Buttonwood

A spike in the dollar has been a reliable signal of global panic

Are we due one?




There are two types of sellers in financial markets. The first kind sell because they want to.

They may need cash to meet a contingency; or they might coolly judge that the risks of holding an asset are not matched by the prospective rewards. The second kind sell because they have to.

The archetype is an investor who has borrowed to fund his purchase and has his loan called. If there are lots of forced sellers, as can happen in periods of stress, the result is a rout.

Involuntary selling can amplify any decline in asset prices. A called loan is not the only trigger. It might be a ratings downgrade; an order from a regulator; or a jump in volatility that breaches a risk limit. What happens in the markets then feeds back to the broader economy, making a bad situation worse.

This brings us to the dollar. An evergreen concern is the scale of dollar securities issued or held outside America. In the midst of the financial crisis of 2007-09, the Federal Reserve set up currency-swap lines with other central banks to deal with a lack of dollars, as borrowers outside America were caught short. In stressed markets a spike in the greenback is a tell. Investors sell what they own to buy the dollar not because they want to but because they have to.

So far the dollar has traded reasonably. In recent weeks it has rallied against a clutch of currencies hurt most by the slump in oil and commodity prices and lost ground against the yen and Swiss franc (the other havens in a storm) as well as the euro (see chart).

Perhaps there are stresses out there, but they are obscured by other factors weighing on the dollar. There has been a sense that it is due a fall. It looks expensive on yardsticks of value, such as purchasing-power parity. The Fed’s interest-rate cut earlier this month, with further reductions likely, means that holding dollars has become less appealing.



Yet it is easy to forget how bearish sentiment on the dollar was in 2008. Many expected it to fall in the teeth of a crisis that had, after all, originated in America. Instead it spiked as banks outside America scrambled to get hold of greenbacks in order to roll over the short-term dollar borrowings that funded their holdings of mortgage securities.

In 2015-16 China ran down its reserves by $1trn in part to meet demand for dollars from Chinese companies who had borrowed heavily offshore. And notwithstanding attempts by countries, such as Russia, to de-dollarise their economies, the greenback is as central to the world economy as it ever was.

If there are hidden strains in cross-border finance, they will eventually be revealed by spikes in the dollar.

It would be foolish to rule this out. No doubt pockets of stress will emerge in the coming weeks—a hedge fund, say, that has borrowed dollars to buy riskier sorts of assets and faces a cash crunch.

But the sort of aggressive borrow-short-to-lend-long bets that intensified the 2007-09 crisis have been much harder to make. Banks have tighter constraints on their lending. Panic by overborrowed foreigners does not seem a first-order concern.

Other plausible, but voluntary, changes in behaviour would affect the dollar in a variety of ways, or not at all. Foreign investors might simply choose to sell (or refrain from buying) American securities amid the current turmoil—a sort of financial self-quarantine. But surplus savings must be put to work somewhere.

Asian funds have been steady buyers of overseas debt securities. Japan’s Government Pension Investment Fund, a $1.6trn pool of retirement savings, had signalled that it will increase its holdings of foreign debt and equities in the coming financial year.

There is no sign that it is backing away from this, says Mansoor Mohi-uddin, of NatWest Markets in Singapore. Indeed there is a logic to its front-loading foreign-asset purchases, as a means of weakening the yen and helping Japan’s exporters.

Japanese funds have in recent years preferred to buy euro-denominated debt, because the costs of hedging euro currency risk is low.

But if the Fed keeps cutting rates, dollar hedges will become cheaper. Currency-hedged Asian investors might then tilt towards American assets.

That would be neutral for the dollar (because of the hedging) but a welcome fillip for issuers of corporate debt in America.

The dollar remains an unloved currency. Witness the surge in gold prices spurred by seekers of an alternative. It is the currency investors are forced to buy, not the one they want to buy. The dollar’s calmness is reassuring. A sudden spike in its value would be a bad sign indeed.

Coronavirus is a global crisis, not a crisis of globalisation

The distinction matters as leaders will otherwise draw the wrong lessons

Robert Armstrong

web_Coronovirus economic drawbridge
© Ingram Pinn/Financial Times


There is no longer any doubting the seriousness of the coronavirus crisis. But we need to be clear about what kind of crisis this is. It has the potential to do worldwide economic and human harm.

But it is not the result of a flaw in the organisation of the world economy, in the way people, goods and money flow across the globe. It is a global crisis, not a crisis of globalisation.

The distinction is important, because if politicians and business leaders take the wrong lessons from this crisis, the world will be less prepared for the next.

It is not surprising that, when Covid-19 still looked like a Chinese rather than a global problem, US commerce secretary Wilbur Ross said that the virus, regrettable though it was, would “help accelerate” the return of jobs to North America. If you see the world economy as a zero-sum game, one country’s loss must be another’s gain.

For US president Donald Trump’s trade adviser, Peter Navarro, the virus shows “we cannot necessarily depend on other countries, even close allies, to supply us with needed items”. The best response to any threat, on his view, is to pull up the economic drawbridge.

What is more surprising is that the Trump administration is not alone. The virus has revealed the hidden costs and fragility of global supply chains, triggering a “backlash” to globalisation.

Happily, the backlash so far is only among politicians and pundits. Yes, some supply chains were shortening long before the virus hit, and this crisis will lead to changes in others. But companies still see the advantages of global trade, consumers still benefit from it, and it still makes the world a safer place.

Economically, coronavirus sits alongside the Fukushima earthquake and nuclear accident, US-China trade conflicts, and other recent global disruptions. What they have in common is that they demonstrate the dangers of highly concentrated, just-in-time supply chains — not international ones.

For too long, companies arranged their operations with only cost in mind, says Per Hong, a supply chain consultant at A T Kearney. Yet crises “underline the need for companies to design their supply chains around risk competitiveness” rather than cost alone. The companies he works with are not localising supply, but mitigating risk with regional diversification. “It is the exact opposite of unwinding the global nature of our supply chains,” he says.

Fukushima demonstrated how much of the global microchip supply chain passed through Japan, with many lower-tier suppliers clustered near the earthquake. But afterwards, as Willy Shih of Harvard Business School points out, big customers saw the risks and shifted some of their sourcing to Taiwan.

What they did not do was turn to domestic chip production. That would have been a mistake.

Microchips are the perfect example of how local specialisation, spread across the world, creates better products than is possible in any one place. The best chip manufacturing equipment comes from Holland; the strongest chip designs from the US; the best foundries are in Taiwan; and so on.

Nor can companies, with profits at stake, indulge in Mr Navarro’s fallacy that all threats originate abroad. The UK’s domestic coal supplies did not protect it during the 1980s miners’ strikes. America’s vulnerability to hurricanes and floods is demonstrated repeatedly. The next crisis might start anywhere.

This is not to deny the value of bringing production closer to demand. In the garment industry, responding quickly to changing tastes and advances in technology make a strong case for “nearshoring” production. Levi’s is deploying fully automated technology for finishing or “distressing” its jeans with lasers. This 90-second process, completed near the final market, used to take a worker in a low-cost country half an hour.

But companies such as Levi’s are nearshoring to give customers what they want, not to reduce the risks of international trade. Nor are they practising good global citizenship by “bringing jobs home”. What is home? Big, modern companies have customers, employees, and shareholders all over the world.

That global companies are not creatures of any one country is a point of attack for globalisation’s critics. But if we believe that companies have responsibilities to all their stakeholders, do we really want those responsibilities to vary depending on where those stakeholders happen to have been born?

That would be immoral. It is a virtue, not a vice, of global companies that they build relationships of mutual advantage that do not respect borders. Globalisation binds our fortunes together.

That these bonds makes us collectively richer is clear, given that the countries which have embraced global trade, along with education and investment, are the most prosperous. The rise of globalisation since 1990 coincides with more than a billion people rising out of extreme poverty. Neither governments nor companies should turn their back on that legacy because of coronavirus.

Even in the current crisis, globalisation can make the world safer. That national economies are fused by the connective tissue of global companies means each country has a selfish interest in helping others. That is a source of stability that anti-globalist rhetoric can only serve to dilute.

High-Frequency Traders Feast on Volatile Market

Profits climb sharply with help from sophisticated computer algorithms and strategies that take advantage of rips and dips; ‘a quarter for the record books’

By Scott Patterson and Alexander Osipovich


     Photo Illustration by Emil Lendof/The Wall Street Journal; Photos: iStock


Fast-trading investors have made big profits during the market’s volatility, with strategies ranging from sophisticated computer algorithms to ones as simple as “selling the rips and buying the dips.”

High-frequency traders, which typically deploy sophisticated algorithms and powerful computers to move in and out of markets at lightning speeds, tend to do well when markets are volatile.

Virtu Financial Inc.,one of the largest high-speed traders, last week said it expects to post trading income of between $509 million and $519 million in the first quarter, more than double the amount from the same period last year and its highest quarterly trading income since the company went public in 2015.


High-frequency firms have struggled in recent years amid a period of low volatility and steadily rising markets. Still, they are estimated to account for around half the trading volume of the U.S. stock market, having largely replaced the floor traders who once controlled exchanges’ ebb and flow. Virtu is a designated market maker for the New York Stock Exchange.

Like market makers, high-speed traders often make money on the difference between buy and sell orders, known as the spread, by selling high and buying low as stocks tick up and down.

Spreads in heavily traded stocks, such as Apple Inc.,which are typically 1 or 2 cents, have ballooned to 30 cents or more in recent weeks because of the highly volatile, fast-moving markets. While wide spreads indicate riskier market conditions, firms that can exploit the difference can earn sizable profits.

Some plain-vanilla rapid-trading strategies are also faring well, traders said.

“Our traders are having some of their best months in years,” said Dennis Dick, a trader at Bright Trading, a Las Vegas broker dealer that provides computer-driven trading platforms for day traders. He said one of the strategies that has worked best is “selling the rips and buying the dips”—selling stocks after big moves higher and buying after sharp downturns.

Mr. Dick said traders are looking for stocks that get pushed too low or too high during big market swings that drag the entire market up or down. Right now, he said, many are buying stocks that are low in debt and selling stocks with lots of debt that will likely suffer as the economy deteriorates. If a low-debt stock gets pummeled during a big selloff, traders will swoop in and buy, expecting it to rebound.

Thomas Peterffy, chief executive of Interactive Brokers Group, an electronic brokerage popular among day traders, said daily volume handled by his firm has more than doubled to more than two million trades a day in the past three weeks. New accounts are also surging, he said, a sign that people confined to their homes might be turning to trading.

The losers among the computerized trading strategies, at least so far, are those that bet on longstanding correlations between different financial instruments. Such dislocations can cause losses in statistical arbitrage, or stat arb, strategies.

Among the correlations that broke down during the worst of the selloff last week were between stocks and Treasury-bond prices, which usually move in opposite directions. But during the recent selloff, investors fled both. “Treasury selloffs on big down equity days mean that correlation is finally getting challenged,” said Pav Sethi, chief investment officer at Gladius Capital Management, a Chicago trading firm.



Mr. Sethi said another breakdown in correlations has been between stocks and a broad measure of market volatility, the Cboe Volatility Index, or VIX, known as the fear index.

Typically the VIX rises when stocks fall as fear spreads through Wall Street, and vice versa.

While the VIX soared to record levels as the market plunged in recent weeks, the link hasn’t always worked as expected.

Such haywire trading patterns mean trouble for quantitative investment firms, said David Magerman, a former executive at Renaissance Technologies, one of the biggest and most successful of what are known as quant firms. The models the firms deploy, often based on years of returns, get scrambled as investors head for the exits all at once.

“The big jolts to the markets are a coin flip for quant funds,” Mr. Magerman said. “Once the markets calm…quant funds that are still around should clean up.”

Although volatility has mostly benefited electronic trading firms, “you can still be caught by surprise,” said Rob Creamer, CEO of Chicago-based firm Geneva Trading. “There are a lot of markets that have been so dislocated that it’s been incredibly challenging.”

One victim of the extreme moves was Ronin Capital LLC, a Chicago-based trading firm that incurred hundreds of millions of dollars in losses on strategies tied to the VIX, people familiar with the matter said. Futures-exchange operator CME Group Inc. said March 20 that it auctioned off some of Ronin’s portfolios after it failed to meet capital requirements.

A person reached at Ronin’s office didn’t respond to requests for comment.

Some quick-draw traders that don’t use complex algorithms are also benefiting from the market’s swings. Daniel Schlaepfer, CEO of Select Vantage, which has more than 2,000 day traders world-wide, said his firm’s top 10 record days have occurred this month. Daily trading volumes across the firm have doubled since markets began their slide, he said.

Traders at Select Vantage typically hold stocks for less than 15 minutes and never sit on positions overnight, he said. In ways, the firm acts like a vast, human-driven high-frequency firm that rapidly buys and sells stocks throughout the day.

“We’re way up. We’re up full-force,” Mr. Schlaepfer said.

This Is The End: The Myth Of A Return To Normal

by: Mark DeWeaver, CFA



Summary
 
- The market is signaling something much worse than a temporary slowdown.

- A golden age of globalization, laissez-faire policy, and high corporate profitability is over.

- There will be no ‘V’-shaped recovery.
 
Those who expected lightning and thunder 
Are disappointed. 
And those who expected signs and archangels' trumps 
Do not believe it is happening now.  
- Czeslaw Milosz
 
 
TV pundits and US government officials continue to reassure us that once the COVID-19 nightmare is over - presumably as soon as the weather warms up - everything will quickly get back to normal.
 
But, if that is the case, why are risk assets cratering? Why this week's Donald J. Trump signature stock market crash? Aren't market participants supposed to be looking more than a few months ahead?
 
Perhaps, we are merely in the midst of a media-induced mass hysteria, and it will only be a matter of time before people snap out of it. We should then get a 'V'-shaped recovery with the economy bouncing back and the bull market picking up where it left off.
 
I find that hard to believe. Markets are clearly discounting something much worse than one negative quarter.
 
I think they are discounting not just a temporary, virus-induced slowdown, but the end of a decades-long era of strong profitability, driven by globalization and laissez-faire policy.
 
Globalization has, of course, been under threat since the beginning of the Trump administration's trade wars.
 
The abrupt disruption of supply chains resulting from China's 'people's war' on the coronavirus is only the final nail in the coffin. Businesses were already scrambling to find alternatives to war-torn China.
 
Now, the scramble will become a stampede, particularly as there is no longer any real prospect of a reset in US-China relations. At this point, each government has become entirely focused on blaming the other for the pandemic. The Chinese are even fantasizing about cutting off exports of medical supplies to the US, as fans of Tucker Carlson Tonight will be aware.
 
The problem for the multinationals is that, in the short term, there are no good alternatives to the 'world's factory'. First-world countries will obviously not be attractive places to site labor-intensive manufacturing.
 
And, no developing country will be able to match China's transport infrastructure, logistical capabilities, and vast industrial scale. Supply-chain relocation must unavoidably result in lost gains from trade and will be a long and expensive process.
 
Making China weak again will not make corporate America great again anytime soon.

A reversal of China's integration into the world economy will also result in a protracted Chinese recession, one which Beijing, its superior 'model' notwithstanding, will be powerless to arrest. This, too, will be bad news for earnings.
 
For many of the US-listed names-names like Apple (NASDAQ:AAPL), General Motors (NYSE:GM), Disney (NYSE:DIS), Starbucks (NASDAQ:SBUX), and Boeing (NYSE:BA), to cite but a few - China is either already a significant revenue generator or a key geography for future growth.
 
There are no obvious substitutes for the China market, particularly with Europe already in a demographic death spiral.
 
Ironically, even as the last remaining major socialist country goes into a tailspin, the pendulum in the developed world is already swinging from blind faith in markets to naive confidence in government intervention. This confidence can only be strengthened by the apparent effectiveness of public health measures taken in China, Korea, and Taiwan.
 
Their successes will be taken not just as evidence that market solutions are not always efficient but rather as proof that they can never be optimal.
 
One victim of this shift in the zeitgeist will be the Republican Party, which risks losing control of the White House and possibly the Senate as well.
 
Washington's current corporate-friendly regulatory policy may next year be reverting to the more heavy-handed Obama-era status quo ante. Whatever one thinks of the relative merits of these two approaches, this will surely be an unwelcome development for many companies.
 
The talking heads' tale of a return to normal is predicated on the idea that a shock as devastating as COVID-19 will have no permanent implications for the global economic order or the political climate. All that is required is to get through the next few months, ideally with the help of some temporary fiscal stimulus.
 
Sure a few companies may go bankrupt, but so what? Others will readily take their places. By the end of the year, the S&P 500 will be making new highs, and we'll be wondering what all the fuss was about.

This is little more than wishful thinking, in my strong opinion.
 
What we are actually witnessing is a major turning point for financial markets and the world economy.
 
This is the end not only of the 'fifth wave' of an eleven-year bull market and an unprecedented US expansion, but also of the 'Chinese century', the global growth story, and the retreat of the state.
 
It may not quite be the end of "everything that stands" or of all "our elaborate plans."
 
But it is certainly the end of much of what we have gotten used to taking for granted.

Russia Explains Why It Killed The OPEC Deal

by: Vladimir Zernov
 
 
Summary
 
- I follow up on my previous article regarding the collapse of the OPEC deal.

- Russia's deputy energy minister provides his rational for Russia's decision and sends signals to the market.

- Russia looks serious about tolerating pain from low oil to gain market share and deal a blow to U.S. shale for both political and economic reasons.
 
 
At the beginning of this week, I wrote about Russia's reasons for abandoning the OPEC deal in an article titled "Why Russia Killed The OPEC Deal". It did not take long for Russia to explain its reasons in an exclusive interview for Reuters.
 
Those investors who are seriously interested in the oil space should definitely read the whole Reuters material (it is short), while I'll focus on the main points and provide my commentary.
 
We'll also look at what this means for the various segments of the oil industry.
 
The interview was given by Russia's deputy energy minister Pavel Sorokin. It is very important to keep in mind that such high-level officials are not in the business of providing market analysis and forecasts. Instead, they are providing their signals to the market.
 
Without further ado, let's look at the key points:
  1. Russia believes that it is impossible to combat a situation when the demand is constantly falling, and the bottom is unclear.
  2. Moscow's initial position was to extend the agreement without additional cuts for the second quarter. Also, Moscow did not exclude the possibility of extending the OPEC deal even further.
  3. For Russia, the new cuts would have meant cuts of additional 300,000 bbl/day, bringing the total cuts to 600,000 bbl/day, which is technologically challenging.
  4. Sorokin stated that oil prices in the range of $45-55 per barrel are fair and will allow to invest in projects and keep supply coming.
  5. He believes that oil prices will increase to $40-45 per barrel in the second half of 2020 and continue their upside to $45-50 in 2021.
  6. In a Russian-language version of the interview (you can run it through Google translate), he added that while the ruble-denominated price of 3,000 per barrel is very comfortable, prices in the range of 2,100-2,500 rubles per barrel are satisfactory. I don't know why the authors of the interview decided to omit this information from the English version as I believe it also sends an important signal.

Let's go step by step. When Russia says that it is technologically challenging to adjust production, it says the truth - Russian oil is mostly extracted in unfavorable conditions.
 
Let's look at the weather in Nizhnevartovsk, a city that was built for oil workers who developed the Samotlor field:
 
 
 
In cold conditions, it is technologically challenging to make downward adjustments to production, so Russia does not have too much room for maneuver unlike Saudi Arabia whose climate is completely different.
 
Once the production cuts are implemented and production reaches some stable level, keeping production at these levels does not require much efforts so Russia's offer to maintain the previous deal is not surprising.
 
Russia's cold climate is hardly news to anyone. The most interesting part of the interview is the "oil price forecast" part, which is, of course, not a forecast but a signal to other oil producers. The level of $45-55 will be sufficient enough to put an end to the growth of the American shale production and at the same time to balance Russia's budget. Also, the path to $45-55 is presented as a long one (since Sorokin does not expect oil to reach $55 in 2021), promising months of hard pain for higher-cost shale producers, especially those who are burdened with debt.
 
As I noted above, the ruble-denominated price of oil is a very important factor. American producers sell oil for dollars and have costs in dollars. Russian producers sell oil for dollars but then convert them into rubles - and have costs in rubles. Therefore, the ruble-denominated price of the barrel of oil is more important for Russian producers and the Russian budget than the dollar-denominated price. Russia's Urals trade with a $3-4 discount to Brent.
 
As I write these words, Brent is trading at $34 per barrel, while one dollar buys you 74.5 rubles. Applying a $4 discount for illustrative purposes, we get a ruble-denominated oil price of 2,235, in line with the acceptable level of 2,100-2,500 rubles per barrel presented by Sorokin.

It is always challenging to read the political tea leaves, but in this case, objective facts seem to fit well into the subjective narrative - Russia is serious about sustaining low oil prices for a material period of time. So, what does it mean for oil-related equities?
 
Given the additional problems with coronavirus, both WTI (USO) and Brent (BNO) may find it hard to rebound from current levels and even carry additional downside risks, especially in case Saudi Arabia and UAE turn their stated intentions to raise production into reality.
 
The biggest hit comes to heavily indebted offshore drillers, which require higher oil prices for the much-needed upside in dayrates. Valaris (VAL), Noble Corp. (NE), Seadrill (SDRL) find themselves in a very challenging situation. The environment is a bit easier for Transocean (RIG) and Diamond Offshore (DO) but they face the same existential risks. Stocks of other drillers like Borr (BORR) or Pacific Drilling (PACD) will also find themselves under pressure despite the fact that they are already trading in the penny stock zone.
 
Shale players (both oil and gas) with debt challenges have also found themselves under pressure: Antero Resources (AR), Chesapeake Energy (CHK), Whiting Petroleum (WLL), Oasis Petroleum (OAS), SM Energy (SM), Extraction Oil & Gas (XOG) and the like. While such falling price charts may ultimately present a one-day upside opportunity for day traders, it is highly likely that the prolonged low oil price environment will force the weaker companies into restructuring.
 
Therefore, anyone willing to speculate will be safer doing such speculations in healthier players like Concho Resources (CXO), EOG Resources (EOG), Pioneer Natural Resources (PXD) - but keep in mind that there may be more room to fall, and that short sellers have not yet turned their attention to the healthier bunch - short interest in the above-mentioned companies is low.
 
Services - Schlumberger (SLB), Halliburton (HAL), Baker Hughes (BKR) - have already been materially punished. It is clear that the prolonged oil price downside will lead to a major drop in capex spending as companies will try to survive the downturn by cutting costs everywhere they can. Judging by current dividend yields of oil service players, the market tells us that dividends are unsustainable - and I agree with the market.

I maintain my view that the best opportunity will ultimately be presented by majors - Exxon Mobil (XOM), Chevron (CVX), BP (BP), Total (TOT), Royal Dutch Shell (RDS.A) (NYSE:RDS.B). Dividend adjustments are certainly possible even in the case of majors since no one knows at this point how long the coronavirus problems will last. For those looking for a bargain, the ideal scenario will be to buy majors after a sell-off that follows a dividend cut. Currently, there's panic in the market (and generally in the world) so we may see times when hot heads will start talking about the ultimate demise of major oil producers - that would be the best moment to initiate a new position or to add to an existing one if you have decided to sit through thick and thin.
 
To sum it up: oil is getting hit by a double blow from the collapse of the OPEC deal and coronavirus containment measures. Currently, it looks like Russia is very serious about sticking to its new position and trying to deal a blow to the U.S. shale, both for political and for longer-term market share reasons. The situation on the coronavirus front gets worse day by day (when I say this I mean containment measures; I'm not an epidemiologist and I can't evaluate the biological impact of the virus and its potential spread) which is very concerning for oil.
 
When Brent oil visited sub-$40 territory back in late 2015-early 2016, it fell towards $30 for about five weeks. The rebound towards $40 took eight weeks, and oil traded near $40 for about four more weeks before it was ready to move to the upside. In total, it took oil about four months to get firmly back above $40. Given the current external shocks that did not exist at that time, it's hard to believe that oil will have a quicker rebound.
 
This is certainly the time of fear - and a time of opportunity. Manage your risks properly and good luck!