Article / 04 December 2012 at 14:36 GMT

Steen's Chronicle: My Christmas wish list

Chief Economist & CIO / Saxo Bank

Dear Santa, this year I only have one wish. Could you please take all politicians, central bankers and chief economists far, far away for the next five years? I promise you Europe will be growing at 3%+, the US at 5% and Asia will be reformed and moving smartly towards its proper role in the world economy when they come back. Yes, it is that simple. 

Over the last six months I have upset a lot of policy makers with my insistence that all macro policies are wrong. What really concerns me is that they refute my ideas by telling me that their intervention has been a success and vindicates their actions. Come on – to paraphrase John McEnroe: they cannot be serious!

Youth Unemployment in Club Med is higher or at rate of unemployment in the Gaza Strip
The extend-and-pretend policies have reached new extremes, as Club Med yields are collapsing and policy makers are busy congratulating themselves. Meanwhile, youth unemployment in several European countries exceeds that of the Gaza Strip (45%), where the economy, everything else being equal, has a slightly tougher set of political and financial circumstances.


No price discovery
The market lacks a true “price discovery” mechanism. We are all brought up using the yield curve to price risk against, but now macro policies have destroyed the yield curve. Cash flows, asset valuation, virtually any investment not only had to take into account the price the market could bear, but also the time value and price of money, which was mostly fairly and transparently set in recent decades, even if the central banks had a strong hand in manipulating the price of money at the short end of the curve. The price of money is what allows businesses and investors to calculate what funding costs are justified and the value of potential profits.

Now, with heavy handed manipulation of the entire yield curve and the implicit macro policy put in place when the least whiff of a systemic risk arises, everyone now thinks that low volatility is the new black. Having been in the markets for almost 30 years, I think that low implied volatilities are not a green light for risk but the contrary! I would suggest that the “calm before a storm” metaphor is highly applicable – volatility potential is currently sorely mispriced and it’s likely we are merely conserving energy before some sort of explosion. Removing systemic tail-risk like we have seen in Europe or as the Bernanke Fed thinks it has done in the US does not mean we have a sustainable solution. On the contrary – it continues to encourage a lack of accountability and is also a sign that the “business model” of the macro policy makers is failing. 

This is why I continue to argue we need a real crisis that will falsify the current macro policy beliefs and allow us to topple current macro orthodoxies just like the natives of Easter Island toppled their enormous statues when the going got tough and they weren’t answering to the people’s needs. That’s the only way we’ll clear the decks and find a mandate for real change.

Club Med yields are down, but money is still fleeing
Club Med banks are busy buying their local government bonds as they feel, probably rightly so, that the German election next September offers them a “safe passage” from now until then. Meanwhile, the private citizens of the same countries continue to take money out of their country. This is not exactly a coherent message, but for those living in Macro Intervention QE Fantasy Land, the yellow brick road of extend and pretend seems to go on forever.


Consensus is at bullish as it gets
The consensus headlines suggest that the current environment of easy monetary policy, political stability and current “reasonable” valuations create the perfect conditions for not only a Santa Claus rally and even a great 2013.
Isn’t it ironic that one year ago, the consensus was that 2012 would be a relatively tough year for stocks (a tough year for most strategists is anywhere from flat to up only a couple of per cent)? Mainstream pundits were calling for S&P to have a slow year and there was even the odd analyst calling for an actual drop. Now, however, the consensus is back up in the stratosphere.

Bloomberg Consensus Call for S&P500 End 2013

Source: Bloomberg LLP

Get this: not a single pundit in this survey thinks that the S&P500 will be down next year! The mean is up 10% versus 5% for the same time last year.

Here is the same table from December 5th, 2011 and again with Bloomberg LLP as source:

Bloomberg Consensus Call for S&P500 End 2012

Source: Bloomberg LLP

Note that this time last year the S&P500 started at 1277.00 – meaning at least some had an idea of some downside and the more average expectation was for a 5% increase in return. Sentiment – relatively – is twice as strong this year and not a single strategist can imagine the S&P500 falling. This makes one wonder on how simplistic the risk environment have become. It’s totally binary: either risk on or risk off, nothing in between.

This uniform belief in higher markets reminds me of my young days on the trading floor in Chase Manhattan Bank, London (and yes I have told this story before, J.).

We had one customer, let’s say he was in the chocolate business, who surveyed the world’s ten biggest banks on their outlook for the next 12 months for the major currencies.

He then took the predictions and looked at the consensus – and if there was more than 80% agreement – he took the opposite position in a major option play. This customer was by far the most profitable client I have ever met. So maybe in this environment, the idea that mean-reversion is stronger than the argument that extend-and-pretend macro policies can only mean clear sailing.

Valuation vs. Economic Conditions
My new favourite indicator is this chart produced by my colleague Mr. Peter Garnry, where he measures the difference between the MSCI World and real economy as expressed by IFO surveys. The point here is not that stocks necessarily need to collapse, but either that the economic conditions need to pick up or that we need a correction to offset some of the froth created by the belief that in extend-and-pretend will take us safely into 2015.
We are trading at disparity equivalent to the IT bubble in 2000 – sure, stocks can still rise another 10-20% from here, but your marginal risk is extremely risky and potentially very expensive.


We are still short USDJPY – Short AUDUSD, Long USDZAR. We bought a small put option on risk: a 1380 Dec S&P500 put with Dec-21 Expiry @ 13.25 yesterday, but overall we are awaiting some realistic levels to re-enter the market.
For 2013, we like sectors like agriculture, aluminium and insurance. We like supply vs. demand rather than weather concerns in agriculture. Twenty-five per cent of aluminium production costs are in the energy input, and US producers are looking at 10-year lows in natural gas prices for their electricity input costs. Finally, most insurance companies’ investment books are trading at 50% or less of value due to the “AIG-risk”.

Again, let me stress, I see 2013 as a year of transition where positive- and negative forces will fight it out.

We could see major social tension and radicalism in Europe as the young without jobs fight the old with jobs and the private sector tells the public sector enough is enough. And what concerns me the most is a strong move to the political extremes. History tells us this is how things evolve, but for now the market sees only Happy Holidays and low rates and low risk forever.

Safe travels,


Rcernava Rcernava
Spot on!!
goldfinger goldfinger
Excellent insight. Tell me how does the west unravel its QE. I can't for one moment think that the market is going to pick up £325b of UK debt on top of new issuance and keep rates at a modest level. The loss to the bank would be stupendous, and balance sheet blown out the water. The gov't is already playing high jinks with the banks supposed income from these gilt purchases. Is the £35b borrowed by the treasury really going to be returned to the bank. I think not! Ditto the USA but more extreme. Surely, from that point of view rates will have to stay low till infinity. Or, until gov'ts retire the debt. Or, am I barking up the wrong tree
goldfinger goldfinger
At the risk of becoming garroulous, I see you're short $yen. Is that because you believe Abe won't fulfill his rhetoric?
Steen Jakobsen Steen Jakobsen
Same story - complacency - the JPY is driven by one factor only: deflation, as long as deflation rules, the purchasing power of the deflation economy will increase vis-a-vis the other side.....and yes Abe is all talk - like european politicians.


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