I take late-summer off from writing weekend notes. Reading more, recharging. And I’m working on a longer-form piece about a favorite strategy for the wild decade ahead. A scalable opportunity whose star is rising. Something overlooked, unloved. Be back with it in early September.
In the meantime, dusted off an anecdote that preceded the 2018 VIX debacle - exploring Goodhart’s Law (see below). In a world of unprecedented policy overengineering, how shall we interpret the signals sent to us by the markets we so actively manipulate?
Week-in-Review (expressed in YoY terms): Mon: South Africa extends ban on public gatherings as 3rd covid wave continues / violent riots continue in response to Zuma’s arrest, ECB’s Lagarde signaled there would be change to its forward guidance at 7/22 meeting, G20 fin mins endorsed plans for global tax agreement, majority of Brazilian’s support opening Bolsonaro impeachment proceedings, Japan PPI 5% (4.8%e), Turkey home sales -29.1% (16.2%e), S. Africa mfg prod 35.3% (46.8%e), India IP 29.3% (6.26%), S&P +0.4%; Tue: US CPI 5.4% (4.9%e) / core CPI 4.5% (4%e), Israel approves 3rd booster jab for Pfizer vaccine, S. Africa releases soldiers to help quell riots, US warns US companies that even indirect links to Xinjiang violates laws meant to target human rights abuses, Australia cons conf 110 (107.8e), China expts 20.2% / impts 24.2%, German CPI 2.1% as exp, Turkey IP 40.7% (37.2%e), US NFIB 102.5 (99.5e), S&P -0.4%; Wed: RBNZ halts QE a full year ahead of expectations, BoC tapers QE to C$2b/week, Turkish CB unch as exp, Fed’s Powell admits recent inflation uptick was above his expectations / highlights that 2.5% infl in 2022 is within the range of expectations, European Commission unveils plan to cut emissions by 55% by 2030, S. Korea unemp 3.7% (3.8%e), Singapore 2Q GDP 14.3% (14.8%e), UK CPI 2.5% (2.2%e) / RPI 3.9% (3.4%e), UK Home prices 10% (9.4%e), EU IP 20.5% (22.2%e), S. Africa ret sales 15.8% (12.3%e), US PPI 7.3% (6.7%e), S&P +0.2%; Thur: BoE Saunders talks about removing stimulus sooner than anticipated, BoK unch but sounded hawkish despite covid resurgence, China kept MLF at 2.95% - rolls 100b of 400b maturing (moderately dovish), gas prices in US hit highest since 2014 ($3.155/gallon), Fed’s Bullard thinks we are in situation where we can taper / Fed’s Evans says will talk about taper for a couple meetings at least, Germany ravaged by floods (42 dead), Tokyo logged 1,308 covid cases – 6m high just week before Olympics begin, US senate passes bill stating all goods from Xinjiang region were produced with “forced labor” and therefore banned, China GDP 7.9% (8%e) / ret sales 12.1% (10.8%e) / IP 8.3% (7.9%e), Australia unemp 4.9% (5.1%e), UK unemp 4.8% (4.7%e), US empire mfg 43 (18e) – highest ever, US initial claims 360k (350k exp), US impt prices 11.2% (11.1%e), S&P -0.3%; Fri: BOJ unch but will begin buying foreign currency denominated green bonds, Los Angeles to reinstate indoor mask ordinance starting Saturday (including vaccinated people), S. Africa protests settle down as 25k troops are sent in, China snubs senior US official in worsening diplomatic stand-off, Germany/Belgium deaths from flood continue to mount (120), first positive covid case within the Olympic village, N. Zealand CPI 3.3% (2.7%e), Singapore non-oil exports 15.9% (8%e), EU final CPI 1.9% as exp, Russia PPI 31.1% (29.3%e), US ret sales 1.1% (0.4%e), UofM sentiment 80.8 (86.5e) / 1y infl exp 4.8% (4.3%e) / 5-10y infl exp 2.9% (2.8%p), S&P -0.8%
Weekly Close: S&P 500 -1.0% and VIX +2.27 at +18.45. Nikkei +0.2%, Shanghai +0.4%, Euro Stoxx -0.6%, Bovespa +0.4%, MSCI World -0.3%, and MSCI Emerging +2.3%. USD rose +13.2% vs Ethereum, +5.1% vs Bitcoin, +1.5% vs South Africa, +1.3% vs Canada, +1.3% vs Sweden, +1.2% vs Chile, +1.2% vs Australia, +1.0% vs Sterling, +0.6% vs Euro, +0.1% vs Mexico, and flat vs China. USD fell -2.7% vs Brazil, -1.5% vs Turkey, -0.6% vs Russia, -0.2% vs Indonesia, -0.1% vs India, and -0.1% vs Yen. Gold +0.2%, Silver -1.9%, Oil -4.3%, Copper -0.8%, Iron Ore -1.9%, Corn +7.0%. 5y5y inflation swaps (EU flat at 1.58%, US +3bps at 2.27%, JP -8bps at 0.09%, and UK +3bps at 3.72%). 2yr Notes +1bps at 0.22% and 10yr Notes -7bps at 1.29%.
YTD Equity Indexes (high-to-low): UAE +40.1% priced in US dollars (+40.1% priced in dirham), Saudi Arabia +24.3% priced in dollars (+24.2% priced in riyal), Taiwan +22% (+21.5%), Sweden +18% (+24.8%), Austria +17.3% (+22.1%), Canada +16.3% (+14.6%), Russia +15.4% (+14.6%), S&P 500 +15.2%, Czech Republic +15.2% (+16.6%), Mexico +14.4% (+13.8%), Netherlands +13.9% (+17.9%), Poland +13.4% (+18.1%), South Africa +13.3% (+11.1%), Finland +13.2% (+17.8%), MSCI World +13.1% (+13.1%), Norway +13% (+16.3%), France +12.4% (+16.4%), NASDAQ +11.9%, India +11.5% (+13.9%), Hungary +11.5% (+14.2%), Denmark +11.3% (+15.8%), Belgium +10.9% (+14.7%), Euro Stoxx 50 +9.8% (+13.6%), Russell +9.5%, UK +9.5% (+8.5%), Germany +8.9% (+13.3%), Korea +8.9% (+14%), Israel +8.4% (+10.5%), Singapore +8% (+10.8%), Switzerland +7.9% (+12.4%), Argentina +7.7% (+23.2%), Brazil +7.7% (+5.8%), Australia +7.5% (+11.6%), Italy +7.2% (+11.5%), Ireland +5.4% (+9.1%), Greece +3.5% (+7.1%), China +2.7% (+1.9%), HK +2.7% (+2.8%), Spain +1.8% (+5.4%), Thailand -0.7% (+8.6%), Indonesia -1.6% (+1.6%), Portugal -3.5% (-0.1%), Japan -4.3% (+2%), New Zealand -5.5% (-3.2%), Chile -6.4% (-0.6%), Malaysia -10.6% (-6.4%), Philippines -10.7% (-6.2%), Turkey -19.4% (-7.7%), and Colombia -20.4% (-11.5%).
Anecdote (Oct 2017): “When a measure becomes a target, it ceases to be a good measure,” said the Englishman, stepping outside of himself. “That’s Goodhart’s Law.” Charles Goodhart observed that central banks measured money supply, and found certain M1 growth rates to be optimal. But once they targeted that optimal range, M1 lost its value as a measure. Market and economic actors adjusted their behavior to game the M1 system. So central bankers shifted to M2, then M3, and M4. “Investing is obviously not a science, but if it were, we would say that you can’t act on something and observe it at the same time.” French colonialists discovered this in rat infested Hanoi, when they offered a bounty for killing rodents. To receive the reward, the Vietnamese were required to produce severed tails. Soon thereafter, tail-less rats scurried throughout the city. The bounty hunters removed their tails and released them to the filthy sewers to breed. Boosting their bounty. “Investors discover pricing anomalies from the past. And they pile into them, ensuring that for a time they persist.” They mistake the distortions of their wall of money for the wisdom of their observations. They interact with the market as if they’re exogenous, when, in fact, they’ve become endogenous. “Today’s greatest example of Goodhart’s Law in action can be found in volatility markets.” The VIX index measures the expected volatility of the S&P 500, and is calculated by multiplying expected 30-day variance by 100. As a measure of market fear, it was quite useful, until it became something that could be traded. “The sheer size of outstanding positions in VIX futures, VIX options, ETFs, ETNs and bank volatility selling programs is such that those trading these markets can no longer separate the true measure of volatility from their own actions.”
Good luck out there,
Chief Investment Officer
One River Asset Management