Uncertainty, “The Highly Improbable”, Goldman Sachs, And Some Swamp Draining

The “highly improbable” has become more probable lately.

At least that’s my contention.

The paradox – and I’ve discussed this with investors both online and in person – is that despite the growing sense of uncertainty, the VIX is depressed and market participants are positioned as if they’re absolutely sure of where things are headed. Note the latter point. The data on positioning indicates a high level of certainty among individuals but at the very same time, the very same data suggests that the market as a whole isn’t certain at all.

What does it tell us, for instance, when real money is record net long 5Y Treasury futs, but specs are record short?

5y

(Deutsche Bank)

Individually, investors are certain but viewed as a group, the investor community is highly confused (that is, if we define the investor community as all market participants, then the fact that one group is record long and another group is record short suggests that the investor community as a whole isn’t certain at all). Uncertain certainty or certain uncertainty?

hazy

Further, I’m not sure it makes sense to say that the highly improbable has become more probable. It makes sense on the surface (i.e. anything seems possible in the current political environment), but can the highly improbable really become “more probable?” That’s akin to saying  “the highly improbable has become less improbable” which in turn is like saying “the highly dead have become less dead lately” or, alternatively, “the highly dead have become more alive lately.” Does the first sentence of this post therefore make any sense?

Good questions that, despite their metaphysical feel, have real implications for markets when we consider that the “highly improbable” describes the black swan events that we, as investors, try so desperately hard to anticipate.

With all of that in mind, here’s the latest commentary from Goldman who discovered when they spoke to clients that no one has a clue what’s going on.

Via Goldman

“Unsettled” is our best description of fund managers’ mindset as the new administration takes office. During an extensive series of client meetings in the US, Europe and Asia, it became apparent that investors are confused about how to best position portfolios under a Trump presidency.

Optimism is reflected in the strong performance of markets during the 73-day transition period between the election and inauguration. Investors have embraced the prospect of faster GDP growth and higher inflation as a result of reduced corporate taxes, a looser fiscal policy, and less regulation. Surveys such as NFIB small business confidence and consumer confidence both soared to their highest levels in 12 and 15 years.

S&P 500 index has climbed by 6% since November 8 led by Cyclicals broadly and Financials in particular. Europe, Japan and MSCI Asia stocks have returned 8%, 12% and 1%, respectively. Implied inflation during the next decade equals 2.0% and the 10-year Treasury now yields 2.47%.

Policy uncertainty was a topic of concern raised in every client meeting. While we expect corporate tax reform legislation will be enacted in 2017, the magnitude of cuts and offsetting revenue proposals are unknown. Many tax reform ideas have been discussed in general terms but the administration has not yet endorsed any specific proposals. Investor confusion increases when a topic that appears to be gaining political momentum – such as border-adjusted tax reform – is suddenly discredited when the President dismisses the idea saying it is “too complicated.”

Of course given the number of former Goldmanites that are, thanks to Trump, now a part of government, maybe the bank could get some perspective by just asking their former employees.

Some perspective on that last point, via FT:

Goldman insiders say they see no problem with its senior people heading off to top jobs in Washington. If executives are much in demand for public service, Mr Blankfein told the New York Times last week, it is because they are talented and hardworking and can afford to take a pay cut. Many people leave the bank in their late forties or early fifties to give something back, he said. Two good examples would have been Hank Paulson and Robert Rubin, both of whom led Goldman (as co-chair and chief executive respectively) before running the Treasury department.

On a call with investors this week, Harvey Schwartz, the bank’s chief financial officer, discussed the departure of Gary Cohn, its former president and chief operating officer, to become director of the White House’s National Economic Council. Mr Cohn joined Goldman in 1990 as a silver salesman and became a partner in 1994, the same year as Mr Mnuchin. If Mr Mnuchin is confirmed by the Senate, the old Goldman colleagues will hold the two top economic jobs in the country.

“Obviously we’re all going to miss Gary,” said Mr Schwartz. “It’s fantastic that he’s willing to contribute all of his experience to our country. And it’s a long tradition of senior leaders at Goldman Sachs doing that. We’re all quite proud of what he’s decided to do.”

Analysts, too, are sanguine about the string of Goldman-linked appointments, which includes Stephen Bannon and Anthony Scaramucci, both ex-investment bankers, and Dina Powell, former president of the bank’s charitable foundation. Jay Clayton, named to head the Securities and Exchange Commission, the market watchdog, is a Wall Street lawyer who acted for Goldman on the injection of government money in the depths of the crisis. Gretchen Butler Clayton, his wife, works at Goldman as a private wealth adviser.

“Draining the swamp” alright.

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