Steen’s Chronicle: Three things can’t be hidden long: The sun, the moon and the truth (Buddha)

This week saw US GDP rebound an impressive 4.0% taking the run rate for GDP in 2014 to 2.3% still shy of the ambitious 3.0% the consensus firmly believe in. Wall Street is busy selling strategies on how to hedge the coming hike in policy rates from Fed and we are, again, told how rates will explode.

This narrative will implode and shortly if I look at Saxo Bank's JABA models:

Main Macro and Market calls:

• Fixed income will outperform all assets class’ in 2014 – View established in Q4-2013. Long 1.5% Danish Government bond, Long Bunds futures, Long 10 Y USA.

• US Dollar will sell off in H2 of 2014 – NEW VIEW. Long EURUSD and adding short USDJPY. Targets: 1.40+ and 96.00 USDJPY. Yield in US will accelerate to downside in Aug-Nov.

• Germany will reach negative growth by Q1-2015 & France will be in recession. Euro growth reach zero again. 2014 another lost year in economics and non-reforms

• Inflation expectations will bottom in Q4 – major buy signal for gold, silver and more importantly mining.

• Short Dax since 10.000 - and still believe in 25-30% correction in H2-2014 as projected all year.

• Geopolitical risk will see keep energy prices elevated – leaving the consumer with less disposable income and companies with thinner profit margins.

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ALPHA Positions: (all of which is more than three month old except EURUSD and Crude)

Fixed income: Long Bunds since November 2013 / Long 10 Y since April – adding IEF on this “Fed scare”

Equity: Short DAX only

Commodities: Long Sep. WTI Crude (since two weeks ago)

FX: Long EUR/USD from yesterday just below 1.3500 in Sep. Futures, Short AUDUSD Sep Futures (one month old), short ZAR calls – and looking to sell USDJPY

========================================================================BETA positions:

Long 80% fixed income since Q4-2013 – mainly Danish government bonds, Bunds and IEF.

Long 15% long equity: AA, INVN, VALE – looking to buy mines, insurance companies and utility in Germany. Major short position not confirmed yet.

Cash 5%

The world will see lower growth & lower yields in 2014 - yet another lost year in non-reforms and easy money

There is no denial Q2 GDP was good, neither that the US has created more jobs (mostly part-time though), but…… that the Fed is ready to take a risk and go early on raising interest denies history and even logic.

Furthermore, the US GDP was always going to rise in Q2 – Our JABA models had this outlook from late last year:

SAXO BANK Economic JABA model on US GDP

(*) The Saxo Bank JABA model is a proprietary model that uses lead and lags from multiple business & economic vectors to predict future moves.

The pink dotted line is GDP – note how is rises in Q2 only to collapse into Q1/Q2 2015

US GDP has averaged 2,0% in the last five years I don’t see it rising from this low-trend level and on the GDP I have following comments:

1.) From the 1st GDP release to the final 3rd correction the net change is on average 1.46% since 1970s – I see Q2 being 2.5% if not 2.0% offered by its third correction

2.) Tax receipt data does not confirm the uptick:

3.) US GDP has been reduced to an exercise in measuring inventories. It’s extremely volatile but also important to note they are way above their average for the last eight quarters further more in the last five years US GDP has grown 2% per year – when you exclude inventories the so called Real Final Sales even Q2’s numbers was? Yes – 2%!

4.) Disposable income continues to lag and so does housing – the two key components in the US economy.

Clearly, to me, this short-term sell-off is directly correlated to a narrative dictated by Wall Street to create trading volumes. Yes, it is a hard claim, but rest assured that next time chairwoman Yellen has a chance to show her extremely dovish credentials she will. A bigger concern for the Fed must be the fact Wall Street in its narrative almost totally ignores the wording and the text from Fed officers. Fed communication policy is failing day by day and its projections have little impact on investors.

My key call both in macro and trading remains new lows in interest rates (10 Y and above in maturity) by Q1 or Q2 2015. The high growth expectations and denial of international geopolitical risks will accelerate the move to the downside inside the next two months.

I suggest adding to IEF or simply buying more 10 Year Treasury bonds.

A new call is a weaker US dollar over the next two months. To that end I have added long EUR Sep Futures to my Alpha portfolio yesterday (31st July) below 1.3500. US data will disappoint as shown in the Saxo Bank JABA model and our US dollar model is now supporting the same outlook.

I expect EURUSD to trade 1.40+ on the above plus deflation in Europe & USDJPY to trade towards 96/95.00 in next cycle.

In Europe my view is similar – the big call being Germany will hit negative growth by Q1-2015 – this call has been in place since Q4-2014 due to several factors:

1.) Rebalancing of growth in Asia – the investment drive in China and rest of Asia since 2008 has kept Germany afloat growth-wise through export orders but now the net flow is negative.

2.) The US current account deficit has halved over the financial crisis from above than 400 billion US dollars in deficit per year to less than 200 billion. Germany and export nations simply need to find an additional 200 billion dollars of exports just to “stand still”. It also raises a key questions (hat-tip: Bo Petersen): “Who can afford someone else's growth?” - or put differently: If the Germanic model of exporting only should work somebody must accept a deficit.....in low growth, rising deficits and debt service, that “someone” is becoming ever more elusive!

3.) Germany has the worst energy policy in Europe, if not the world. It decided to be dependent on Putin’s gas instead of nuclear power. Electricity in Germany is now a “luxury good” for many households. Only Denmark has higher electricity prices.

4.) The minimum wage and lack of labour market reforms. The new coalition rolled back or even reversed some of the great progress made since Schröder. I have a lot of

sympathy for Chancellor Merkel, as a female leader and a former east-bloc citizen. But clearly, she has made a lot of strategic mistakes in trying to keep her chancellorship

I have been long fixed income in Denmark and Germany since Q4-2012 – the target is sub 1% and new lows in yields as deflation will finally make investors realise we are steering straight to Japanisation due to inactivity and lack of reform.

If Germany hits zero growth in Q1-2015 where does that leave rest of Europe, especially France? Yes…..indeed.

Finally, the missing link in the puzzle is China… again our Saxo Bank JABA model has seen an uptick but remember it’s based on “doing more of the same” in China – spending fiscal Yuan's instead of changing structure. China remains a story I doubt, but the model rules:

Finally,

Energy is my new focus. Rising geopolitical risk keeps prices elevated and many years as a trader in the US reminds me that the correlation between gas prices and consumer confidence is almost one to one.

Our Saxo Bank JABA model sees higher energy prices in this cycle and this will subtract from consumption and growth but also makes Germany and other energy deficient countries look naked in the strategic field of providing energy cheaply and efficiently.

What’s even more concerning is that inflation-adjusted energy prices are now back at 1970s prices – yes the last true energy crisis, where I as “wee boy” could not play football on Sundays as no one was allowed to use private cars on Sundays!

I very much doubt that the “Fed scare” initiated the sell of I have been looking for – the Fed will not move early, neither does the data in “truth” support the present narrative of US recovery, but what concerns me and could create added momentum is bloated VaR – value at risk. Don’t forget we are leaving behind the lowest recorded volatility in FX and equity which means that to get a ”real return” many investors have extended their leverage as their confidence rises. Banks are fighting to get ready for AQR (asset quality review) in Europe and increased capital requirements in the US which means the banks are carrying the lowest inventories of risk to their balance sheets EVER!

Many people think they understand options – very few realise that the real risk in options is not volatility per se, but “discontinued” pricing – the fact prices do not go up and down in the expected range but jump by several standard deviations. That’s 2008, 2000, 1998, 1992, and 1987 for you. Fat tails. They generally happens when the market is at it’s most confident and can see no wrong. The narrative becomes one of infinite returns for very little risk. Sounds familiar?

Yes, the truth is often ugly, but often liberating too. We need to move away from chasing paper profit to investing in people, ideas and prospects. We should not fear the coming sell-off, but embrace and use it for creating a true mandate for change. It’s about time.

Safe travels,

Steen Jakobsen

My research on www.tradingfloor.com: https://www.tradingfloor.com/traders/steen-jakobsen

My Twitter account: https://twitter.com/Steen_Jakobsen

Latest important links:

GDP US comment: https://www.tradingfloor.com/posts/us-1st-gdp-release-an-impressive-40-but-watch-the-corrections-comingfirst-of-our-jaba-mo-1209715

War and markets: https://www.tradingfloor.com/posts/steens-chronicle-war-markets-1125555

From here to eternity in the age of low interest rates: https://www.tradingfloor.com/posts/from-here-to-eternity-in-the-age-of-low-interest-rates-999217

My macro presentation for Q2-2014: State of flux: https://www.tradingfloor.com/posts/macro-update-global-economy-in-a-state-of-flux-656762

Germany may have won the World Cup but its economy is cooling fast: https://www.tradingfloor.com/posts/germany-may-have-won-the-world-cup-but-its-economy-is-cooling-fast-1076281