Meet Mr and Mrs Consensus

• US investors convinced China’s fall is inevitable, ignoring Silk Road
• Fed is indecisive, incoherent and driven by the consensus narrative
• US investors have ignored the outside world for far too long
• Fund managers are all crowding into the same old trades

I’m just back from the US and from attending a major macro conference. Dare I say I met Mr and Mrs Consensus! A quiet unattractive couple.

If everybody meekly follows the prescribed narrative we all become sheep. Image: Grant Wood.

US managers and industry overall are stuck in second gear and cannot shift. Maybe a revisit to the late Baroness Thatcher’s definition of consensus is in order:

“To me, consensus seems to be the process of abandoning all beliefs, principles, values and policies. So it is something in which no one believes and to which no one objects. »

I have so many observations that I hardly know where to start but let me shoot from the hip:

China

Everyone thinks everyone else is getting China wrong. Amazingly, everybody thinks their own brand of analysis of China is infallible. In the case of US-based investors it is always: “…it’s only a matter of time before China caves in…”

No one – and let me stress no one even mentioned the Silk Road during my 2½ day stay – not a single a word? Remarkable considering that it’s the biggest investment/supply programme since the Marshall plan.

For the record my view remains: No one fully understand China but to ignore a 55% saving rate and the Silk Road is utter nonsense. Furthermore China’s monetary easing has a long way to go should they want to pursue that and the “net impact” of the reserve requirement ratio cuts already in place RRR cuts is about to kick in….

CNY will not ‘devalue’ before SDR inclusion is in place, but will move +10% weaker after this happens – a natural consequence of more open capital accounts and domestic pressure to do so.
In other words, not doom but certainly not gloom either, maybe Michael Pettis‘ comment comes close: « China is not going to see a soft or hard landing, but a long landing! »

Fed

Two former Fed officials attended the conference: Chairman Ben Bernanke and the Dallas Fed’s Richard W. Fisher.

Bernanke stuck to the company line of monetary policy being invalidated by lack of fiscal support and a line of argument which at best was incoherent at worst was a downright admission of Fed guidance being similar to the ancient art of tea leaf reading..

A performance, which was as “entertaining” as a lukewarm glass of water.

True to form, the Dallas Fed’s Fisher was was more clear and outspoken: “The Fed should have hiked in September”…

Speeches since the by the current Fed chair Janet Yellen and her colleague William Dudley display “remorse” , Fisher says. Again, a fiscal policy reboot was needed, but now with the disclaimer that it was extremely unlikely to happen in 2016 or 2017.

The right equilibrium rate for US interest rates was impossible to gauge, but it was most certainly higher, Fisher concluded.

The overall combined takeaway from the two Fed officials was to me: They had little grasp of the present situation, the low productivity was a conundrum for them and overall they both believed in the theory of rather going late than early.

There is a firm believe among current and former Fed officials that a 2016 hike is still on the table, but it’s also clear that Fed and its staff are lost, totally lost, as to where the economy is going, what the strong US dollar means in the medium term and are very concerned on the “structure of the fixed income market”. In other words, the Fed is not going to come forward in a clear and decisive way from here but will be swayed by whatever headline is driving the consensus.

Emerging markets

There was no love for emerging markets; most people had negative EM as their number one trade and with expectations of considerable underperformance still in store. The one comment which stood out was that if you exclude energy and commodities from EM then it’s getting cheap but not yet deeply discounted. However, excluding energy and commodities of course is futile considering the big cap companies’ main business’ in EM!

EM is cheap on all metrics in my book, but I do agree that you need a catalyst: “…a weaker US dollar in my theory”… to kick start it…

The same negative EM crowd was heavily long USD arguing that less liquidity was driving investors to the US as a safe haven. Only one attendee briefly mentioned the “global recycling trend” – pointing out that the fall in global reserves has so far in 2016 offset the net impact from European Central Bank and Bank of Japan quantitative easing!

Of course, you know my USD theory: “The end of recycling” and by definition the path of least resistance would be a lower USD for growth and a restart of positive news.

Short EM and long USD was easily the most crowded trade I took away from this week visit to the US.

Hedge funds and market liquidity

Several managers I spoke with were increasingly frustrated with their long-short equity/bottom up analysis and I sensed and got confirmed that long-short mandates increasingly meant being long Amazon, Google and Apple!

Yes, there is considerable style drift in the equity space, which can be seen in the lack of breadth in the stock market. The 2% and 20% model is under attack because infinite QE created a heavily domestic focus for both equity and macro managers. You really only needed to be Fed and US market focused to get a return. Now as volatility is increasing, as “noise” increases on the Fed’s they need to revisit global macro after seven years of neglect. Not an easy job to catch up with and telling by the quality of international analysis I listened to at this conference they need some more time to get it right.

If this is all you can think of then it’s time to think again. Montage: iStock

Conclusion

My trip to the US confirmed what I had feared:

• The Fed is lost and the “guidance failure” is really upsetting the financial markets. Fed is still looking for hikes, and 100% of people I met in the market are looking for no change.
• China – everyone thinks they’ve got the right analysis on China. I doubt it – China is an enigma but if they all ignore the Silk Road programme and 55% saving rates to GDP in their negative view surely they need more time?
• VaR – managers – extremely crowded trades: Long USD, underweight EM and commodities overall. Everyone now talks about “structural issues in the fixed income market” – the market and the Fed agree on this.

Action

None for my part.

Got 20% in gold.

Initiated first long AUDUSD (Australia – the opportunity of the decade?) Around 0.7000 gone neutral to long market.

I think both VW and Glencore are big stories, but not as big as market fears. Expect seasonal strength to play out post October 10 and I stick with my S&P projection from August, which means low, is in pretty soon and here’s why:

Source: Bloomberg, Saxo Bank

• The world has just moved one step closer to global deflation making “easier monetary policy” the response in a world of no ability to fiscally expand.
  China data will surprise on upside for the balance of 2015.
• Every time in history when the market has been more than 10% down, with falling commodity prices and a strong USD the Fed would be looking to ease not hike!
• Global easing or pretend-and-extend version 4.0 is close. Central bankers simply don’t believe a bloated balance sheet and debt financing is an issue or worse they seems to think economic theory offers no alternatives.

Market confusion is at maximum here – participants doubt Fed, guidance, top line growth, bottom up analysis and worst of all they doubt themselves.

The world is about to wake up to a new dose of medicine – the final straw before we move to the real agenda of taking losses in debt and introducing reforms?

Let’s hope so.

By Steen Jakobsen

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