Quick Thoughts on Markets: May 24

Quick thoughts on where markets will be/are:

  1. Multiple expansion thru 2019; bull market to continue or trade sideways with lower earnings estimates, lower guidance. P/E forward and trailing, P/S, P/CapEx, all rising thru 2019
  2. Small cap debt expansion as small business owners feel more wealthy when tax season comes around in 2019, combined with rising defaults on personal debts
  3. Slower housing as a result of more expensive mortgages, less refinancing; further consolidation of wealth to middle class that bought single family homes in the early 2010’s
  4. Flat real rates as inflation rises mildly along with gasoline prices this summer into higher nat gas prices into winter. More expensive imports (fiscal policy)
  5. Flatting yield curve on long end, steeper on short end with the infection point decreasing signalling decreased optimism on future growth, end of existing govt bond purchases by central banks.
  6. Emerging market yields will continue to rise to combat the rise of the dollar; currency flows important to watch to determine winners/losers in coming debt restructuring (2019-20?) Might see some runs of EM ETF’s, which cause some liquidity issues in smaller markets.
  7. No ETF liquidity worries, unless markets stop functioning properly for several days. No way to call another vol spike like Feb. ’18. VIX continues to stay bounded around the 12-16 range on average, gone are the single digit vol days, with less Central Bank purchasing (of course, barring a significant change in geopolitcs).
  8. Swedish market may see some M&A activity with weak krona, especially from the eurozone.
  9. Watching cryptos for more use case adoption. Right now only diehards believe it is a store of wealth, only use case that’s fully developed is black markets.
  10. Big tech led markets up so it will lead markets down.



Opinions are my own.


Fall of Empires

Sir John Glubb wrote an essay regarding the rise and fall of empires and the corellaries between them. The essay, titled Fate of Empires, has a lot to digest so I won’t be able to cover all of it here. I highly recommend you read it and draw your own conclusions with what is happening in the world today.

Glubb speaks on certain defining eras, deemed ‘ages’, that are common to all empires:

  1. Age of Pioneers
  2. Age of Conquest
  3. Age of Commerce
  4. Age of Affluence
  5. Age of Intellect
  6. Age of Decadence

I’d like to begin in the Age of Intellect:

The dawning of this age gives rise to the thinking (wo)man, who believes problems can be solved through intellectual horsepower alone. This stage involves the influx of capital into universities and research institutions, accompanied by a boom in scientific and intellectual discovery. Philosophical and democratic debate ensues, as in ancient Athens with Plato and Socrates.

However, Glubb argues, “Amid a Babel of talk, the ship drifts on to the rocks.” Thus gives rise to the anti-intellectual “school of thought”.

In the 2016 US Election, the populous elected a man of action rather than words.

The 45th President, Donald Trump, has made no secret of his disdain for learning and specialized knowledge, sneering at a campaign rally in 2016, “You know, I’ve always wanted to say this—I’ve never said this before with all the talking we all do, all of these experts, ‘Oh we need an expert’—the experts are terrible!” (2)

The notion of anti-intellectualism perhaps will change the trajectory of the United States empire. The citizens may find that the brainpower of the intellectuals cannot solve the problems created by inaction, frivolity and greed. The intellectuals may wake up to the desire for action over words; creating a new type of leader, both dynamic and capable, which will meet the demands of the populous. People want a nation they can believe in, one that stands for the ideals they strive to emulate.

I’m not saying intellectualism is inherently “bad”, just that argument often leads to more disagreement until hubris is cast aside (and there is no lack of hubris in Washington at the moment). If action does not replace words, patriotism continues to decline, and internal political rivalries continue to deepen, I fear for the fate of the United States.

Religion as a solution:

… it was inevitable at such times that men should look back yearningly to the days of ‘religion’, when the spirit of self-sacrifice was still strong enough to make men ready to give and to serve, rather than to snatch. (Glubb, 18)

Born-again, fundamentalist Christians overwhelmingly voted for and approve of our current president. As a nation, we should be wary of the path this may take us. (7)

At the height of their intellectual era, the Arab empire (roughly 800-1100) was the richest nation on earth, with Baghdad as its capital. The intellectuals of the nation discovered the earth was a sphere a full five hundred years before Galileo. They also were on the brink of discovery of flight, nearly 1,000 years before the Wright Brothers. Experimental physics, algebra, cameras, astronomy, and chess were all products of this era (5).

Academics have long maintained that the great Islamic theologian, Abu Hamid Al Ghazali, who lived from 1055 to 1111, single-handedly steered Islamic culture away from independent scientific inquiry towards religious fundamentalism. In a remarkable intellectual shift, he concluded that falsafa (which literally means philosophy but included logic, mathematics and physics) was incompatible with Islam.

After writing his book, The Incoherence of Philosophers, Algazel as he was known in medieval Europe, is said to have “stabbed falsafa in such a manner that it could not rise again in the Muslim world”. Thanks to his unparalleled mastery of falsafa and Islamic law, he injected repugnance among Muslims for science that ultimately led to its decline and, in the process, the decline of Islamic civilization. (6)

In 1203, the largely uneducated and illiterate Mongol empire under Ghengis Khan was established as a major power in Asia. In 1258, Baghdad was sacked and pillaged by Ghengis Khan’s son, Hulagu Khan, definitively marking the end of the Golden Age of Arabic intellectualism.

I leave you with the following from Glubb:

[The] spirit of dedication was slowly eroded in the Age of Commerce by the action of money. People make money for themselves, not for their country. Thus periods of affluence gradually dissolved the spirit of service, which has caused the rise of the imperial races.

In due course, selfishness permeated the community, the coherence of which was weakened until disintegration was threatened. Then, as we have seen, came the period of pessimism with the accompanying spirit of frivolity and sensual indulgence, by-products of despair. It was inevitable at such times that men should look back yearningly to the days of ‘religion’, when the spirit of self-sacrifice was still strong enough to make men ready to give and to serve, rather than to snatch.

But while despair might permeate the greater part of the nation, others achieved a new realisation of the fact that only readiness for self-sacrifice could enable a community to survive. Some of the greatest saints in history lived in times of national decadence, raising the banner of duty and service against the flood of depravity and despair.

Thanks for reading,


What I’m Reading: Bonfire of the Vanities – Tom Wolfe


  1. https://www.federalreserve.gov/monetarypolicy/reservereq.htm
  2. https://www.opendemocracy.net/transformation/nicholas-baer/american-idiot-rethinking-anti-intellectualism-in-age-of-trump
  3. https://www.thebalance.com/current-u-s-federal-budget-deficit-3305783
  4. http://people.uncw.edu/kozloffm/glubb.pdf
  5. https://www.independent.co.uk/news/science/how-islamic-inventors-changed-the-world-6106905.html
  6. https://www.thenational.ae/opinion/comment/how-the-decline-of-muslim-scientific-thought-still-haunts-1.382129
  7. http://www.pewresearch.org/fact-tank/2016/11/09/how-the-faithful-voted-a-preliminary-2016-analysis/

Knee Jerk Vol & the Fed


The Fed is now shrinking its balance sheet; they are no longer buying new securities as they mature. Below is a bit of analysis on if the Fed’s recent activities in shrinking its balance sheet is the cause of the recent rise in volatility.

Quick note: Data is at a weekly tenor, from Jan. 8, 2014 to April 4, 2018.


The thinner vertical line denotes when the Fed began to shrink their balance sheet last October; the thicker vertical line denotes when we had that massive vol spike in February of this year.

On the surface, the Fed’s action doesn’t appear to be the cause of all the hullabaloo, i.e. the shift from risky assets to safer assets.

If we turn to bonds, we see the following.


Rates on 10-Year Treasurys have moved higher since the Fed began shrinking it’s holdings of US Treasurys. Recall, bond prices fall as rates rise. Less buyers = lower prices = higher rates.

It appears these movements aren’t directly related to the recent rise in volatility.

However, there appears to be an inverse relationship between bond rates and the VIX Index.

A simple linear regression would see if the markets follow each other and if there was any preditcability between the markets. The equation is as follows:


Regression Summary:

reg summary apr6.JPG

We see a significant coefficient, with a value of -8.545, and an insignificant alpha. Therefore your new equations is:


If you predict a 25 bps rise in bond rates, we would expect to see a 2.3136% fall in the VIX Index, with 95% confidence:


The VIX is crazy volitile and the regression has a small R squared, so take the results with a grain of salt.


Thanks for reading,



  1. http://www.statisticshowto.com/probability-and-statistics/f-statistic-value-test/
  2. https://www.cnbc.com/2015/09/25/what-happened-during-the-aug-24-flash-crash.html
  3. https://fred.stlouisfed.org/series/TREAST
  4. Yahoo Finance
  5. Bloomberg


Note: The VIX and the 10-Yr are already percentages, so they’re calculated in absolute terms.

Delta VIX = VIX Value Today – VIX Value Yesterday

Delta 10-Yr = 10-Yr Today – 10-Yr Yesterday

Bogus Tweet Risk


Most financial media is focused on “tweet risk” or “trade wars”. To me, these seem like water under the bridge. It’s in China’s interest politically to retaliate to trade sanctions, but not in their interest to crash US markets. They hold a massive amount of US Treasurys, if they stop buying US bonds, rates will shoot through the roof and China loses. The following analysis attempts to succinctly summize the economic situation.

Tempered Expectations of Future Growth

We’ve crossed the 50 bps level in the 2 to 10 year US Treasury Spread, signaling lower expecations of future growth prospects, strengthening the late stage economic growth narrative.



US Dollar Slides


The DXY Index represents the US Dollar vs a basket of major currencies. Yields in the above chart are represented by the Generic 10-Year US Treasury yield. Higher yields depreciate a currency, as stated by Interest Rate Parity.

A weaker dollar allows foreign investors more buying power in US markets.

Resilience of US Goverment Capital Markets

The 10-Year Treasury rate now sits at around 2.75% following last week’s sale of a LOT of Treasurys. The market is handling this flood of supply well (nearly $300bil last week), as bonds have rallied in the face of rising interest rates. The US Treasury Department will auction off $48bil of 3-month T-bills and $42bil of 6-month T-bills this week.

Rates on the short end are slightly higher following a Fed funds rate hike in March, but longer term yields have fallen since last month signaling strong demand for US debt.


Higher Volatility but Lower Tail Risk

We’ve seen elevated levels of stock market volatility since the beginning of the year. However, since last month we’ve seen less tail risk, i.e. a flatter Volatility Skew.

  1. Elevated levels of Volatility overall
  2. Lower levels of Vol Skew


Tail Risk is the risk of a Black Swan event. This is measured by the relative demand of out of the money calls and puts. As the volatility smile flattens, the market is pricing in less tail risk, albeit at an elevated level of overall volatility.

Higher vol means more trading, which is good for financial services, as are higher rates. A trade war will be bad for industrials. I’ll be watching financials (XLF), and industrials (XLI).

Thanks for reading,


What I’m Reading: Lords of Finance: Bankers Who Broke the World



  1. https://www.wsj.com/articles/treasury-to-sell-90-billion-in-debt-1522342484
  2. https://www.wsj.com/articles/foreign-investors-are-bulking-up-on-u-s-treasury-bonds-once-again-1522693557

Disclaimer: The opinions above are my own and are for information purposes only.  This post is not intended to be investment advice.  Seek a duly licensed professional for investment advice.


FX Dynamics

Two competing forces in FX markets: Interest Rate Parity and Hot Money

Interest Rate Parity states that a lower yielding currency should appreciate relative to a higher yielding currency. According to the International Fischer Relationship, higher yielding currencies have higher inflation domestically. This inflation difference causes the high yielding currency to depreciate relative to a lower yielding currency.

An alternative force is hot money.

  • Hot Money = Change in foreign exchange reserves – Net exports – Net foreign direct investment

These are the yield chasers. Higher yield means higher returns, so the high yielding currency apprciates. Investors who chase yield invest so called “hot money”, that will vamoose once yields elsewhere are higher. A country heavily dependent on Hot Money (see: Germany 1928-9) may see wild fluctations in capital flows. See the following excerpt from Lords of Finance…:


Hot money is tough to measure, but it is considered a yield seeking activity. If yields start to rise, money will flood from US equities to bonds, depressing equities. For now, a glut in supply stemming from a fiscal expansion is keeping US yields low.



  1. https://www.economicshelp.org/blog/glossary/hot-money-flows/

Gotta Pay the Debt Collector

This entire rally is being fueled by credit, not real gains in productivity. A tweet:

Screen Shot 2018-01-15 at 8.49.57 PM

Let’s investigate. See: Three body problem. Tl;dr Good companies make good stocks, and high quality, trustworthy governments issue to low yielding, safe bonds. There is correlation, but as an investment strategy the relationship seems to be working less and less. Ben Hunt doesn’t dismiss the corollary, he merely introduces a third party in the market. He believes the third body to be central banks and their whopping balance sheets. Hold that thought…

See: Economic Machine, Ray Dalio. In order for there to be growth in an economy, there must be more transactions. A transaction is exchange of cash or credit for goods or services. More cash and credit available in markets means more transactions. One (wo)man’s spending is another (wo)man’s income. FYI: American’s on average spend $97.10 of all every $100 earned.

Credit cards fuel spending; consumers borrow from their future selves to spend today, in the hopes of having a higher income in the future. If rates on credit are low, the cost (interest) to the consumer to borrow today is less than if rates are high. This encourages borrowing. More borrowing, more spending, more transactions, more “growth”.

Below is a graphical representation of the relationship between interest rates and outstanding credit:

Screen Shot 2018-01-15 at 9.50.15 PM.png

M2 is the amount of liquid money available in financial markets, it’s clear that the government is printing more, and at a faster rate, than they used to. The best fit line is polynomial, not linear (with an explainability of 98.7%). Also, note the trend of the yellow data set. That’s consumer debt (boat loans, car loans, RV loans, credit card debt) owned by the US Federal Government.

Here’s that same graph less M2 and the Fed Funds Rate since 2007:

Screen Shot 2018-01-15 at 9.58.01 PM.png


Here’s who owns all outstanding consumer debt:

Screen Shot 2018-01-15 at 10.02.22 PM.png

Check the rift in 2010. This is the government absorbing the blow from 2007-08, through foreclosures. Notice how the US Govt’s share of the pie gets exponentially bigger every year since 2008.

The Federal Reserve of the US, a government sponsored enterprise, has the power to print money and buy securities (bonds) in the open market. The Fed prints money and lends it to the US Government through the purchase of US Treasuries. The government then takes said cash and buys your debt from the banks who lend you money; the banks receive a lower rate of interest than they would from you, but they also receive a guarantee from the US Government they they’ll get their money back. Your payments pass through your bank and onto the US Government’s bottom line. Theres a quasi-governmental agency that does this with Mortgages called Freddie Mac. And we all know how that worked out.

I posit that the growth realized by the US Stock market is fueled by debt, not “…profitability and growth”. There’s a storm coming, and we best be ready when she does.

Best of luck. Thanks for reading,

– Tommander

What I’m reading: The Money Game – Adam Smith


  1. https://twitter.com/realDonaldTrump/status/952538350333939713
  2. Economic Machine – Ray Dalio – http://www.economicprinciples.org/
  3. http://www.epsilontheory.com/three-body-problem/
  4. http://www.freddiemac.com/capital-markets/index.html
  5. https://tradingeconomics.com/united-states/personal-savings
  6. https://www.urbandictionary.com/define.php?term=wahzoo
  7. https://www.amazon.com/Money-Game-Adam-Smith/dp/0394721039
  8. FRED – https://fred.stlouisfed.org/series/TOTALSL
  9. https://www.federalreserve.gov/releases/g19/about.htm

So let me get this straight…


US Government Treasury bonds are the safest asset in the world today. They are implicitly guaranteed to get you your principal back at the maturity of your bond. Economists and investors commonly consider yields on Treasuries to be the ‘risk-free’ rate; meaning rates on Treasuries are the smallest amount of return an investment should provide.

Higher expected growth in the future means longer term bonds will have higher rates. Similarly, if lower growth is expected in the future, longer term bonds will have lower rates relative to shorter term bonds. A common metric quoted in financial news is the “ten to two”, i.e. the yield on a ten year US Government bond minus the yield on a two year US government bond. The ten to two measures the steepness, or slope of the yield curve. Note: slope is also used as a rate of change, i.e. velocity, in calculus (think, economic growth).

Here’s the yield curve today versus a year ago:

Screen Shot 2017-11-21 at 10.11.33 AM.png

The yield curve was steeper last year than it is today. We’ve realized some massive growth over the last year (see table below), and the Treasury market is beginning to temper it’s enthusiasm on future growth.

Screen Shot 2017-11-21 at 10.44.26 AM.png

Note that as home prices rise and wages do not, they’re financed with debt not cash. *cough* 2007 *cough*.

The 10-year Treasury yield minus the 2-year Treasury yield is at it’s lowest level in 10 years. That includes November 2007, right before the market went nose-fuckin-down.

Screen Shot 2017-11-21 at 10.47.17 AM.png

Disclaimer: the ten to two was already on its way up in November ’07, after inverting in March ’07.

It’s pretty much written in stone that money follows performance. Top performing Morningstar funds are given five star ratings. According to this WSJ article, five star rated funds attract massive amounts of assets, only to underperform their past performance: “Only 58, or 14%, of the 403 funds that had five stars in July 2004 carried the same rating through July 2014…”

So let me get this straight, we’ve seen massive performance in the last year. We’ve seen the ten to two at its lowest level in ten years. Why are equities still going up?


  1. The cost of money, i.e. interest rate on loans, is so low that arbitrageurs are borrowing to buy stock, because stock market returns are stable and greater than interest rates on loans. This is called leverage, and is a product of financial engineering. This could be huge once stocks start to fall. (Note: Check leverage levels in the market, thoughts on where to look readers?) Housing growth is also being fueled by easy money, just like last time.
  2. Quantitative easing loaded banks with cash and they’re using it to purchase assets, like money market accounts. Note: I’d like some clarity here, not sure if this is even fundamentally correct. Banks are paid for their excess and required reserves at 1.25%, which is about the same as a 5-year US Treasury bond (1.30%). Why would they get rid of their cash if they’re making 1.25% on every dollar per year; IT’S FREE MONEY FROM THE FED?
  3. We’re hitting the euphoria stage of markets. (See: This is Your Brain on Investing). Markets continue to push all time highs, and the financial media is eating it up. If markets continued at this clip for the next 3 years, both the Nasdaq and the Dow Jones would DOUBLE again (Sauce: Rule of 72). If yearly performance of the Nasdaq and DJIA continued, this is how it would look in November of 2020, does that look right to you?


Good luck, thanks for reading,

– tommander-in-chief

What I’m reading? Wealth, War & Wisdom – Barton Biggs


  1. https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/Historic-Yield-Data-Visualization.aspx
  2. https://fred.stlouisfed.org/series/T10Y2Y
  3. http://www.epi.org/nominal-wage-tracker/
  4. https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-region.htm