Sunday, October 9, 2011

Reflections From Greek Gods?

Hooked up with my buddy from Toronto on Saturday. He's a currency trader at a large bank and has been successfully trading for over 20 years. We are blessed with beautiful Indian summer weather in Montreal so we decided to enjoy lunch and drinks at a terrasse.

We discussed all sorts of things and because he's a successful trader who has a knack for printing money, I paid close attention to what he told me. Below are some key points we covered:
  • On the recent weakness of the euro: He told me he started shorting the euro when he got back from his vacation in Greece in early September and told all his clients to go short at around 1.41. He then told them to start covering at around 1.32. He added: "That's why I'm not that impressed when I read one of your recent comments on shrewd hedge funds that Brevan Howard and other elite global macro funds made good money in September. If you shorted the euro at the right time, you made excellent profits." He doesn't see Europe collapsing from the European debt "time bomb," but does see restructuring of peripheral economies' debt. Indeed, the latest from Bloomberg is that euro-area finance ministers are now discussing a Greek debt haircut of as much as 60 percent.
  • On why Germany still wants a strong euro: He explained to me why Germany will not allow the euro to depreciate too much. "They are a manufacturing powerhouse who want to keep the cost of their inputs low. If the euro depreciates too much, it will cause inflation and raise input costs. It will stimulate French exports, which is where the tension lies, but do little to stimulate the peripheral economies. Greece, Spain, and Portugal don't really export much and Italy exports high end goods which are fairly immune to the global slowdown as long as the rich keep buying luxury goods."
  • On the US dollar carry trade: Interestingly, he notes that the US dollar carry trade still explains why the dollar rallies every time there is bad economic news coming out of the US and why it weakens when good news comes out. This is counterintuitive but it makes perfect sense when you understand the mechanics of the USD carry trade and how global investors borrow in US bonds to fund other risky assets. Moreover, whenever there is a crisis, where do global investors seek refuge? US Treasuries, and since the US bond market is much bigger than the stock market, this is positive for the US dollar as investors need USD to purchase US bonds. Also interesting to note is the US dollar carry trade's relationship to global equities. Howard Simons of Minyanville notes: "...we are at the juncture where weak or negative stock market returns outside of the U.S. will be associated with a rising dollar and vice-versa. More troubling is the self-reinforcing nature of this relationship: Weak stock returns outside of the U.S. create dollar strength, and dollar strength erodes the carry trade into non-U.S. assets. This risk is going to be with us for a while considering how dollar carry trades have accumulated since late 2008."
  • On the Canadian dollar acting as a safe haven currency: My buddy thinks foreign central banks will start diversifying their currency holdings and this will benefit the loonie (our currency). Why will they diversify into Canadian dollars? Because they already have enough exposure to USD and euros, and got whacked when the Swiss National Bank recently decided to peg the 'safe haven' franc. When I raised my concerns over the Canada bubble imploding, he told me that will impact Canadian stocks but not the currency. "Think about it. If the bubble implodes and the Canadian economy falters, the Bank of Canada will lower rates, bond yields will drop, Canadian bonds will rally. Moreover, the Canadian economy is in a sweet spot if the US economy recovers or if China continues to grow strongly. All this benefits our currency and foreign central banks will diversify into the CAD."
  • On why portfolio flows matter: Currency gyrations are being exacerbated by the wild gyrations in the stock markets. "Large swings in the stock market force big funds to rebalance their portfolios more often, which leads to big moves in currencies. This is where discretionary trading becomes important because if you understand when these portfolio rebalancings are occurring, you can profit."
  • On whether the China "bubble" is about to pop: Everywhere you look, people are warning you that the China "bubble" is about to pop. My friend and I think this is total rubbish. I like what he said: "Every government lies about their economic activity. I don't trust US official figures going into elections next year and I don't trust Chinese figures either. The Chinese will lie about the real growth rate which probably fluctuates around 6 to 9%. If they publish too strong of a growth rate, investors will fear overheating and inflation. If they publish too low, all the doomsayers will scream the bubble is imploding, so they prefer to manage expectations. Following the Olympics, growth did come down, but China is still growing strongly. more importantly, the Chinese are planning long-term, not short-term. They're thinking and planning for the next 30 years, not the next five years. They will eventually overtake the US as the number one economy, but that's decades away. The US remains the world's most important economy" (I agree and have written on the myth decoupling).
  • On the real inflation rate: My friend told me that inflation is running much higher than official figures show. "They tell us to look at core inflation which excludes food & energy costs but that's a huge chunk of people's budgets." I told him that I noticed Starbucks jacked up the price of their coffee and that coffee prices in general have been rising sharply, but that the long-term threat to the global economy remains deflation, not inflation. Demographic trends, high unemployment, technology and other structural factors will keep inflation in check. The biggest fear of financial oligarchs is that we are heading towards a Japanese-style protracted debt deflation period, which is why they'll keep pumping liquidity into the system.
  • On where stocks are heading in Q4: My buddy is bullish on stocks in the short-run (see Gann360's pitchfork setup) and generally in the long-run but he also trades them and rarely buys and hold stocks. "They'll keep pumping liquidity into the system and stocks will rally and stumble along the way." I told him that I found the moves in Q3 were way overdone, especially on Chinese solar stocks which got hammered into oblivion and Chinese shares in general. Some Chinese companies' shares like Focus Media (FMCN), rallied sharply last week. I still feel that extreme pullbacks in Chinese solars should be bought, but investors tread carefully, these are very volatile stocks that have entered a death spiral as of late.
  • On where banks are heading: My friend told me he sees banks being "recapitalized and nationalized." Indeed, Zero Hedge reports that Dexia's Belgian bank to be 100% nationalized and the way things are heading, other banks will be nationalized in the future.
  • On the UBS scandal: By now everyone has heard about the UBS rogue trader who lost $2 billion. "They fired the CEO but they should have fired everyone else below the chain. Our bank has a series of risk measures including detailed reporting to prevent against such losses. A group of people there didn't do their job. What's worse, this was a delta-one strategy, highly levered to the Swiss franc, and you'd think the largest Swiss bank would have known that the Swiss National Bank was about to peg the franc. It also shows you how corrupted these Swiss banks have become because they accept monies from dictators around the world who in turn place their relatives in positions at these banks even if they're not qualified and then they're surprised when spectacular blowups occur." Told my friend that it's not just Swiss banks; the same thing happens at some Canadian banks where incompetent fools are placed in positions of power because they're good buddies with the CEO.
  • On the "Occupy Wall Street" movement: We talked a lot about income inequality in the US and elsewhere and where global capitalism is heading. The "Occupy Wall Street" movement is spreading across America. I think people are fed up with the tyranny of financial oligarchs and how they control governments across the planet. People are suffering from unemployment and witnessing record Wall Street bonuses. My friend cautioned me, however: "'s not just a Wall Street phenomena, it's across corporate America where CEOs get paid multiples of workers. I know I make a lot of money trading currencies but my total comp represents 3% of what I personally make the bank and unlike others who can write off expenses, I get taxed hard on what I earn and have the constant pressure to produce." He's right but I think that there are still too many weasels Wall Street who are not producing anything of social value and are not paying their fair share of taxes. Also, I believe the reason why Warren Buffet is asking the ultra-wealthy to pay their fair share of taxes is because he's ultimately afraid of a social revolution. Don't laugh, communism was overthrown and this model of financial capitalism is on its way to being toppled too.
  • On the Greek and European crisis: We talked a lot about Greece and Europe. Over the weekend, Troika officials are criticizing the slow rate of reform implementation in Greece. But even though everyone is focused on the negative headlines of the day, Europe and Greece will eventually come out of this crisis stronger. Germans are already backtracking and starting to invest in Greece. Of course, they're dictating the terms and German companies will profit handsomely. Greece will also benefit. One of the biggest projects Germans are investing in is a huge solar farm. This will create jobs and help cut the Greek debt over the next decade. We also talked about the Greek-Israeli alliance and think this is very positive. Israelis and Russians are interested in exploring natural gas deposits in Cyprus and even though this is causing tensions with Turkey, this will help bolster the respective economies of the region. Greece has so much potential. It should truly consider becoming the financial center of Europe and incite financial firms to set up their trading operations in Athens. Of course, London and Berlin will protest.
I leave you with a must watch episode of CNN's Fareed Zakaria GPS (will post full podcast when it is available). You'll see excellent interviews with Starbuck's CEO Howard Schultz, Michael Lewis and Tom Friedman. I really like the interviews with Schultz and Lewis. Lewis' new book, Boomerang, is now on my must read list. Lewis said we get the democracy we deserve and he thinks the crisis is not over, it will get worse, and only then will real change come.

Finally, my friend and I talked about our future. Told him as long as I'm healthy, want to stay hungry, stay foolish, and explore more entrepreneurial ventures. We talked about starting a global macro fund here. He already has a sizable tranche of seed money if he decides to start a hedge fund (not as sexy as people think) and I'm working on getting him meetings with institutional investors I trust. He is a true alpha generator and has a proven track record of delivering incredible risk-adjusted returns. There is no doubt in my mind that he can easily work at Bridgewater, Brevan Howard or other top global macro funds but for now he's happy where he's at and he knows the meaning of enough.

As we parted ways, we agreed that crisis or no crisis, Greece will always be paradise for us and millions of others. I'm still suffering from post paradise stress disorder as my mind is still in Crete (do you blame me?). I'm hitting the gym hard trying to shed off the weight I put on there eating awesome food and drinking a few beers by the beach. When it comes to enjoying life, Greek Gods will continue smiling on Greece and trump those annoying global macro gods we fear. I wish Canadians a happy Thanksgiving and Americans a happy Columbus Day.

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