Friday Speedrun: July 7, 2023
Fireworks in the carry trade
Hello. It’s Friday. Thanks for signing up. I’m Brent Donnelly.
The About Page for Friday Speedrun is here.
Here’s what you need to know about markets and macro this week
Global Macro
Welcome to the 7th day of the 7th month in a year where the digits all add up to 7. Markets were closed for some portion of the week as the Canadians and Americans celebrated their countries’ birthdays and the rest of the world slacked off in sympathy. In celebration of the sevenness of today’s data, here are seven descriptions of how the seven deadly sins manifest in financial markets.
Lust: The lust for money makes us enter suboptimal trades with excellent optics because we dream of riches instead of assigning realistic probabilities that yield accurate expected values. When we see an option that pays 7:1 we lust for that lottery-like gain.
Gluttony: Hedge funds take on too much leverage in the pursuit of larger gains and traders put on positions that are way too big in a gluttonous search for outsized profits. Proper portion control is like correct position sizing. Gluttony can also manifest as overtrading. Investors and traders learn that each trade stimulates the dopamine center of the brain and triggers feelings of pleasure similar to those activated by a spoonful of ice cream on the taste buds or a line of cocaine in the nostril.
Greed: Wild-eyed speculators see only the right-hand side of the distribution and buy overpriced assets without conducting proper due diligence. “Greed is good” says Gordon Gekko but greed can be bad too. It can be very bad. YOLO options trading presumes one can put up $100 to make $1000 in a repeatable fashion, yet this sort of get-rich-quick, greedy mentality almost always leads to ruin.
Sloth: Speculators look for easy ways to make money, like drawing a trendline on a chart and buying when it breaks. The hard work of analyzing 10-Qs, or listening to 100s of conference calls, or reading boring central bank speeches can give you an edge in a world of lazy humans and simplistic approaches.
Wrath: Sometimes, when we lose money, we trade out of anger in an attempt to get our money back. Impulsive, angry trading is similar to the act of a gambler who is down bad and chases his losses to get revenge—and to get his money back.
Envy: When we hear about other traders making outsized gains, we are envious. This triggers FOMO trading where speculators chase rising asset prices not because they think they are making smart investments, but because they are jealous of the gains made by those they deem to be dumber than themselves. Envy and FOMO lead to herding.
Pride: Overconfidence bias resulting from excessive self-esteem or arrogance causes investors to overestimate their skill and underappreciate risks and the general efficiency of markets. Overconfidence also causes traders to overtrade and get involved in markets where they have no business trading. Feelings of superior intelligence and a history of past success can convince an investor that they are smarter than the market, even when empirical data show that this is rarely the case. The wisdom of the crowds means that markets are mostly, but not always efficient. Humility is an investing and trading superpower.
Whether you are an investor, trader, financial analysts, economist, or other financial market participant, you are best served by embracing diligence, kindness, patience, and humility. These virtues (and others) are an antidote to the Seven Deadly Sins.
The theme in global markets this week was the ripfest in yields. The US housing market and US infrastructure / fiscal story can no longer be ignored as the data comes in hot like wasabi. ADP and ISM were particularly notable and the recessionistas’ dreams of imminent collapse in the USA are on hold yet again. NFP was fine but not blockbuster.
Help wanted signs everywhere, solid earnings growth, strong ADP data, twice as many jobs advertised as unemployed people… And yet there is still a huge cohort out there yelling “bullshit!” Some people want to believe the bad news scenario so badly that they will never see good news, no matter how glaring.
Nice chart from Justin Wolfers.
The legends over at Macrodesiac call this: The Cycle That Just Won’t Die.
Stocks
Some jitters in global markets this week as rising yields finally got a bit scary. Asia was particularly weak but nothing overly alarming. The VIX popped from 13 to 16 but the pain was minimal.
Here is this week’s 14-word stock market summary:
We found out it’s possible for stocks to go down. It wasn’t that scary.
Bonds
On the verge of a breakout. Too many good data points in the US and markets can’t pretend recession is coming soon anymore. It doesn’t seem to be.
US 10-year yield
Fiat Currencies
This story was scary enough to trigger some rethink on European carry trades.
The most popular carry trade in Europe has been the Hungarian currency (HUF) and with the conflict in Ukraine still raging and economic data in Europe mostly soft… The market rotated out of HUF and into safer-seeming carry trades on the other side of the ocean. Out of HUF and PLN and into MXN, for example.
Short USDMXN and EURMXN (short USD or EUR vs. long Mexico) continue to be by far the most-favored carry trade as MXN appreciates nicely and yields in Mexico remain juicy. The other carry trade that has been working well is long USDJPY as Japanese investors like the 4% yield on US 10-year notes and the Bank of Japan remains locked in La La Land, imagining that inflation in Japan is still too low.
If you are a fraction master, you might have noticed that short USDMXN and long USDJPY can be combined into one trade by canceling out the USD legs: Long MXNJPY.
Below is a chart of that bad boy. Mexico’s policy rate is 11.25% and Japan’s is negative 0.10%! That’s a big yield differential. The economic textbooks say that investors will show gluttonous greed when presented with this sort of carry trade.
El tren imparable: MXNJPY total return, 2014 to now
Currency appreciation plus a huge yield pick-up sounds like a bit of a free lunch, and MXN has been a free lunch for more than a year. When it turns, it will be epic, but people have been saying that for months. As long as all is quiet in financial markets, MXNJPY rages on. But all is not quiet in financial markets and carry is experiencing a bit of a mini moment now.
Crypto
Crypto volumes are low, but they are no longer making new lows. That is encouraging. It’s not bullish, but it’s encouraging. Here’s the latest from The Block:
Crypto trading volumes (7-day average)
And here’s Dave Nadig with a nuanced look at the BTC ETF story:
https://twitter.com/DaveNadig/status/1676978900440604674
The approval of an ETF could take ages, but it’s a critical determinant of short-term price direction and could set up as one of many great buy the rumor / sell the fact trades crypto has become known for. You need to own GBTC or BTC before the ETFs are approved, not after.
Commodities
Crude oil is making an impressive base around $70 as SPR refill talk and multiple attempts by OPEC to restrict supply seem to be putting in a floor. The Russia / Ukraine war-driven round trip from 65 to 130 to 65 is complete and now the onus is on the bears. As long as crude trades above 62/65, it looks like it’s forming the strong base of a 65/86 range. Below 60 = lights out.
I’m a big fan of symmetry in charts because as simple as it sounds… Symmetry is a common feature of natural systems, including markets. If something rallies from 60 to 120 in 10 months (as oil did into 2022) … And then it loses steam and you’re guessing how far it might fall, and how fast… You could do worse than guess “maybe it’ll drop back to 60, in about 10 months.”
As you can see from the red lines in the oil chart, that’s approximately (but not exactly!) what happened). Symmetry is a common feature of moves on all fractals in financial markets. You can use symmetry as one of the best, simple, finger-in-the-air ways to estimate the future path of a market once you have concluded its primary trend is exhausted.
Markets tend to exhibit roughly similar volatility over time and therefore time and price symmetry are real. If you would like to go into a bit of a rabbit hole on time and price symmetry in markets, this paper from 1997 is an excellent start.
NYMEX crude oil, mid-2021 to no
Alright. That was 6 minutes. You’re done.
Get rich or have fun trying.
Links of the week
The first two links (courtesy of BB and Suv) will insert many interesting thoughts into your mind.
Interesting / smart 1
This is a long and slightly rambling read but it is well worth it and there are many, many useful nuggets. You need around 12-15 minutes of time but it’s worth it.
http://paulgraham.com/greatwork.html
Interesting / smart 2
Even if you don’t really grok every specific element of this (I didn’t) … Still interesting and useful.
There is more to the world than just rates
Good piece from Stephen Kirchner.
Music
This is not a recommendation, per se, but more an interesting factoid that will only be relevant to people over the age of 45 or so. This week was my 20th wedding anniversary and I was about to write “Looks like we made it!” in reference to the famous 1976 Barry Manilow song.
Then, I figured I’d better check the meaning of the song before quoting it because I just know the catchy chorus, not the rest of the words. Good thing I checked!
The song was first released in 1976 on his album This One's For You, and was issued as a single in 1977 where it reached the number one spot on both the U.S. Billboard Hot 100, and the U.S. Adult Contemporary chart.
Despite the optimism suggested by the song's title, the narrator is actually ruminating on the fact that he and his ex-lover have finally found happiness and fulfillment—though not with each other. They have, indeed, "made it," but apart, not together. Songwriter Will Jennings commented:
Richard Kerr and I have often remarked on the people, millions of them in the world, who misunderstood the lyric of "Looks Like We Made It." It is a rather sad and ironic lyric about making it apart and not together, and of course everyone thinks it is a full on, positive statement. I don't know. Perhaps it is... in a way.
I acknowledge the average age of a Friday Speedrun reader is probably 27 years old, but maybe I’ll save one person from some bad symbolism on their wedding anniversary here.
Great commentary, Brent - I really liked your note on the seven deadly sins with trading and its antidote: diligence, humility, kindness, and patience. Also, an interesting note on the USDMXN carry trade - wonder how long that trade goes on for? Finally, congrats on your 20 year wedding anniversary, here's to 20 more years of fun with the missus!
Great stuff. One of my ‘must reads’, along with the Haymaker and anything from Tony Greer. Love that Lucas Joyner track...