Macro-Strategist Speaks Out Re Summer Sleepiness?: A Rareview with Sight Beyond Sight

Below extract courtesy of this a.m. edition of Rareview Macro LLC’s daily publication “Sight Beyond Sight”

Editor Note: Performance Speaks Louder Than Words, and the SBS model portfolio as of Aug 15 is a noteworthy +3.72% YTD (and 0.33% WTD) when compared to the universe of macro strategists who, according to news media, have been struggling (whether because of mis-timed moves, over-reaction to events, or completely missing the geo-political mark)

Neil Azous, Rareview Macro LLC
Neil Azous, Rareview Macro LLC

Many in the professional community have rebalanced their long positioning out of Europe or remain short on it against another region. The underbelly of the macro strategy is very weak and many are forgetting that unless the inflation metrics really weaken from here, there are multiple steps that will need to be taken before full-scale European style QE can be introduced. That means part of the recent spread compression, where investors bought on the view QE was imminent, needs to come out of the market. The same can be absolutely argued about Gold, since the backdrop of relative peace and the traditional correlation of the metal to Brent Crude Oil should bring the price down.

Interestingly, this de-escalation of risk is not a result of diplomacy by any party to the Ukraine or Iraq conflicts. Instead, it is the result of ongoing military progress on both regions.

Firstly, Brent Crude Oil is showing the largest negative risk-adjusted return in Commodities. While the “barrel” has been weak for days, it is the acuteness of today’s price decline, which has seen it challenging a new low in price, which is significant. This is a direct result of Kurdish/Iraqi forces recapturing the Mosul Dam following US air support. While we have sympathy for the human atrocities taking place, the market only cares about the security apparatus and containment in key oil-producing regions. Additionally, the fact that this key strategic area has been secured means it is less likely to be lost again in the near-term.

Secondly, it is being reported that Ukrainian forces continue to gain significant ground against the rebels, including taking back the stronghold of Donetsk. Why is this important?

Because if Kiev or Moscow do not want a larger conflict, the final crushing of the major rebel forces means that the next steps are negotiation or compromise. Again, this is not about lining troops up on a boarder, humanitarian concerns, or saber-rattling. That happens daily on many borders already. It is about removing the actual military action taking place. A reduction in the “fog of war” would be material.

Thirdly, the pause in the ground assault by the Israelis into the Gaza Strip has now stretched to five-days, as planned. While it remains extremely fragile, the temporary truce is expected to be extended tonight.

We are not naïve and we recognize that we have no real insight into any of these conflicts. We acknowledge as well that any one of them could change direction in a matter of minutes. However, the fact is that we start a new week with all of them pointing to a more constructive trajectory.

The second reason why Europe is seeing relief is because so much negative sentiment had built up over the last week, which was most visible in Fixed Income.

There are 17 sovereign interest rate curves in Europe. Ten-year bond yields in six nations ended at a record low last Friday. Email traffic over the weekend was extremely skewed to the move lower in global fixed income yields. The two most observations we saw most often included the fact that US Treasuries are trading at a rare yield premium over German Bunds and the relative attractiveness of US Fixed Income due to the higher yield.

Investors are also still not doing their homework – perhaps because school is still out for summer. For some reason we can’t fathom there is a belief that Russian sanctions will lead to the same cold winter weather conditions in continental Europe. While we have a lot of sympathy with the view that European growth will be impacted, it is prudent to take a rational approach. Too many have become conditioned to fear the worst. For example, there is a 4.5% difference and much less recovery time involved between a -5.0% down move in GDP (not realistic) and -0.5% (realistic). For everyone to immediately move to the view that Russian sanctions will cause a deep and prolonged recession, that is accompanied by an even larger correction in risk assets that what has already materialized (i.e. -10%) is, just childish. Instead, it is more responsible to work on the assumption of a -0.5-1.0% fall in GDP that can be worked off over six-months or sooner, especially if the EU relaxes the sanctions, which we know many policy makers would like to do as soon as possible.

Finally, it is important to note that European equities have already corrected by -10%, the data from last week showed that the flow of money out of High Yield bonds is slowing down and in some cases reversed back to inflows, and professionals have capitulated in short Sterling futures (symbol L Z1) and long British Pound (symbol: GBP) positioning. The takeaway is that positioning is much cleaner than investors realize, ex-sovereign debt of course.

Collectively, our view is that sentiment had turned too negative too fast and investors have yet to update their models with the data points on the European backdrop that we outlined above.

To be clear, we are much more constructive on the Asian and US markets and continue to believe the business cycles in those regions are diverging, and improving, relative to Europe. However, that does not mean we do not want to be opportunistic and trade a relief rally when the profile suggests we should. This is especially true when so many investors are on vacation and could be forced to chase a rally from afar or at a much higher price when they return  – if, that is, the geopolitical developments hold on to their recent positive momentum.

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