The Middle Kingpin - October 15, 2015

Click Here for this Week's Letter

Greetings,

We’re seeing macro funds drop left and right. It’s debatable whether or not most of these are truly macro funds in the classic sense, but the low interest rate environment has certainly made trading difficult. Some were caught flat-footed when the SNB removed the floor under EUR/CHF in January, but, for the most part, it seems like many failed to appreciate how quickly China is slowing. September inflation data confirmed that Chinese PPI fell for the 43rd consecutive month at -5.9% Y/Y, while CPI barely stayed above zero at +1.6% Y/Y – well below expectations.

It’s been well documented that China is transitioning towards a consumption-led economy, but exports are still the main driver for now. On Monday, September trade data showed exports contracting at -3.7% Y/Y, which is actually a slight improvement from August. However, imports continued to collapse at -20.4% Y/Y, well below expectations and a significant drop from August.

The sharp contraction somewhat reflects the decline in commodity prices, and also suggests weakening domestic demand. That’s not surprising when you consider that real interest rates, deflated by PPI, are currently 10.5%. Is that appropriate policy for an economy that is clearly slowing?

Typically, real interest rates are calculated using CPI, but in the macro world PPI is more appropriate for China because of its outsized impact on the manufacturing sector globally. The massive contraction in PPI over the last 3.5 years implies that China’s main export has been deflation, and it’s starting to show up in developed markets. Data on Tuesday showed that the UK joined the EU in recording CPI growth below zero. US CPI for September will be released this morning with expectations for a below zero reading, but yesterday’s PPI data was already negative at -1.1% Y/Y.

It’s amazing that the VIX is back below 20. The conditions that led to the sell-off in August have not changed, and look like they’re getting worse. Policymakers are responding, especially in Asia. On Wednesday, the Singapore Monetary Authority announced it will ease monetary policy for the second time this year after narrowly avoiding a technical recession in the third quarter. Even Fed officials are starting to waver about a hike this year, after repeatedly insisting each meeting is “live.” Fed governor Tarullo said in an interview, “right now my expectation is – given where I think the economy would go – I wouldn’t expect it would be appropriate to raise rates” this year. Fed governor Lael Brainard offered similar remarks on Monday.

These ticky-tack stimulus measures and commentary from economists do little to support the economy and make it extremely difficult to trade this market, which is partly why these reputable funds are closing down. It’s increasingly clear that until, or unless, we see a major turnaround in China things will continue to deteriorate, and we could be looking down the barrel of secular stagnation on a global level.

The Cup & Handle Fund is up around 7.0% YTD, and +25% Y/Y. We were actually adding longs last week, and decided to hedge a bit yesterday. I would really like to load up on one position, but it’s important to maintain a balanced portfolio. I’d hate for one outsized position to bring down a fairly balanced portfolio, regardless of my conviction. The October investor letter went out two weeks, and it’s still not doing much of anything. If you’d like to start receiving these letters click here.

As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

Until next time, tread lightly out there,

Michael Lingenheld

Managing Editor – Cup & Handle Macro

Posted to Cup & Handle Macro Research on Oct 14, 2015 — 11:10 AM
Comments ({[comments.length]})
Sort By:
Loading Comments
No comments. Break the ice and be the first!
Error loading comments Click here to retry
No comments found matching this filter
Want to add a comment? Take me to the new comment box!