The euro jumped after minutes of the European Central Bank's December meeting on Thursday paved the way for a shift in forward guidance early in 2018. Meanwhile, gold is showing resilience, defying calls for a correction.
Article / 15 August 2012 at 14:19 GMT

The Three H’s: Hope, Holiday and Help

Chief Economist & CIO / Saxo Bank

After spending two weeks in my holiday hammock considering life’s big questions (please, just kidding!), it’s abundantly clear that this market can’t keep grinding higher based on the three H’s of: Hope, Holiday and Help. Policy makers are trying to create hope as they go on holiday and vaguely promise more help. The market has taken this as sign of commitment, but the policy makers' only commitment is to buy time and try to bridge the gap between expectations and reality as we head into a the next batch of very important event risks.

The list of “Hopes” is a long one:

  • The European Central Bank will finally get approval to print money
  • The Federal Open market Committee will announce a bigger and better QE3
  • Israel will not attack Iran
  • The Eurozone crisis is merely a question of confidence – we’ve just been too pessimistic - Greece will stay in the Eurozone; Spain and Italy are contained and ok (Just look at their two year yields now!)
  • The US fiscal cliff will be resolved
  • Economic data is not as bad as it seems
  • Rising energy and food prices are a passing thing.

Holiday is a time for reflection and pause. As policy makers are officially on holiday, there’s a vacuum in terms of new macro impulses. We know that the market has been reacting more to tail-risk probabilities than real data since this crisis started and as such, this summer rally might be a product of the idea that “No noise is good news.”

As for the Help is coming mentality, it goes a little something like: Draghi and Bernanke will provide a put on the market, and prevent harm at every turn. They will print money – new debt – to solve the issue of too much debt. It will work, wait-and-see, remember the old saying: “Time heals all wounds”. If we pretend-and-extend just a little bit more, the up-cycle might just return. Central bankers are now not only willing to but also soon able to print even more money than before.


The Fundamental Chart of Hope: Expanding Central Bank Balance sheets

Central Bank balance sheet as percentage of nominal GDP

Lack of alternatives and a zero bound interest rate economy
The lack of alternative investments in a zero-bound interest rate environment has crowded out all investments except high yield credit and the stock market. My colleague David Karsbøl commented this morning: This looks more and more like 2005/2006 – where the market and investors were desperately seeking out yield. Any yield!

VIX CBOE volatility

We know how it all ended in 2008. Yield chasing is the most dangerous game in macro trading. The yield that looks attractive in a zero bound economy and with a VIX below 15 percent does not look that smart when event risks begin to unfold one after the other. The risk models simply don’t work well with zero interest rates and low volatility, and even the tail-risk models (Black Swan’s) fail to accurately assess the true market risk. We have to remember that reality is far more important than models, and it is in live trading that we’ll see the crisis addressed – no model will predict it, certainly not any based on the recent time capsule of delusory market logic.

Trouble in paradise or merely an orderly correction coming?
There is some trouble in paradise as the higher market valuations of late have mainly come from higher Price/Earnings rather than increased earnings and revenue.

Price Earning on S&P 500 chart

I also note that since the end of July, the US 10-year yield has shifted sharply higher and has broken a trend, at least in the short-term it has broken its down-trend. Is the rise in yields from slightly better US data, persistent inflation or a general concern on the lack of progress on the US fiscal cliff? I don’t really know, but it concerns me relative to the market’s complacency as it again increases the tail-risk.

US 10 Year Government Bond yield

Finally, the good old Dow Theory is issuing a stark warning on this move. I did a mini Macro update on this yesterday: Dow Theory divergence, with a chart showing clearly how the new high for the year in the Dow Industrials is not confirmed by the Dow Transport index:

Dow Theory Divergence

In the more direct valuation department, the fact that consumer brands like Apple continue to make new highs, while a “real economy” sector like mining is trading at 10-year lows in multiples lows, is considerable cause for alarm.

Tail-risk is the present pricing model for market valuations
The market does not react to economic data per se, but since the financial crisis it has mainly traded up and down due to ‘perceived’ tail-risk. This tail-risk has never really gone away if we look at the cold hard reality of the challenges facing us, but the recent “Rally of the 3 H’s” suggests that the tail risk has somehow receded. (See the list of present tail-risks below.) Most of the latter centres on the market hopes that the Draghi/Bernanke Put option will work, particularly perhaps in a year of a US Presidential election. To give them credit it has worked - so far, just as it worked in 2006 and through much of 2007.

The major upcoming event risks are listed below with links for further details:

August 30 - September 1, 2012: Jackson Hole: Federal Reserve Bank of Kansas City hosts more than 100 central bankers, policy makers, academics and economists at its annual economic policy symposium. Ben S. Bernanke will do the opening remarks and it’s widely expected there will be a “leak” of his monetary intentions just as we saw at the Jackson Hole conference of August, 2010, that heralded QE2. (I remain extremely sceptical that we’ll see this unfold).

September 6, 2012: ECB meeting. We get whatever Draghi’s “appropriate modalities” might be – a plan or just another plan for a plan? Here is the Introductory statement from the August Press Conference. (It’s important to reread!)

September 12, 2012: The German Constitutional Court makes its ruling on the legality of the Eurozone’s permanent bailout fund, the European Stability Mechanism, and the separate pact on budget discipline. The decision is absolutely key. Overall, it’s expected that the court will allow the ESM to go ahead, but also that it will further define the limits and constraints which must be respected. Note also that the European Court of Justice has a case in front of it brought by an Irish member of Parliament. (Link: Reuters: German top court sees no reason to delay ESM ruling)

September 12, 2012: The Dutch election. Mr. Rutte’s minority government called an election in late April after new austerity measures could not be agreed. It seems the Dutch, like so many others have had enough of the Eurozone. The front-runner so far in the polls is the far left (similar to Denmark) based on this EU resentment, according to this piece by WSJ: Far Left Emerges as Frontrunner in Dutch elections on Anti-Austerity Campaign. The latest polls have anti-immigration VVD and the Socialists leading. For those who read Dutch, Google has commissioned an excellent overview page: Dutch election courtesy of Google

September- October 8, 2012: The Troika (ECB, IMF and EU Commission) are back in Greece for the month of September to follow up with a progress report before paying out the 31 billion Euro tranche of aid which is to be approved at the EU Finance Ministers meeting on October 8-9 in Luxembourg.

We have been right in our macro calls, both economically and politically, but have massively underestimated the dynamics of no alternatives and zero bound interest rates' impact on risk allocations, but we remain confident in our call for: A meeting of the EU Cardinals.

There will be a final show-down, whether by the end of this year or early in 2013, in which the “Cardinals” of Europe will need to decide on the EU’s fate and how much they will do to support it. Greece and maybe one or two more countries will get a “pause” from the Eurozone. Germany will need to commit fully to the union and move towards a smaller, stronger group of countries if a real fiscal and political union is the end game for EU policy makers.

With the “three H’s” as our main theme for the rest of August, we will now go almost square on High Yield Corporate Credit. It has been an excellent run, but it’s time to take profit (+765 BPS YTD) – this makes our present portfolio look like this:

Equities: 5% (unchanged)
Bonds: 10% (+10%)
Commodities: 10% (unchanged)
Corporate Bonds: 10% (from 25% in July and 50% prior to this since Q3-2011)
Cash: 50% (unchanged)
Alpha plays: 20% (downside bets and tail-risk insurance)

FX exposure remains the same (Since Q4-2012): US Dollar 50%, NOK and SEK 50%

To reflect this above scenario, we could see some value in the following trades:

1. Short S&P based on Dow Theory with tight stop above recent high (see Dow Theory chart above and my recent thoughts on this.)
2. Buying USD vs. JPY based on yield differentials (see my recent comments)
3. Buy VIX index
4. Reduce High Yield exposure – relatively


The market is very frustrated. We all see too few risks when hope is high, and too much risk when its doom-and-gloom that prevails. We need to learn that as long as the politicians play a game of buying time, the market will mean revert with bigger and bigger tail-risk as the main price.

Ignoring the tail-risk is deadly, but it also wrong to predict doom-and-gloom when the noise is the loudest, as we need to zoom in on how ultimately this crisis will be resolved. For now, though, you should be buying a record of the Three Tenors rather than basing your investments on the Three H's.

Safe travels,



seemore seemore
What is not real on the market ?
Steen Jakobsen Steen Jakobsen
My definition of REAL is tangible, measurable, proven where as all we get for now is: promises and plan for plans..
seemore seemore
Relax, this is the realty we live in, so :)
Steen Jakobsen Steen Jakobsen
:-) Indeed it is....
edragon edragon
Living on a promise; a promise to pay later if ever.
Jim88 Jim88
Steen, very good article. I agree with you mostly... Germany is likely going to seek a “smaller” EZ sooner rather than later. ClubMed’s countries need decades to improve their economies and become more or less competitive, that could drag existing EZ into even more painful spiral unless ECB could print a lot. And there is no way round – debt pooling will only buy time and finally will destroy even still “healthy” economies in the EZ regardless of a prospect of a fiscal union. Only the way for the “existing” EZ to resolve this crisis (at this stage certainly) is to print-print, but Germany won’t agree obviously. This is a GREAT Deadlock… Regarding the markets behavior – it is absolutely in line with a human psychology – buy on hopes (rumors), sell on disappointments (facts) :) A swing trader inside me is annoyingly saying: SELL whatever you can right now… :)


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