Gentlemen vs Players

The more I’ve proselytised about playing the short side of late, the more I’ve felt like I’ve been forcing the issue. And forcing the issue is rarely a ticket to riches.

Back in early May, the short call felt to me like a cracking trade. Investors were bullish again. But the wholesale banking model was as bust as ever (as judged by base rate to libor spread). The banks weren’t intermediating between savers and borrowers. Oil was skyrocketing. Inflation was running out of control, and policymakers were becoming increasingly fractious and unpredictable. The set-up was so good I doubled my risk exposure.

Six weeks later and everyone is bearish. A friend told me that his favourite contrarian indicator, the hacks in his morning meeting, had capitulated; they were all selling. Now everyone knows about emerging market inflation. Yet the central banks in the UK, Europe and the US have all stepped away from further hikes. Something is changing.

And if we get a bit more fundamental, global inflationary pressure has probably peaked. US monetary growth has remained well contained. And there’s no doubt that we have seen a veritable collapse in the velocity of money globally this year. As Gavekal point out, it’s interesting that the dollar didn’t break to new lows while oil broke to new highs.

I’ve been reading a great little book by Ed Smith called ‘What Sport Tells us About Life – Bradman’s average, Zidane’s kiss and other sporting lessons’. And in it he discusses the disappearance of the amateur in sport. Sport is so serious, so professional, that many players have tied themselves up. They’re unable to ‘play’; to experiment, to take the risks you have to take to learn new skills, to get better.

Ed Smith compares the career of Kevin Pieterson, who seems to have fun playing, and who doesn’t appear to give a toss about whatever anyone – selectors or crowd – thinks of him – and Mark Ramprakash. Ramprakash had an incredible county record – including 100+ averages in 2006 & 7. But come to the tests, he was a Muppet. Why? Because he took it all way too seriously.

My feeling, being bearish right now is taking it all too seriously. It all seems entirely logical. You’ve finally marshalled your arguments and convinced the asset allocation committee. Er….

So, anyway, I’ve gone long. Long the dollar, long Euribor, and long the Dow Jones. And I’m due to go long the rate contracts in Australia and New Zealand – it’s just I’ve got to wait up to do it.

My idea is pretty simple. The inflation showing up in the developed world is a lagged effect of the blow out in the US current account deficit from 2002-6, and the massive expansion of credit from 2003-7. From 2006, the current account deficit in the US has started to shrink. But in an odd way. The oil deficit has actually expanded – from two percentage points to four. So Gulf spending has accelerated as an inflation pressure. But at the same time, the non-oil deficit has collapsed from 5.5% of GDP to 2.5%. It means that, outside the oil states, we have a massive deflationary force. And without a doubt, the collapse in the shadow banking system in Europe is compounding this pressure.

In short, global inflationary pressure has become very narrow. And those emerging markets, like India or Vietnam, where local monetary authorities allowed inflation to get out of hand, well, they’re now acting to control that inflation.

Now, if you wanted a major recession in Europe – what would you need to achieve it? Er, a major inflation scare just as the leading indicators, money growth, and housing were collapsing and the banking sector was shutting up shop. That’s if you wanted to be dead sure of a recession. But it’s been a rough couple of months for those who believed Europe was heading for the macro morgue – and decided to buy rate futures to play it. But I think the trade has turned. And I’ve gone long Euribor. A year from now, the ECB will be cutting aggressively. And all the while, there will be fewer dollars from the states to stimulate growth, and the banks will be gearing those diminishing dollars less aggressively. The banks will struggle to intermediate between savers and borrowers across Europe. My bet, these pressures deliver a European crisis in a year to two years time. By then, I suspect that the Euro will be back through parity.

So I’m long Euribor, and long the dollar against the Euro. But why long the Dow Jones? Well, no two ways about it, it’s a punt. A punt on the idea that everybody’s bearish now, that there’s money in the wings, but that market inflation expectations may just have peaked. I’m not married to the trade – but I might just sneak a cheeky single or two before the opposition catch on.