - Business Sunday programme, a guest columnist for the Australian Financial Review, a regular author for Personal Investor, Wealth Creator and Shares magazine and is the former Treasurer of the Australian Technical Analysts Association.