Wolves of Wall Street?
If You Only Look At One Chart…
Time is short, so here is one chart to get you thinking in a new direction.
Love Bitcoin? Hate Bitcoin? A trade for all weathers
- The Bitcoin investment trust is trading at a substantial premium to the value of the Bitcoin it holds – something must give.
- Arbitrage opportunities abound for investors who can buy Bitcoin and short GBTC. The spread suggests that arbitrage in Bitcoin and GBTC is difficult due to liquidity.
- The premium of the trust suggests that either Bitcoin’s price will rise further to meet institutional demand, or the GBTC must fall back towards its Net Asset Value.
- The smart money seems to have cottoned on – Citron Research has already driven down the premium of GBTC this morning…
Right Here, Right Now
The best trading ideas of the week from RVP Contributors
Sell the S&P 500
Forget the price chart; focus on deteriorating momentum, says MSA.
MSA’s unique approach to technicals focuses on the underlying momentum trends in action rather than just the price chart. The S&P 500 is wavering, breaking key long-term momentum support and the broader trend. Could this be the moment the S&P 500 cracks?
As I have noted previously, seasonality has the S&P all set for at least a hiccup. MSA see a decline in the cards – but not a crash. Watch out in 2018 if momentum keeps falling.
Adam’s Portfolio Picks
I have picked only the most compelling and highest conviction trade ideas of our RVP Contributors and will track them in a portfolio for you to follow.
No new Portfolio Picks this week.
Note: This is not investment advice. You understand that no content published as part of the services constitutes a recommendation or a statement that any particular investment, security, portfolio of securities, transaction, or investment strategy is suitable for any specific person
The Big Call
Legendary hedge fund manager Stanley Druckenmiller said when you see something in the market that really, really excites you, “Bet the ranch on it.”
These are the Big Calls, the investment themes that can make or break you. Think differently from the crowd and have a different time horizon, and you have an edge. RVP, with its crack team of financial minds, identifies the Big Calls and guides you through the investment opportunities when they present themselves.
Where are the Wolves of Wall Street?
Emerging Threats to the pack
Wall Street has a colourful history. It had a humble origin as the road beneath a defensive wall set up to protect early Dutch colonists of New Amsterdam from the local indigenous population. Slavery was introduced to Manhattan in 1626, and thereafter employers would gather at the local slave market on Wall Street to hire out slaves for the day or the week.
Since those dark days, many things have changed – fortunes have been made and lost – yet today thousands of bankers still toil for long hours in the money game on Wall Street. Nonetheless, the ravages of time leave few places unchanged, and the Street itself has been slowly transforming.
What’s got me reminiscing?
Reading through Tony Greer’s Morning Navigator takes me back to my old days in investment banking – the early sales calls, the market chatter, the lively buzz and shifting narratives of capital markets. With its insider’s view of what happens on Wall St, the Navigator has got me feeling nostalgic.
Wall Street emerged from the interplay between those who had capital and those who needed it. It was there to finance the railways, the industrialisation of America, and every major business initiative since. There has been no shortage of speculation, but the gambles added up to efficient capital allocation.
The media likes to portray Wall Street as a crazed casino full of colourful but shady characters engaged in the machinations of high finance, raucous parties, and all manner of unethical behaviour. The reality is somewhat different: long hours, lots of face time, endless deal books, relentless client calls, and dwindling pay packets.
What really makes Wall Street tick?
First things first. Investment banks are generally two things in one. You have your old-school investment bank where mergers, acquisitions, bond issues, and IPOs get underwritten. This is big-fee, one-shot-deal territory, where bankers bid to be the guys delivering the offering.
The investment bank takes home a percentage of any deal, and in the good times that can mean big fees, in part because, when you are undertaking a takeover of Kraft Foods or offering initial shares in SNAP, you don’t compete on price; you compete on delivery.
Number of Listed U.S. Companies Continues to Drop
Source: US Global Investors
So how’s that business going? Well, fewer companies are listing, and more are delisting and buying back shares. The broad US equity market is shrinking from its 1990s peak. M&A fees have held up, mostly due to mega-mergers like Dow and Dupont and Anheuser Busch and SAB Miller. But with a shrinking market and antitrust legislation, it’s hard to see much more consolidation coming amongst the US mega-caps. The shift toward private placements in Silicon Valley and even the emergence of ICOs (The Hack 21st July) threaten the future pipeline of deals for the investment bankers of Wall Street.
Capital markets – the other side of the bank
The other side of the investment bank is its trading and research operation. This is the capital markets division where ‘sell-side’ sales traders and analysts broker stocks and publish recommendations. It’s a fee-based model where disruptive new products like derivatives are rewarded with healthy margins until everybody gets in the game and arbitrages away most of the profitability:
Source: Quartz Media LLC
A myriad of changes to the markets is steadily driving down profitability: high-frequency trading, electronic trading, regulatory burdens, and of course passive investing (see The Hack April 21st). Usually, in a bull market the equities business makes money hand over fist, and clients are drawn in to trade more and in greater size – animal spirits run wild and everybody buys in. As Jesse Felder explored in ‘Is the Stock Market Euphoric?’, today’s market just feels different somehow…
The proliferation of passive and quant strategies means that most of the bull returns are going to ETF investors and ETF providers, with little margin or need for equity research or specialised broking. If everybody just buys the S&P basket, how can Wall St generate meaningful fee income – they make cash by encouraging trading: Switch GM for Ford, switch JPM for Goldman, etc.
Consolidation means cuts
On the topic of mega-mergers, just look at the way the US banking industry has consolidated. Fewer banks mean less competition but also a diminished Wall St. Cost cutting is the order of the day as low-interest rates, passive investing, fewer deals, and more regulatory burden results in fewer bankers.
US Banking Consolidation
Source: Federal Reserve; GAO
Disintermediation and the rise of Bitcoin
The meteoric rise of Bitcoin has been one of the most fascinating phenomena of the decade. I remain a long-term bull on the ‘digital gold’, as I stated in The Hack 26th May. The first-ever successful digital currency has revolutionised global payment systems, allowing transfers of value across borders with no intermediaries. The network value of Bitcoin has exploded, and the dollar value of the currency has closely tracked its utility:
Bitcoin Network Value and Volume
Source: h/t Willy Woo @dangermouse117
This first big cryptocurrency has broken down the cosy frictional profits earned by Wall Street middlemen – and the threat looks set to deepen as the technology extends to ICOs through alternative blockchains.
Banks have been scrambling to develop their own ring-fenced blockchains and place themselves at the centre of this transformational technology – and that’s just part of the process of going mainstream. In much the same way that the internet itself started out as a libertarian project and ended up as a broadly commercial platform, I expect blockchain too will slowly be integrated into the fabric of existing institutions. The developments that come next to shake up our financial system will be exciting.
Mumbai, Shanghai, Dubai, or Goodbye?
The GFC saw a shift to emerging markets. As investment banks in the US slowed into the crisis, the idea of ‘decoupling’ took hold, and bankers migrated east to the riches of the Orient. The structural shift to Asia didn’t last in that cycle, but it will continue due to the demographic clout of nations like India and the industrial and financial might of China.
Source: Rhodium Group
One of my takeaways from J Scott Laprise is that One Belt, One Road is an initiative that Wall Street will struggle to profit from. Just as the industrialisation and then financialization of America was a boom for Wall Street, so too could OBOR be a feast for Chinese and Asian banks as deals are struck and railroads financed.
Wall Street no more?
Not so fast. You don’t pay top dollar to hoover up the best talent from Ivy League universities just to watch your preeminent position at the money through slide away. You can be sure that Wall Street will still be alive and kicking in years to come – but less assured that the same jobs, structures, and even bank names will still exist. The cycles of change are getting shorter and more powerful – Wall Street has ridden this bucking bull for years and will continue to do so – but it’s hard to see a future where we can still call the men and women who toil there ‘masters of the universe’.
Are You On This Yet?
In such a fast paced world staying on top of relevant market news and developments is tough. RVP scours the globe for the most interesting stories and distils them, keeping you ahead of the crowd.
How committed are traders?
And why it matters…
One piece of data that keeps many traders in the office late on Fridays is the weekly Commitment of Traders (COT) report. The report, released by the US Commodity Futures Trading Commission, tracks commercial and speculative positioning in key futures markets, with data captured each Tuesday. The report gives investors a high-level view of futures holdings, which can be telling when bets become extreme.
Here is a simple example of analysis from Ole Hansen of Saxobank:
The warning sign here is the stretched fund positioning. A large long position has grown for gold speculators, and everybody who is speculating is stacked on one side of the boat. Who takes the other side of this bet, then? Usually, it is the producers – gold miners and dealers – who can hedge their prices in the futures market to ensure future cash flows.
This producer position is often called the ‘smart money’, although gold, having limited industrial use and greater financial and emotional interest, is something of an anomaly. The smart money side is more applicable to oil or copper, where supply and demand dynamics are more profound. The basic premise is that if an oil company that delivers physical oil wants to hedge prices, the outlook is probably not good for the oil price – so who would speculate on the other side of that bet? Still, the issue is muddied by business considerations: Shale producers, for instance, must hedge in the current environment to secure any financing.
Gold: Managed Money Position
Source: Saxo Bank
Why is this positioning dangerous? With so many speculative long positions in gold, and with the failure of the price to strongly break resistance, there is a risk of a rout if all those speculative positions try to exit at the same time. Essentially, the positioning is ‘potential energy’ for a big movement – in an orderly market it seems quite benign, but in a shock, the unwind of so many positions can lead to extreme price movements.
My favourite example is the 2008 Porsche/VW stock market short squeeze. Porsche was building a stake in VW shares then, driving up the price. Short sellers, who saw the move as temporary, jumped in… until Porsche announced that it had acquired 42.6% of VW plus options for 31.5%, with the desire to take a 75% share.
Now realizing that a shortage of shares was available to cover, shorts started to try to close their positions. Unfortunately for them, the German state of Lower Saxony had the residual 20% stake in VW for long-standing political reasons and weren’t selling. Now, obviously, margin calls started to come into play as the price was driven upwards, creating a cascade of capitulation. The result was that the short position suffered an epic squeeze:
Volkswagen Price Chart
What looks extreme today?
Following the automaker theme, an interesting short position currently exists in Tesla. Tesla is a value investor’s nemesis – its fundamentals defy all rational economic sense. Yet the stock price has gone from strength to strength, including an epic move up to $387 in June. Notably, though, short interest in Tesla is 27% of the float.
Tesla Short Interest
What I find interesting about this chart is that each peak in short interest since 2015 has followed a price decline; and after short interest peaked, a huge rally followed. It stands to reason that a lot of weak hands might have been late to the Tesla shorting party, and subsequent squeezes have exacerbated the unparalleled share-price performance of the world’s most consistently unprofitable automaker.
OK, but where are some big macro positions?
Copper. The red metal has been on a tear, breaking through some key technical levels. Greg Weldon captured the price shift perfectly in ‘Let’s Get Ready to Rumble’:
But where the price goes, sentiment and positioning often follow.
Copper positioning on the speculative long side has gone crazy:
HG Copper: Managed Money Position
Source: Saxo Bank
The basic short position (in red) has generally remained stable, but long positions (blue) have exploded, with the price (grey) to the upside in the last quarter. This leaves copper very vulnerable to a reversal. Without a significant pickup in industrial demand, the price of copper could start to lose momentum, and then the unwinding of a large speculative position would make for a volatile move down.
It’s crucial to consider other elements of a trade, too – positioning is only part of the story. Sentiment is another important consideration. Generally, sentiment also follows price. But weakening sentiment combined with a heavily skewed positioning scenario can lead to a significant price move. This is something Tommy Thornton of Hedge Fund Telemetry tracks in his daily: Copper sentiment is weakening even as the price pushes new highs for the year:
Source: Hedge Fund Telemetry
A big setup?
In addition to the heavy gold long speculative position, the short positions in some gold miners are worthy of note. If investors are betting big on an upside move in gold, then one of the most leveraged trades is in the gold mining sector.
Rising industry costs mean that many miners are barely breaking even at current gold prices – so a move up in gold could see a substantial turnaround in earnings. The level of short interest in some gold miners is quite extreme (as covered in The Hack June 9th) – especially when investors are betting so heavily on rises in the gold price itself.
The essential takeaway for investors remains that positioning is a part of the puzzle. Remember, just because an idea has garnered a consensus, that doesn’t make it wrong. But when we throw in sentiment shifts, price, and of course some deep macro fundamentals, everything needs to add up. Positioning shows you where a trade is vulnerable and by what order of magnitude – but often a catalyst for changes in price and sentiment needs to emerge in order to unwind the trade; and as the Porsche/VW example shows, the catalyst is usually fundamental.
The Circus comes to town
The debt ceiling debate is coming around again in September. Once it has been hit, the debt ceiling prevents further borrowing, aside from any budget agreements. This hard limit is somewhat arbitrary since GDP growth and trade rely on a continuous rise in debt.
Does it matter?
In the past, the debt ceiling has generally been raised smoothly – with the odd hiccup and temporary shutdown. Most players in the markets expect a non-event, as Tony Greer pointed out in his RVP debut:
Forecasters in a WSJ monthly survey of economists saw a 22% chance of the government shutting down. I think the odds of a conspiratorial shutdown are far less than 1 in 5. This September will be no different than debt ceiling conversations past, and have no dramatic effect on the bond market.
Essentially the ceiling is a legal formality between the President and Congress, requiring them to simply agree on a new limit so that the federal government can continue to function and avoid a technical default.
The operative word being agree
US politics has been nothing short of dysfunctional in recent years. Excessive political point scoring has sunk the political process into a quagmire of partisan positions, making real policy change exceptionally difficult. Trump has so far struggled to win the support necessary to push through any major policy initiative.
He has struggled, too, with the ghosts of tweets past:
Internationally, the idea of a ceiling seems absurd. Only Denmark and Kenya have a debt ceiling that is a hard number rather than a set percentage of GDP, and only seven countries in total have any kind of formal debt ceiling. (A number of countries might, however, be well advised to consider the idea, given where they are ultimately heading.)
Worldwide Government Debt to GDP
Will there be a government shutdown?
Sometimes partisan politics dictates that the debt ceiling debate needs to go right to the wire. For instance, 2013 saw a 16-day government shutdown and a last-minute deal to avoid a default. We could see a similar situation this time around, especially given the difficulties Trump has already encountered with all his proposed legislation.
With the US now reeling from Hurricane Harvey, another federal shutdown could prove profoundly damaging. President Trump already has an extremely low approval rating, so to be seen as an effective helmsman of the federal government is crucial to him at this point – or we could see pitch forks at the gates of the White House….
Source: The Simpsons
The bottom line for the USD
The current debt ceiling limit of $19.8tr has already been reached. The US Treasury is holding back on issuing any major bonds due to the hard limit; as a result, we should be seeing falling bond yields, especially in shorter-term issues.
However, the likely outcome of raising the debt ceiling could be a spike of renewed issuance of USTs as the government borrows again to bolster cash reserves – as I examined in ‘Game Over for the USD? Not so Fast…’. The likely outcomes are rising Treasury yields and a rising USD. I don’t think the USD will rise because sentiment concludes that US politics are now functional. I think flows of dollars will be attracted to new government debt, which will crowd out other borrowing and inadvertently raise US interest rates.
Watch for a turn.
There isn’t time each week to discuss everything that is going on in markets. Here we piggyback on previous RVP Weekly Hack talking points and let you explore some stories further.
The digital advertising giant is starting to meet challenges commensurate with its size. Just a few months after I noted Google’s record EU fine, the company is back in hot water. This time Google is trying to make amends with customers through refunds for ‘ad fraud’. (Ad fraud occurs where software bots drive fake clicks on websites.)
Google is offering only paltry 7–10% refunds to customers, due to the way costs are distributed; but the frightening issue remains: Who guards the guards in digital advertising? With layers of middlemen, automated exchanges, and an overseer (Google) sitting on top of this opaque system, something must give. Will it be the advertisers, the current market structure, or Google’s margins?
The rise of renewable energy has been slowly shifting the global energy mix away from hydrocarbons. Energy experts have continually underestimated the rising impact of solar and wind power in providing for the world’s energy needs. A group of scientists predicts that 139 countries could be powered by 100% renewables by 2050.
At the national level, bigger is better. Countries with lower population densities and more space have greater energetic potential, which should advantage nations like the US and China at the expense of micro-nations like Singapore and Hong Kong.
Until next time
You understand that no Content published, as part of the Services, constitutes a recommendation or a statement that any particular investment, security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Neither the Site nor the Services are intended by Real Vision to provide, tax, legal or investment advice, and nothing on the Site or in the Services should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by Real Vision or any third party. You alone are solely responsible for determining whether any investment, security or strategy, or any other product or service, is appropriate or suitable for you based on your investment objectives and personal and financial situation. You should consult with an attorney and tax professional regarding your specific legal and tax situation. You further understand that none of the creators or providers of our Content and Services, or their affiliates will advise you personally concerning the nature, potential, value or suitability of any particular investment, security, portfolio of securities, transaction, investment strategy or other matter. To the extent any of the Content published as part of the Services may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person but is for general, educational purposes.