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Category: Business at Bloomberg

Flows before pros?

Flows before pros?

A recent Barron’s interview with James Montier got me thinking. In it, the GMO man answers a question about lofty valuations across both bonds and stocks that have caused consternation for asset allocators seeking good value in the market. In response, he says: “The US market is at its second or third most expensive point in history. So people are saying, ‘I either don’t understand the world anymore, or I don’t think that valuation matters anymore.'”

I think he has a point but maybe not the one he means. Valuations do matter because in a world of inflated asset prices but suppressed actual price inflation or economic growth, they’ve become the easiest and most surefire way for investors to generate outperformance, and so, that is what they are chasing. I still think Citigroup’s Matt King put it best, when he argued two years ago that something fundamental had changed in the market’s behaviour.

The crux of this argument is that markets used to be self-limiting. Prices of securities would move up to a point where their yields would become unattractive, at which time investors would trim some of their positions, causing prices to go down and yields to recover. Now the intense search for returns has altered that dynamic, with investors chasing inflows as a means of getting higher prices and higher profits.

While the notion that  value investing is disappearing in a market that has moved ever upward for the past five years is not exactly new, King’s presentation here is stark. Investors have been moving in tandem, he says, making markets far more homogenous. The chart below shows investor positioning in credit markets, where the number of longs has vastly outnumbered the shorts, along with the International Monetary Fund’s herding metric. In short, investors across a number of asset classes are going mooo as one-way positioning dominates…

We often say the market can stay irrational longer than you can stay solvent. Maybe the updated version should be that the market can self-perpetuate for longer than expected.

It’s not just about the VIX

It’s not just about the VIX

There’s so much talk about volatility right now — and specifically the stubbornly low behaviour of the VIX  — that I thought I’d do a round-up of some of my previous pieces on it.

Please note, I’m in an anti-paragraph, anti-proofreading kind of mood today. So typos and big blocks of text are ahead.

1. On the VIX 

Let’s start with this one, from September 2013, about a new index trying to challenge the VIX, the index that most people associate with ‘volatility.’ For more than two decades, the VIX index run by the Chicago Board Options Exchange has been the financial industry’s go-to method for measuring expectations of volatility in the wider marketplace, with the CBOE turning the index into something of a cash cow thanks to the launch of futures tied to the gauge. VIX-related futures have in turn allowed a plethora of VIX-based exchange-traded products (ETPs) to also launch. With all that money benchmarked to the VIX, it’s no surprise that we have occasionally seen upstarts attempt to challenge it.

2. Selling volatility

Now let’s go here to this story from December 2014. About six years on from the financial crisis and deep in the era of monetary stimulus, investors are struggling to make returns and seize upon the realisation that selling volatility — whether that be through shorting the VIX or some other derivative-based method — can be a lucrative (if risky) strategy. This was the big shift in the volatility market. Instead of having a bunch of banks or hedge funds (or de facto, GSEs) sell volatility, you suddenly have a bunch of buy-side funds and retail investors who are interested and able to do so, the latter largely thanks to the explosion in VIX-related products. The big question, per the piece, is whether these new sellers of volatility are more likely to behave differently than traditional vol-sellers. Are they more or less likely to react to abrupt shifts in volatility?

3. Self-reflexive VIX

By September 2015, the VIX is again in the headlines after the unexpected devaluation of the Chinese yuan spooked markets. While the VIX did jump on this news, it was the VVIX (in effect, volatility of volatility) that reached an all-time record. Here’s my article about that: “When there’s a sudden spike in volatility, as occurred last month, the price of near-term VIX futures rises. Meanwhile, volatility players — notably hedge funds and CTAs — scramble to buy protection as they seek either to hedge or cover short positions, causing a feedback loop that encourages near-term futures to rise even further.” CFTC positioning data at the time did suggest a classic short squeeze as investors closed out their short vol positions post the spike. In effect there were said to be two major forces impacting the VIX, systematic volatility sellers as well as VIX-related ETPs that have to buy or sell futures to rebalance. This rebalancing act makes the VIX curve important, a point picked up on by Chris Cole of Artemis Capital in a story I wrote about a month later: “VIX term structure inverted at the greatest degree in history in August, so much so and so fast that many structured products that use simple historical relationships to gauge term structure switching and hedging ratios just couldn’t handle it,” he said. The concern is that the explosion in volatility-trading means more demand to buy or sell futures to rebalance, which could impact the shape of the curve itself.

4. VIX and beyond!

The proliferation of ETPs tied to the VIX is a concern insofar as it affects the volatility landscape, but it’s not the whole story. To explain, let’s go to Bill Gross, who became the poster child for volatility-sellers after publicly saying in June 2014 — while still at Pimco — that the company was selling “insurance, basically, against price movements” to juice returns in an era of low interest rates. Not once did he mention the VIX. It wasn’t until October 2014, after Gross’s abrupt departure from Pimco, that we got a better sense of what that insurance-selling strategy might mean when the U.S. Treasury market experienced a sudden melt-up, of sorts. At the time, there was plenty of talk that Pimco was liquidating some derivatives positions, which ended up having an outsized effect on the underlying cash market. The U.S. government’s report on the episode later mentioned that: “In particular, anecdotal commentary suggested that some dealers had absorbed a portion of the sizable ‘short volatility’ position believed to have been previously maintained by large asset managers. As volatility spiked on October 15, those positions would have prompted some dealers to dynamically hedge this exposure, exacerbating the downward move in yields.” Then, in August of last year, the BIS published a paper on asset managers dabbling in eurodollars including the example of Pimco in 2014, which I wrote up in a piece called “This is where leverage lives in the system.” That article contained a laundry list of potentially risky strategies across rates (viz eurodollars, futures, forwards), credit (using swaptions and swaps) as well as equities (options, VIX ETPs, etc.). What’s my point? I don’t mean to underplay what’s happening with the VIX, but my concern is that if we’re looking for potential flash points in the financial system then we may want to broaden our horizons.

The End

The End

Is this the end? Are you my friend?
It seems to me, you ought to be free.
You used to be mine when the chips were down.
You used to be mine when I weren’t around…
The Doors.

Those immortal lyrics spring to mind courtesy of this Citi survey of investors:

I’ve been surprised by the suddenness with which markets appear to have shifted gears from an apparent six-year reliance on easy monetary policy to pinning their hopes on the expectation of fiscal stimulus that is still far from materializing. We’ve touched on it in our various coverage at Bloomberg but it seems this will be the theme to watch in 2017. How rapid is the tightening? How pervasive? And, crucially, can the market remain relatively resilient in the face of rising rates and investors who still have a massive long position on credit?

Speaking of which, as is becoming tradition around here, here’s this year’s list of credit coverage. You’ll notice it peters out as the year goes by. That’s because I got busy with a new home and some new work. See you in the new year and here’s hoping your 2017 be filled with all the right kind of surprises.

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Round Lots?

Round Lots?

About a year ago, Joe Weisenthal and I started a podcast called Odd Lots, a reference to atypical trade sizes and also an indication of what we hoped would be a whole bunch of unusual subject matter. This week we published our 50th episode and I believe we’ve kept our promise.

We’ve covered everything from the evolution of bananas, to psychoanalytic philosophy, Seinfeld economics, and pirate insurance, to a Middle East highway and country music – all with a markets angle of course! Along the way, we’ve also discussed more traditional financial topics such as the 2008 crisis, ponzi schemes, oodles on market structure, central bank stimulus, exchange-traded funds, bubbles and shadow banks.

Despite this  grab bag of subjects and a sometimes esoteric bent, we’ve consistently made it into the top 10 ‘Business News’ podcasts on iTunes – not least thanks to our amazing producers, Magnus Henrikkson, Sara Patterson and Alec McCabe. Here’s to another 50 episodes.

Subscribe to Bloomberg Odd Lots on iTunes Podcasts

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oddlots

Low-hanging fruit in the oil patch…

Low-hanging fruit in the oil patch…

This story is about oil drilling components.

More than that, however, it’s about how energy companies are trimming the fat in some of the most basic ways possible – by standardising subsea drilling components, engineering contracts, even light bulbs. It’s at once an indictment of the oil industry, and the amount of fat that still has left to be trimmed after a period of excess, and an illustration of the degree to which technological revolution beyond shale drilling is now bringing down costs – in some cases by as much as two thirds.

… While the specs for Norwegian Sea drilling might provoke reactions akin to the oil field’s name—the Snorre—such standardized pipes and casings could hold the key to a pervasive mystery about today’s energy market: Why is everyone still drilling when prices are in the basement?

Even as oil producers have planned $1 trillion worth of spending reductions between 2015-to-2020—cutting staff, delaying projects, and squeezing contractors—they’ve continued to green-light new wells from the Norwegian Sea to Brazil, and from Uganda to the Gulf of Mexico. Those initiatives mean oil production will continue to grow, adding to the supply glut and putting downward pressure on prices.

It’s a development that has both baffled and frustrated the world’s biggest producers of crude, who have been waiting for lower prices to force a rollback of global production. They have largely blamed the resilience of the world’s oil drilling on U.S. shale producers, as well as efforts to maintain market share, but the Snorre and other projects like it suggest there may be another–much more boring–culprit at fault …
Read the rest of ‘How Actual Nuts and Bolts Are Bringing Down Oil Prices’ over here.
Peer-to-Fear

Peer-to-Fear

In January of this year I resurfaced some of my older reporting on the peer-to-peer, or marketplace, lending industry and wrote this line in the first article about Lending Club raising interest rates for the riskiest borrowers on its platform:

It’s worth recalling the words of some investors at the time who criticized LendingClub’s lofty $8.9 billion valuation—reached partly because of overwhelming enthusiasm for all things tech-related.  “These companies are really specialty finance companies, but look at where specialty finance companies trade in the public markets,” said one major marketplace lending investor at the time [of LendingClub’s late 2014 IPO].

It’s a point that, like much of my coverage, has been oft-repeated since – especially in the wake of recent news that Renaud Laplanche, LendingClub’s CEO, resigned following allegations of internal control issues and a rather sloppy ABS deal with Jefferies. My interest in marketplace lending has always been its overlap with traditional finance and the degree to which – as I’ve often written – the disruptive sector has been  co-opted by the very thing it sought to disrupt. In fact, one of the earliest enterprise pieces I wrote on the nascent industry, from January 2013, included the following gems:

“The one thing about peer-to-peer lending is it’s still a relatively manual process. This business needs a lot of scale to be profitable,” said a P2P analyst.

“In order to grow this business one must really have made relationships on the institutional side,” said a P2P CEO.

“On the surface it really almost comes across as too good to be true,” said a P2P institutional investor.

More than three years later and the pressures of scaling a ‘technology’ business that still relies on direct mail for advertising, and which derives much of its value from avoiding the legacy costs (including regulation) of traditional banks, seems to have come to a head viz LendingClub’s apparently lax internal controls, funding and securitization processes.

For those interested, here’s my more recent coverage of the industry’s travails.

When credit market concerns arrive at the marketplace lenders, January 2016 – Recall that the bear case for marketplace lenders was always a turning of the credit cycle that would either produce a rise in borrower defaults or result in a dearth of funding as skittish investors cut their lending on the platform. At the beginning of this year, credit markets spasmed,and LendingClub raised rates on lower-quality loans on its platform by about 67bps as it sought to better compensate nervous investors.

More trouble in bonds backed by peer-to-peer loans, March 2016 – A rating agency slapping a credit rating on a securitization only to downgrade it eight weeks later because of faster-than-expected-delinquencies seems … reminiscent of something.

A new class action suit wants to treat peer-to-peer lenders like mobsters, April 2016 – A scoop about a class action suit that strikes at the heart of the marketplace lending model and came on top of the already troublesome Madden vs Midland Funding decision, completed the ‘doomsday duo’ of funding concerns and regulatory scrutiny for the industry.

LendingClub is turning out to be anything but a direct lender, May 2016 – The resignation of Laplanche sent LendingClub shares plunging and, more significantly, exposed one of the biggest oddities at the center of the company’s business model. While promising to democratize finance by using new technology to directly match borrowers with lenders, LendingClub has turned to a complicated network of middlemen and professional investors to fund its rapid expansion and disintermediate traditional banks.

And the latest edition of our Odd Lots podcast, which sums up some of my thoughts on the matter:

Welcome to the Age of Asset Management

Welcome to the Age of Asset Management

This was a wide-ranging discussion that I was fortunate enough to moderate at the most recent Milken conference.

I’m told that this post on cross-border deleveraging, combined with some previous work on asset managers, was the inspiration for it. In any case it was a pleasure to discuss everything from capital controls to passive investing and, of course, market liquidity with David HuntJim McCaughanHilda Ochoa-BrillembourgRonald O’Hanley, and Nouriel Roubini.

Related link:
It’s the cross-border deleveraging, stupid! – Bloomberg

It SIVs! It SIVs!

It SIVs! It SIVs!

These are the kind of stories I love to write. The creators of the first structured investment vehicle (SIV), a type of shadow bank that eventually went on to wreak havoc during the financial crisis, are staging a comeback with a plain old vanilla bank.

I’m sad to say though, that First Global Trust Bank does not have the same mythological ring to it as Gordion Knot.

Per the Bloomberg story:

Nicholas Sossidis and Stephen Partridge-Hicks, the bankers who created the model for structured investment vehicles that later collapsed during the global financial crisis, are back.

Sossidis and Partridge-Hicks own First Global Trust Bank Plc, a London-based firm that was authorized to provide banking services a month ago after a three-year approval process, U.K. Companies House and Financial Conduct Authority records show. The new lender is funded by Gordian Knot Ltd., their firm that once managed billions of dollars through a SIV until that vehicle’s 2008 collapse, the documents show.

“FGTB is a simple, narrow wholesale bank,” the lender’s website says. “We will only accept deposits or investments from professional, wholesale investors. Our business model doesn’t cater for retail deposits or current accounts….”

Read the whole thing here.

Allen Stanford, revisited

Allen Stanford, revisited

One of my favourite financial scandals of recent years was the $17 billion ponzi run by Sir Allen Stanford, a knighted Texan who had previously achieved some notoriety for attempting to export an altered game of cricket to the U.S. and who ran the 20/20 tournament in Antigua.

I got a chance to revisit the topic on the latest edition of the Odd Lots podcast, when we interviewed Alex Dalmady – the independent financial analyst who helped blow the whistle on Stanford by publishing a now famous ‘Duck Tales’ note on Stanford International Bank.

Have a listen below, and steep yourself in some post-financial crisis nostalgia with the below FT clipping.

twenty1