Odd Lots - These Were The Most Important Stories for Traders In 2018

Episode Date: December 24, 2018

2018 will go down as one of the most pivotal for financial markets since the financial crisis. We saw the return of significant volatility, amid poor returns in several asset classes. On this week's episode, host Joe Weisenthal speaks with Bloomberg macro strategist Cameron Crise and cross-asset reporter Luke Kawa about the key themes we saw this year.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa, play the podcast, Odd Lots on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. Tracy Alloway is out this week, unfortunately. But with me in the studio here for today's episode, I have Bloomberg macro strategist, Cameron Christ, and Bloomberg Cross Asset reporter Luke Kawa, and I'm very excited to talk to both of them because we are going to do our year in review of markets. Or basically just talk about what the heck happened in markets this year, because I think it was one of the most interesting times for markets across many asset classes that we've had in several years, maybe most interesting since 2011 or the financial crisis, or maybe at least 2015, 2016, and I think a lot of people have questions about what's going on.

so hopefully we will try to answer them. So Cameron and Luke, thank you very much for joining us. Always a pleasure. So it's always tough to disentangle reasons for market moves. And Cameron, I think you're one of the most strident in sort of pushing back against any attempt to do that at all. Nonetheless, this year was characterized by a very sharp turn starting in early October, where we saw some major winners just completely fall out of bed, tech stocks, U.S. equities, which had been doing pretty well up until then, just started getting relentlessly destroyed.

What happened? Well, I think you need to look actually back to February because we had a very similar phenomenon in February. And the genesis was broadly similar, I think, in both instances, where you had a performance, a very good equity market performance that was punctuated with a sharp rise in market interest rates, say the 10-year yield. And at the same time, inflammatory rhetoric from the U.S. president vis-a-vis trading relationships with China. And that is kind of a potent and lethal cocktail for risky assets. And you had a market that was out over its skis. And if you, you might not be old, neither one of you are probably old enough to remember the old wild war.

wide world of sports intro where there was a ski jumper. I remember that. The thrill of victory in January and over the summer and then the agony of defeat. Yeah. In sort of February and then October thenceforth. And so when people try to say, oh, is it the Fed? Is it trade? Basically, you can't really say it.

I think it's a combination of a number of things. I mean, we need to take a step back and remember that the Fed is in the midst of a tightening cycle. monetary policy has gone from unquestionably accommodative to arguably neutral. We had a similar phenomenon, obviously, in 1994, 2005. In both of those years, Fed tightening years, the multiple of the S&P 500 fell pretty sharply. And this was just, I think, to some extent, the latest iteration of that phenomenon. Luke, come in here. When we write the story of this year, the story of this year will be the huge blow-up of the short ball trade, of the trade that essentially you could make your living easily from early 2016 through January 2018.

Early in the year, we had pretty much every equity borne overbought territory. And, you know, things were great. We blew past everyone's, uh, everyone's S&P 500 target or at least like a quarter of analyst targets within the first five sessions. And then it all blew up. And then at two other points this year, two other large market moves that you can attribute to really the, the perils that can befall you when you sell options. when you sell volatility, the drastic fall in crude and the drastic rise in natural gas that wiped

out option seller.com. I think this year is a year we learned how dangerous options can be, or if, you know, people who needed a reminder of that lesson over the past couple years, this is where you really learned it because there's nothing like, you know, your February and then recently what we've had in crude and natural gas. I think that speaks to a theme that old grumpy people like me like to talk about, which is as financial markets have become younger and younger, you've sort of winnowed out people who have seen previous rate hike cycles and know what a rate hike cycle looks like. And typically it is associated with higher volatility. So it's the kids, it's all the youth. Get off my lawn and quit selling options, kids. The Canadian millennials have already traded through a bear market, though. So that narrative, I'd like to. How much is the sort of death of the short vol trade connected to changing Fed policy and a less accommodative, a tightening cycle, basically? I find it less so, just given how, you know, the trade did kind of blow up spectacularly.

And we went on to then price in even more, you know, Fed tightening through Euro dollars for calendar 2019. than we had at the time of, and the fact that, you know, if we were thinking this is, you know, a rates fall transmission, we still haven't gotten rates fall. So I'm wondering the extent to which this will be a 2019 story

in which rates fall really amplifies the equity vaults. I'm not sure that's happened yet this year. I think we also have to look at, we're so used to relying on monetary policies are sort of signals. Let's not forget the importance of fiscal policy because we had the big tax cut passed at the end of last year.

we're having a blowout in the fiscal deficit of the United States. This year, that's meant much higher issuance, both at the long end of the curve and the short end. And that short end issuance, T-bill issuance, has squeezed liquidity to a degree. And at the same time, the Fed is engaging in what's popularly known as quantitative tightening, which I don't think necessarily has a direct impact on, say, equity prices, but it does make short-term liquidity conditions less um, ample than they have been over the, over the last few years. So we've kind of had, uh,

we started the year with markets really excited about the earnings potential created by the tax cut. And the rest of the year, to some extent, has been about, if you will, the negative externalities of the tax cut in terms of the deficit and what that's meant for fixed income markets. One of the things you said, uh, in your first answer is that what characterized recent volatility starting in October and what characterized the volatility spike we saw in February was the fact that unlike in previous sell-offs in the post-crisis era, we saw people selling treasuries at the same time so that if you have a diversified portfolio, some stocks,

some treasuries, you were losing on both sides. You weren't getting that natural cushion. What changed there? Why hasn't this year up until I guess maybe sort of December? Why hasn't it been the case that when equity, volatility spiked, people went to treasuries as a safe haven? Well, I think to some extent this issuance dynamic and the deficit played a part. You know, you also have a new Fed chair, chairman in place this year who essentially got in the seat and came across as more hawkish as his last couple of predecessors. Yes, the Yellen Fed did hike rates three times last year and initiate the balance sheet roll-down process. But I think people had this underlying belief that, listen, we know that if the stock market rolls over, you know, Janet's got your back. And there hasn't been the sense,

I think, that the Powell Fed has got your back until very recently. But Luke, even with the market volatility, the U.S. eco-data looks good. And of course, ultimately, the first, ultimately, the first fed's the Fed has a dual mandate. It's employment and inflation. It's not the stock market. And on its dual mandate, the thing it's sufficiently charged to do, things are still looking okay. Yeah, right? Like we've got, well, we've been at full employment since, you know, you can rewind the clock. Some people think we've been there for three years. We still keep managing to print well over 100K. Inflation, you know, around 2% by by most preferred measures. And I think this is something that, You know, you and I have talked a lot about this year is also characterized that macroeconomic vol, you know, throw out your kind of your turkey shocks and your outside U.S. stocks.

The macroeconomic volatility of the U.S. economy has not been large whatsoever. However, you know, it seems to speak to more changes in market structure for why we're able to get these moves that do make us think that something is going suddenly arrive. What do you mean? Changes in market structure. I mostly the I would bow to cam here and the the withdrawal of liquidity post-crisis regulation that are making it essentially market making is is less of a thing bank balance sheets are not really extended to the same extent and and the rise of passive money all of this allows you to I think have sharper market moves and the thing I wonder is if you're an active manager in this environment is generating alpha more a matter of when you get in than what you're. you buy just because of how the liquid markets have been and how sharp some of the moves we've gotten are. Cameron, you have thoughts on that? Yeah, I think an underappreciated factor, and I think it's underappreciated because it's difficult to quantify, is the increased prominence of quantitative strategies as well, whether it's Vol targeting strategies, which isn't quite the same as the

VAL selling stuff, but it's kind of the sort of the red-headed cousin, if you will, where there's this requirement when the stock market declines for these types of strategies to sell futures, essentially, to reduce its portfolio risk. And then the risk parity stuff, which is a common sort of bogeyman in the closet. And going back to your previous question about stocks and bonds and sort of falling in tandem, they are a popular cause for that because they tend to be, they own stocks. They own generally. own a lot of bonds. And when bonds start to fall, then they have to de-risk everything and they sell everything. Who knows how much of it is down to these guys, but they're certainly, they

weren't there 20 years ago. Right. And they are there now. So it is at least one change in the market structure. I'm picturing you tweeting that and Cliff Asness see your tweet and him freaking out about efforts to blame the computers. Well, funny enough, you mentioned Cliff Asnes. I noticed that the AQR risk parity is no longer. Mutual fund, they're changing their name. They're disbranding, you know, they're removing the risk parity name. So, I mean, maybe that's ringing the bell for the bottom of this phenomenon. Capitulation.

Like, I don't know. Can we talk about the year in trading and the year in markets in 2018 without talking about the effect that just the trade issue has had both stateside and on the broader outlook? Like, I, you can take it, you can take your pick, whether it really started in March with deal or really escalated later in May, but it seems as though everyone was calling for 2018 to be a year of convergence, and the rise of the trade issue completely blew that up. Yeah, I mean, it's been one of the stories of the year. And what markets hate above everything else is uncertainty, right? And that's what we've had with this trade story. Will it be resolved?

When will it be resolved? Will there be, will the tariffs that Trump has announced be enacted? Will there be new tariffs announced and then enacted? Will we have a deal? If so, what will it look like? Oh, who are we going to arrest next? It's become very, very difficult. And I think you look at the UK and the Brexit fiasco, which we haven't talked about yet, as another example of uncertainty. And look at how that's impacted British markets, both stock market where the multiple of the footsy has gone down by 27. percent this year, which is a heck of a lot more than most other markets. And then obviously the pound, which has been, well, pounded. An interesting story with trade is that as the issue's

been raised, mainly you saw whenever it was having an effect on markets, it would have an effect on a sector basis within the U.S. You know, you sell your industrials, you try and hide out in small caps. But then on the global level, it was happening more on the index level, aka sell everything but U.S., China especially underperforms. Yet from the beginning, we've had, you know, this inkling or this idea that we were going to move into tech sometime, that this was going to be about tech, that this was eventually going to become about IP, supply change, and semis. And one thing we've noticed since the recent trade truce, if you want to call it, is that you're starting to see more effects of trade play out on the index level in the U.S.

So that's one story that has been, a 2018 story that is changing as we head into the tail end of the year. The news doesn't stop on the weekends. context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gura. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Ruffini.

We'll bring you the latest headlines, in-depth analysis, and big interviews. All the stories that hit home on your days off. And I'm Lisa Mateo. Watch and listen to Bloomberg this weekend for thoughtful, enlightening conversations about business, lifestyle, people, and culture. On Saturday mornings, we put the past week's events into context, examining what happens. in the markets and the world. That on Sundays we speak with journalists, columnists, and key political figures to prepare you for the week ahead.

Join us as soon as you wake up and bring us with you wherever your weekend plans take you. Watch us on Bloomberg Television. Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts. I'm glad you brought up Brexit and the international situation because even while U.S. stocks were doing fairly well up until early October, the international scene was pretty ugly, particularly emerging markets this year. And I think it's pretty remarkable because I think even as recently as January, we were still talking about global synchronized growth. I don't remember when we stopped, but I think it was earlier this year, which just seems like I can't believe that was 2018 that global synchronized growth. I don't remember. I

as growth was a phrase that people was on people's tongues because it just seems like such ancient history. Yeah, I remember going on your television show in late January and the eight shares, the China Enterprise Index, hadn't gone down

in almost a month. Like, it literally had gone up every single day. Now, obviously that sort of thing can't persist forever and like all great parties, you know, the hangover is usually pretty vicious, which it's been this time around. You know, it's interesting because I think most people would focus on the trade stuff as being a reason for this

underperformance of emerging markets. And that to some extent that's true. But there's a couple of other issues as well. One is the lagged effects of China's own de-leveraging process, which began last year, which is in the absence of any trade tension with the U.S. was always going to slow China's economy this year. And that obviously ripples through the rest of the world. particularly the emerging world who sell to China. And two, the hangover of dollar borrowing, which Luke alluded to a little bit, the dollar borrowing over the last sort of six, seven years by emerging market countries with large external vulnerabilities, the turkeys, the Argentinas, you know,

the Indonesians of the world. And as liquidity is withdrawn from them, I think that ripples through the system as well. Yeah, it was kind of interesting in the early stages of trade heating. up. You know, everyone expects the textbook tells you that, you know, this should have been dollar positive. It wasn't quite in the early stages. The figuring out the dollar this year has just been, you know, kind of a headache at the beginning of the year. We were, you know, it was all about twin deficits going to drive the dollar, going to weaken the dollar. And then, you know, at a certain point, we said, you know, real rate differential, growth differential. It's all going to

be about strength of the US dollar. And, and that's something that's, that's weighed on EMs. Also, the big underperformance of bat stocks, your Baidu, your Alibaba, and your Tencent. Like, in the U.S., it's... These are for those who... These are huge Chinese Internet companies that also have a big weight in emerging market equity indexes. And when you think about how, like, early in the year, we were worried about the potential for Facebook to really get regulated to come under the crush there, that hasn't happened.

Congress has been kind of a joke on that. If anything happens, it's been in Europe. Yet in China, they're actually, like, cracking down on Tencent's ability. to offer new games. So they've been swimming against, you know, regulatory headwind, as well as a slowing growth headwind, as well as a, you know, equity market that's coming under trade pressure headwind. Going back to something you mentioned Cameron about, again, I think it was when you mentioned Brexit,

but something I've been thinking about is, okay, markets hate uncertainty. And there's uncertainty really everywhere you look. And I think there's a real dearth of institutions or individuals. that you can look to that you can say, okay, I feel like really confident that they've got to handle on this. We all know we don't need to talk about our president and his Twitter habit. We have a new Fed chair who strikes me as very competent, but also inconsistent at times. And I think it's hard to like figure out the Powell Doctrine or what the Powell worldview looks like. There was a point earlier this year where I thought, oh, he might actually be more doveish than Janet Yellen.

Then there was a point of it's like, well, he seems more hawkish than Janet Young. It's hard to put a finger on him. And then you look, of course, at Brexit and, you know, you can't have any confidence in any institution there. Talk about that, what that does to the markets. When there's just no institution that someone could say, okay, the adult is going to step in the room and set a clear policy path forward. We can feel confident it'll be executed. Well, I'll take a small issue with your preamble there. I think Powell has generally been fairly consistent. You can argue that he may be overstepped a little bit in early October with his comments about being a long way from neutral. But I think if you look at that comment in the context of what he was saying at Jackson Hull, the symposium in August, which is that the whole concept of neutral interest rates, particularly in real time, is kind of specious.

You know, it's not sort of a line in the sand that you approach it, and as soon as you step over, different things happen. The best you can say, it's kind of a range, and you only know in retrospect what neutral really was. So I'm going to give him a little bit of a pass there. And frankly, I find him quite refreshing because he speaks relatively plainly. And I think generally he's been fairly upbeat about the state of the economy throughout the course of the year.

So maybe I'm just inclined to give a plain speaker a bit of a bit of a technique. I like the plane. But in terms of the effect when you start to question or worry about institutions, I think there was a while there in early October where there was a popular narrative that, you know, the Fed's going to hike until something breaks. I think everything from October 3rd to now has been trying to put that issue to bed and them trying to say like, hey, if the data weakens, we're going to respond. We're not dead set on moving very quickly. They've done a good job of retaining that optionality. But to the larger point of

what does it mean for markets when you start to question institutions? Well, you talked about the FITC re-rating. We've talked about the S&P 500 three rating despite earnings. It seems like you just pay less for each dollar of earnings because you're not as confident in the backdrop. That seems to be one effect. I mean, ultimately, uncertainty and lack of confidence in institutions requires is a higher risk premium across, across assets, across currencies. I mean, obviously, currencies, it's a bit difficult because you have to, you have to buy something. You know, if you buy Eurodollar, you have to buy one, you trade Eurodollar, you have to buy one to sell the other. I mean, maybe you could argue gold, but even gold has been pretty, eh. I mean,

given the apparent manifest risks across markets, it's been pretty, eh, this year. That has been one of the funny jokes of the year, hasn't it? Real rates. Real rates. Not as funny as Bitcoin. Well, let's not talk about that. That's been probably my favorite part of the year, it's the demise of the Lambo crowd. Hey, there's a popular long Bitcoin short the bankers trade that's currently in early December on a six-week losing streak.

Even as banks have gotten absolutely pummeled, that kind of speaks to how bad it's been for Bitcoin. But I think one of the, and we'll see how it plays out over the next year or two, But I think what's been a change this year talking about institutions is the first time and a long time that you've had the president of the United States overtly criticizing the Fed and Fed policy. And I think if you had gone back five years ago and you, you know, change the names to protect the innocent or whatever, you know, whatever the stock disclaimer is on those reality TV shows, if you had said, if you would put the quotes that we've had from Donald. Trump this year vis-a-vis the Fed and shown them to people and said, what will this do to markets? I think they would have said, well, you're going to see a lot of volatility and you're going to see the salt market lower.

And I mean, there's a tendency to just wave Trump off and say, well, it's just Trump being Trump. But, you know, eventually this stuff kind of matters. Yeah. And maybe we were just accustomed last year to nothing mattering. Even North Korea tests. Yeah. No matter.

And let's let's let's not forget. Last year was the anomaly. This year is not the anomaly. Last year was the anomaly in terms of the absolute absence of volatility or drawdown or anything. I mean, the sharp ratio of the S&P or a 6040 portfolio was way too high relative to history. And then this year we got in October the worst month for the 6040 portfolio since the financial crisis. So that's the kind of our, that was our coming full circle money. Every party has a hangover.

Yep. As I learned my chagrin over the weekend. On that note, I think that is a perfect time to end it. This has been another episode of the Oddlots podcast. I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. My normal co-host, Tracy Alloway, is off this week, but you should still follow her. She's at Tracy Alloway on Twitter.

And you should follow our guests. Cameron is on Twitter. He's at Fifth Rule. and Luke is on Twitter. He is at LJ Kawa, and sometimes they banter and go back and forth and argue about all these things that we talk about if you want more. And you should follow our producer, Tofor Forges on Twitter. He's at Forges T, as well as the Bloomberg head of podcast, Francesca Levy, at Francesca Today. Thanks for listening.

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