Too bearish, too late

Posted on October 7, 2015 by Greg

The Gibbs’ family in Singapore was breathing a huge sigh of relief yesterday.  Our application for an E2 investor visa for the USA was successful.  After several months of preparation the 5 minute interview at a window at the US embassy in Singapore was a breeze.  My wife and I celebrated with an impromptu lunch at one of our favourite restaurants – Catalunya’s, looking out over Marina Bay with a bottle of cava and our favourite tapas.

Part of the visa process was to write a business plan showing how I intend to make a genuine economic contribution to the US economy.  My immigration lawyer in Denver, Colorado diplomatically suggested that my five page first effort was not going to cut the mustard.  I am sure you can imagine my 30-page final effort with pictures, graphs and tables lays it on pretty thick.  I made it sound like I am going to be the next Bridgewater Associates. I pointed out that Ray Dalio, started out writing his “Daily Observations” from his two-bedroom apartment.  I wonder if there is a graveyard for old business plans.  Perhaps my grandkids will get a laugh one day pulling it out of a dusty box from my den.

In making my impassioned plea for how my business will thrive, I of course pointed out how the big banks at the core of the FX business, accounting for much of the turnover, information flow and research, are under fire from regulatory changes and litigation and major cultural change.  The business is being shaken up and will never revert to where it used to be.

Banks are moving away from risk taking, more capital is heading to hedge funds that are getting less information. There are increasing numbers of smaller players with better access to electronic platforms but less access to research or market colour.  Banks are now heavily scrutinizing what they say to each other and customers, what goes into research reports, who they are sent to and indeed received from.

Needless to say banks are being forced to cut costs and their market operations are heading in the direction of selling only an electronic platform for execution, not surprisingly cost cutting extends to their FX research departments.  Drum-roll please…. enter Amplifying Global FX Capital…..

Maybe my business plan was egging the custard a bit too much. But one of the top stories on Bloomberg today is an article that reports “Currency Dealers Withhold Trading Ideas amid Regulatory Scrutiny” {NSN NVSW566JIJUY<Go>}.  It reports on a survey done by Greenwich Associates of 2,600 participants in currency markets, corporations and financial institutions in the Americas, Europe and Asia from September to November 2014.  I am not quite sure why the results are reported a year later, but they put some respectability on the claims in my business plan.

A casualty in this change is market efficiency. We all learnt about the Efficient Market Hypothesis in finance classes; the idea that information is immediately factored into prices, making it very hard to ‘beat the market’.  This was very good for governments and regulators, because markets approximated fundamentals and gave the right signals to business and households, making the economy more efficient.  Well it doesn’t take rocket science to figure out if you stop the flow of information, market efficiency goes out the window.

The other laugh of the matter is that many regulators thought that electronic trading made markets more efficient because they generate more volume on narrower price spreads.  It doesn’t work that way, because sometimes it’s pretty clear that everyone is on the one side of the market and then liquidity when it is most needed dries up entirely.  If you don’t have risk takers at the heart of the market making prices, then who is going to make the market?  The answer is that regulators themselves are going to have to make the market; memo to the Swiss National Bank, next time Euro-Swiss falls off a cliff, stick some bids in.  The beauty of this inefficiency is that it is going to make it easier to beat the market if you have the skills and experience. It’s also easier to lose money if you don’t.

Looking at recent market developments, we can see some sharp reversals in a number of rather un-loved emerging currencies.  These include the BRL, TRL, IDR, MYR and THB.  There are some significant short-squeezes underway.  The market had gotten itself in a very bearish frame of mind, possibly a little late in the game, fearing too much a crash in China and further weakness in commodity demand.

Several reports had noted a large exodus from emerging markets.  Reuters reported on 1 October that the Institute of International Finance reported that net capital flows to emerging markets will be negative this year for the first time since 1988, with foreign investment halving from last year and heavy outflows from residents, (link to article).  Bloomberg had a similar report on 29 September noting “Foreigners Pull Record $5 billion as Southeast Asia Stocks Sink”.  So this would gel with a market that was short or under-weight in EM assets.

As discussed in our previous blog-post (Looking for a few quick singles), there have been several events and reports in recent weeks putting the wind up investors and sending them scurrying for the hills.  Not least was the growth downgrades by the IMF reported yesterday presaged by its MD Lagarde a week earlier, along with warnings on emerging market corporate debt in the IMF Global Financial Stability Report.

However, just as the market was getting more panicky and eyeing further collapse in commodity assets, most of the supporting information was dated.  In fact some more recent indicators from China were more balanced.

In the last week, the biggest piece of news has been weaker than expected US labour data, making many doubt the Fed will hike rates this year and perhaps not until well into next year.  I caution here that some Fed members are still saying a hike this year is on the cards.   I am keeping an open mind on the Fed, their messages are all over the place, who knows what they will do.  But it is fair to say, if the labour market is going through a less strong patch, then they will wait until it is clearer that the labour market is tightening further before hiking.  Consequently the USD should be less strong.  And this is supporting the rebound in emerging market and commodity assets.

Asset markets, particular in emerging markets, had already been hit for six, so news of a somewhat softer US labour market was unlikely to further significantly drive funds out of EM markets.  On the other hand, the prospect of lower US rates for longer might send funds back to EM and commodity currencies, at least for a time.

The market appears to be quite flat-footed.  Many commentators are sticking to their bearish calls for China, EM and commodity markets, and not reacting to technical break-outs in several markets, including oil prices, several EM currencies and equities.  China is back from its holidays’ tomorrow and its equites may well join the rebound.

This all may turn out to be noise in a more volatile environment, but in the near term, the market’s excessive bearish mood is likely to be further challenged.

My IT skills are also being challenged.  It looks like I managed to wreck my website ampgfxcapital.com.  I have killed the home page and it is impossible to login.  So I am waiting for my tech guru’s in India to come to the rescue.  So I can’t post this blog, but at least I can email it to you.

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