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It will be a quick and simple one today. Obviously the Chinese virus situation worsened over the weekend. As Howard Marks so eloquently put it this morning on CNBC, “the market has gone from containment to contagion almost overnight.”
As I wrote early last week, I had shifted to a short risk posture (TIME TO TAKE A SHOT AT THE DARK SIDE), but to be truthful, I am not sure what to do here. I was long Nasdaq volatility and with the spike in implied volatility, I have taken a fair amount of it off. The index arbitrageur in me hates being long expensive options. But that’s not the subject of today’s post.
What I would like to do is prepare you for a trade that is setting up beautifully. As most of you are aware, I am ursus arctos horribilis when it comes to fixed-income. Last week, as I got nervous about the flu situation, I rotated myself into a neutral delta long gamma bond position. I must admit that I hedged every uptick a little too quickly as I can’t even let my gamma run to the upside when it comes to bonds. This was about as bullish of fixed-income that I ever get.
I am aware that the virus situation is extremely serious. I know this has a chance of pushing us into a global recession. Please don’t send me any data about how the economy is heading off a cliff. Yup. I understand this is a definite possibility. Why do you think I was short risk assets?
However, I want to make one important point. If there were no virus worries, the U.S. bond market would be many, many handles lower. Why? The American economy was screaming hot before the virus popped up.
Have a look at this chart of the Citibank Economic Surprise Index:
This index measures how much economic releases are beating or missing economists’ estimates. Over the past two months, the American economy has been blowing the doors off of expectations.
Usually this would cause the bond market to back up hard, but worries about the virus caused a monster flight-to-safety bid into U.S. Treasuries:
This was a gigantic move considering the underlying strength in the American economy. And it’s not only economic indicators that are exceeding expectations, but we are seeing signs that inflation is finally starting to bubble up. All in all, absent the flu developments, bonds would be choking on all this economic data. As traders we need to consider the possibility the flu ends up being not as catastrophic as the market is currently discounting. If that happens, where do bonds go? And how do you discount the different possibilities?
A younger, brasher Macro Tourist might have stood in here and proclaimed this bond rally done. I used to make bold calls like that, and I have the stubby-missing-fingers hands to prove it. Knife catching is hard. And not only that, it’s way more stressful than it needs to be.
Therefore I am starting to pick away by buying fixed-income puts. I am going slow, and fully expect it to go against me as I establish my position.
However, a global recession is increasingly being priced into fixed-income markets, and although I understand that outcome is a decent possibility, I suspect the market will be shocked at the amount of stimulus headed down the pike. Be careful in assuming that a coordinated monetary/fiscal response is friendly to the long-end of the bond market. The risk reward is beginning to favour fixed-income trades from the dark side. I dipped my toe in this morning, and I will expand on my reasons in the coming days.
Hopefully I won’t also find ways to lose toes as well as my fingers, but I think this is one of the best risk-reward opportunities out there right now.
Hello Kevin. First, let me say that I enjoy and look forward to your articles here. I don’t know if you read through comments, but if so I have a question: you say above that you are “buying fixed income puts.” Mechanically, how are you doing that? Are you purchasing puts in specific CEFs? Or something else? Which ones? Your articles always are wonderful sources of potential strategy…it’s the implementation that I often need a third-grade primer on….Thanks!
Why would you deal with closed end funds?
There are highly liquid ETFs like AGG and BND and options thereof.
Personally, if I were to make a call against bonds, I would use options on the fund TMF for maximum leverage (leverage factor is 300).
Options on futures is a good way. /ZN (10 year UST futures) or /ZB (30 year UST futures)
Macro Man, as you know timing is everything, you shorting fixed when it is running long and hot may be premature to buy puts. You may want to see “How low can fixed go?” This will save your feet.
Kevin is always an interesting read, but I get the feeling he’s grasping at straws lately. You deal with the world as it is, rather than try to bend it to your will through shear persistence.
Yes, inflation will be coming, but not now. Yes, fixed income will be worth shorting, but not just now.
Right now every central bank in the world is lining up to further ease, and the K man has decided to jump in front of that turbo charged global mega death fixed income steam roller in the hope it will stop. As I enjoy Kevin’s work I hope he’s only put on a short term tactical trade. Betting on the success of yet to be introduced central bank stimulus is a long shot right now (He’s going by the 2016 playbook).
You can’t stimulate inflation if everyone’s home in bed sick. If the virus mutates it could become lethal.
Well, he wasn’t “grasping at straws” when he shorted Tesla the day before one of the single-worst days for TSLA as a public company. And he wasn’t “grasping at straws” last week when he got long equity vol. ahead of the single-largest one-day vol. spike since Vol-pocalypse. 🙂
I like Kevin, but his latest ‘go long equity vol’ was one in a string. He made the same public call back last fall, which I agreed with at the time, and lost money right alongside him. I do follow Kevin regularly and have garnered many valuable insights from his posts.
But for Kevin, major fiscal prompting a wave of inflation always seems to be right around the corner.
He is the last great bond bear: A noble, but perhaps misunderstood creature. 🙂
C’mon, winning in real money investing is being right 55% of the time and cutting losses quickly the other 45%. I think MT clears that bar handily.