Expect Desperate, Insane Behavior From Government In 2018 – Part 2

Authored by Mike Krieger via Liberty Blitzkrieg blog,

The financial crisis of 2008/09 was the most significant event to happen in my lifetime. That event, coupled with the deeply unethical and corrupt response to it, led to a direct delegitimization of governments and institutions worldwide. It’s precisely this self-inflicted destruction of credibility which opened up the window for the birthing of a new monetary and financial system in the wake of Bitcoin’s emergence in early 2009.

Bitcoin is a system designed to be everything the status quo isn’t. Decentralized, transparent, permissionless, with a well-defined and restricted monetary supply curve.

Given the backdrop upon which it emerged, it’s unsurprising that as more time passes, the more popular it becomes.

Humanity is desperate for a major reboot and an entirely different way of doing things. Bitcoin and other crypto assets offer exactly that opportunity in the realm of finance and money, thus capturing the imagination of millions of the most brilliant and passionate people across the world. Since the status quo stubbornly refused to reform and change the system after the financial crisis, humanity had no choice but to take charge and do it independently at the grassroots level.

One thing that’s become increasingly clear to me as I’ve added years and experiences to my life, is that governments, generally speaking, hate freedom. It’s why something as beneficial and benign as cannabis remains illegal throughout the world, and why people like Jeff Sessions still want to criminalize it even in states where the actual people living there voted to make it legal (see Part 1 of this series). While the fairytale we’re conditioned to believe tells us government exists to protect us and create an environment in which humans can thrive, the reality is quite clearly the opposite. The crooked response to the financial crisis demonstrated this in spades to anyone paying even the slightest amount of attention.

As we transition into 2018, increasing numbers of people will see government and large corporations as the unified threat they represent to the global economy and human freedom. Younger generations are particularly aware, as they’ve been thrust into a parasitic system designed to prey upon them via a lifetime of debt serfdom. The more people learn about the way the world really works, the more they’ll want to reject it and create something entirely different. This is where Bitcoin and crypto assets come into play.

As Bitcoin rose through the $10,000 mark, I noticed an explosion in panic and fear on behalf of those who want to keep the current system in place.  This is to be expected, as Bitcoin’s popularity is and should be seen as a report card on the global status quo. The financial system as it’s currently constructed is being publicly rejected with every uptick in the Bitcoin price, and with every billion dollars added to total crypto asset market capitalization. Naturally, this will make those in charge of the current predatory system, and those who have benefited most from it (oligarchs), increasingly hostile to its popularity.

There are so many recent examples of such hostility it’d be impossible to highlight them all, but I’ll provide you with a few examples so you know what I mean.

First, there was the clip of two billionaires discussing Bitcoin on Bloomberg.

These weren’t the only two billionaires who chirped in about Bitcoin last week. Financial oligarch Ken Griffin came out with the truly original line of comparing Bitcoin to tulips, something I’ve heard non-stop in the more than five years I’ve been involved in the community. Via CNBC:

Citadel’s Ken Griffin said Monday that bitcoin may be in a bubble.

 

“Bitcoin right now has many of the elements of the tulip bulb mania we saw back hundreds of years ago in Holland,” said the billionaire hedge fund manager in an exclusive interview with CNBC’s Leslie Picker.

 

Griffin, however, said he does believe the blockchain technology backing the cryptocurrency is valid.

Griffin’s estimated net worth is $8.6 billion. Makes you wonder what sort of society and economy enriched someone like this to such an extent.

Carl Ichan also chimed in. Via Coindesk:

Billionaire investor Carl Icahn has jumped on the bandwagon of financial bigwigs saying bitcoin is in a bubble

 

The business magnate and founder of Icahn Enterprises told CNBC that the cryptocurrency “seems like a bubble” and that he didn’t understand the hype around bitcoin.

 

Icahn stated:

 

“I got to tell you honestly, I don’t understand it … I just don’t get it. I just stay out of something if I don’t understand it.”

He admits he doesn’t understand it, but calls it a bubble anyway. This is surprisingly common.

Of course, there was the infamous nonsense spouted by Nobel Prize winning economist Joseph Stiglitz who appears viscerally triggered by Bitcoin, saying it has no social function and should be outlawed.

Add to the above a plethora of central banker commentary about how dangerous Bitcoin is, and you know status quo types are beginning to sweat. Which brings me to the point of this piece. With Bitcoin having succeeded beyond the wildest imagination of status quo sycophants, many will begin to clamor and beg for an official response in order to defend their sleazy government sanctioned rackets.

At this point, I could attempt to outline all the various ways the U.S. government and others could target free market crypto assets, but I’m not going to do that. The reason I’m not going to do this is because I think the cat’s already too far out of the bag for the power structure to stop this trend. The benefits to humanity generally, and younger generations specifically, will make any attempts to stop this freight train futile. Any government that tries to do so will simply shoot themselves in the foot.

We stand on the precipice of historical shifts in relative economic power.
Those regions that embrace crypto assets will thrive, those that reject them will die.

— Michael Krieger (@LibertyBlitz) December 4, 2017

Unfortunately, most governments exist to protect and defend the status quo, versus doing what’s best for the public. If government actually cared about the future, every single country would be competing aggressively right now to be the most crypto asset friendly region on earth. The human brainpower and talent voluntarily dedicating their lives to this space is extraordinary. It’s a global movement and community the likes of which has rarely, if ever, emerged on this planet.

The smartest people on earth are dedicating their lives to Bitcoin and other crypto assets.

You want to bet against that?

— Michael Krieger (@LibertyBlitz) December 1, 2017

That tweet above more or less summarizes how I see the situation. Anyone who bets against this overall space will ultimately end up historical roadkill. The emergence of Bitcoin and the crypto-asset ecosystem generally is one of the most liberating, paradigm disrupting events that’s ever manifested on this planet. Of course, entrenched interests won’t like it and will try to fight back, but they’ll be no more successful than those who wanted to ban the printing press.

Bitcoin is achieving what global central banks completely failed at. Animal spirits, a dynamic economy and revolutionary innovation.

— Michael Krieger (@LibertyBlitz) November 26, 2017

The above occurred despite governments having placed many roadblocks in the way. Imagine the innovation explosion that would be unleashed if governments decided to support this extraordinary community rather than fight it? At over $11,000 per bitcoin, a lot of money’s been made. While hodlers certainly prefer to spend fiat as opposed to bitcoin, the higher the price rises, the higher the percentage of their net worth is denominated in crypto.

If the U.S. government actually cared about dynamic economic growth as opposed to merely protecting status quo interests, it would unleash the power of this crypto asset wealth creation machine by eliminating taxes on gains. If no capital gains were owed, it’d encourage people to spend some of this newly created wealth in the economy. It’s an obvious move, but because governments are mainly about control and power, their initial reaction likely will be to go in the opposite direction.

The opportunities available right now for regions and nations willing to be openminded about Bitcoin and crypto assets generally are extraordinary. Government roadblocks and bans cannot and will not kill the spirit of this community and the ideals that motivate it. The only question is which regions/governments will put arrogance and control aside to do the right thing by their people. We’ll find out the answer to that question soon enough.

As a declining global empire, the U.S. is unfortunately prone to doing particularly stupid things in order to protect the predatory system beloved by the oligarchs in charge. On the flip-side, there are plenty of wealthy Americans and others with influence who see Bitcoin for the incredible opportunity it is, and cooler heads may prevail. The truth is nobody knows exactly how all of this will turn out.

In the short-term, we’re likely to face increased push back and we should be mentally prepared to face it. In the longer-term, the future appears exceptionally bright.

*  *  *

If you liked this article and enjoy my work, consider becoming a monthly Patron, or visit our Support Page to show your appreciation for independent content creators.

European Junk: "The Good-Looking Ones Are Always Bad News"

Authored by Kevin Muir via The Macro Tourist blog,

Yesterday, a few different readers emailed to ask my opinion about the European Junk Bond versus US Treasury yield chart that Tiho Brkan from The Atlas Investor Blog recently published.

Well, I have to give Tiho credit, his chart certainly stirred up a lot of primal urgings from investors eager to short European junk bonds. Although I am a huge Kodiak Grizzly of a bond bear, I think there are better ways to express this view than shorting European junk. Let me tell you why.

I couldn’t replicate Tiho’s chart exactly as I don’t pay for the Bank of America / Merrill Lynch bond indexes, but I found a Barclays/Bloomberg index that is close enough. So here is my version.

I also couldn’t determine Tiho’s term for the US Treasury yield in his chart, but it sure looks like the 10 year yield, so I am going with that.

So when comparing these two series, let’s start with the obvious. The current on-the-run US 10 year treasury note has a modified duration of a little less than 9 years. This compares to the European Junk bond index that comes in at under 4 years.

The sensitivity to changes in interest rates will therefore be much higher in the US treasury notes. Comparing these two assets with such different term lengths is a little misleading.

But you might say, “I don’t care - look at past yield levels for European junk! I can afford to have less duration because the credit part will skate me onside.”

And yes, if credit spreads blow out, then shorting junk is much better than sovereigns.

What do I mean by that? When an investor buys junk bonds, they are typically rewarded with an extra yield to compensate for the increased risk. The amount of this extra yield is called the option-adjust-spread, and we can chart it.

Currently, European junk bonds only offer 2.67% over the equivalent sovereign yield. Wait! How can that be? The US year yield is 2.22% and the two series have recently converged, so that doesn’t seem to make any sense. But you have to remember that 4 year German bunds are yielding negative 42 basis points, so that means European junk bonds are trading at roughly 2.25% (267 bps more than sovereigns).

As you can see from the OAS chart, these junk bonds have often yielded considerably more than sovereigns. During the Great Financial Crisis they spiked to 20% more, and even during the 2011 European credit crisis, they got as high as 10% over.

So yeah, I understand the attraction to shorting European junk. It’s easy to look dreamily at this chart and imagine spreads doubling to 5% without batting an eye.

But there are a couple of problems with this trade.

There are no easily traded derivatives on European junk bonds. So unless your friendly neighborhood GS salesperson lets you buy CDS protection on this index, it is kind of a non-starter. Yeah, you might find some ETF and leverage it up a bit, but with a 4 year duration, your returns are going to be mediocre, even if you nail the timing perfectly.

Yet even if I worked in a big fixed income shop and could execute this trade seamlessly, I don’t think I would bother with junk, and would instead focus on the sovereigns.

Getting all hot and bothered about the juiciness of European junk is doing nothing more than repeating the US mistake made by all the hedge funds over the past few years. Remember Carl Icahn’s “Danger Ahead” video? It has now been two years since good ‘ole Uncle Carl blessed you with his advice to put on all the same hedges that worked so fabulously in 2008. Go ahead and watch the video again. See how he recommends shorting credit? And no wonder. This trade worked so well in 2008, it is tough to not look at the tight spreads and think they offer a great asymmetrical risk reward profile (to use the buzzwords from all the hedge fund gurus). And I don’t mean to pick on Carl, practically all these mavens have been positioned the same way. Everyone hedges for the last crisis - even legendary hedge fund managers.

For the last two years, these hedges in the US markets have been a disaster, and I suspect they are about to experience the same sort of pain in Europe.

Don’t mistake my lack of bearishness for European junk bonds as a belief they offer good value. Nope. Not a chance. I wouldn’t buy an asset that offers so little upside, but with the potential for so much downside, in a million years.

Yet I do think shorting sovereigns is a much better trade than betting against European junk. What is going to cause European OAS spreads to blow out? Economic weakness. And what will be the result of more economic weakness? Yup - you got it - more quantitative easing. The ECB is already running out of sovereigns to buy, so what will happen the next time? They will venture even further out the risk curve.

I believe European junk bond yields are headed higher, but only on the back of higher sovereign yields. So if the only way junk bonds are going down is if sovereigns go down, why even bother contemplating shorting junk?

Why not just short the actual security that will cause the other security to decline?

I guess I could sum it up by explaining that I am negative on European bonds, but neutral on option-adjusted-credit spreads.

Governments are going to keep spending and printing until we finally get the nominal growth they so desperately desire (note how I specified nominal growth - they will find it more difficult to generate real growth). If you accept this argument, then it makes way more sense to short sovereigns than junk.

I have argued that the European cycle is mirroring the US experience since the Great Financial Crisis, only a few years behind. If that is the case, then there will be plenty of time to short European junk bonds in the coming years.

In the meantime, I am focusing on shorting the government bonds that are the true bubble. It is funny how so many look at junk and salivate over the possibility of shorting a security yielding 2.25%, yet quietly ignore government bonds yielding negative real rates of return with Central Banks intent on creating the very inflation that bond investors fear the most.

I will leave you with these wise words from the Urban Camel:

Remember, those good looking trades that everyone wants to put on are usually trouble. Instead, look for the more reliable, underappreciated one that is often staring right at you.

The End Game

Authored by Kevin Muir via The Macro Tourist blog,

We all know the terrifying debt statistics. We are bombarded every day with bearish reports about the gargantuan Federal debt, and when combined with the growing private sector indebtedness, the monolithic entitlements problem, and the looming pension fund shortage, it is easy to wonder how we will ever get out of this colossal mess.

I do not dispute the numbers one bit. We have too much debt. It’s simple math. We are screwed. Full stop. All of this debt will never be paid back in real terms. Truth be told, I am probably one of the most bearish people out there when it comes to our debt problem.

But I differ greatly from the vast majority of my peers about what that means for the economy and financial markets.

There are three solutions to the problem of over-indebtedness.

The first is to grow your way out. Maybe you cut some spending, hunker down, trim up the sails, and right the ship through good old fashioned economic growth. This solution is a pipe dream left for little children and romantics. In a balance sheet challenged economy, the moment you cut spending, the paradox of thrift kicks in, and the economy rolls over. This is a lesson Japan has learned all too well over the past couple of decades. Not believing Japan’s example, the U.S. repeated the error after the credit crisis of 2008. Thinking overspending was the cause of the problem, the U.S. government (led by the Tea Party) cut discretionary spending to the bone. Remember the 2013 budget sequestration? All of that hullabaloo caused the government to shrink from 2011 to 2015.

Whoa! That doesn’t follow the typical narrative of Obama as a spendthrift fiscally irresponsible President. Didn’t Federal debt balloon under his watch? How does that work? Well, the reality is much of the spending that caused the increase in overall debt was the result of automatic stabilizers - unemployment insurance, etc… Although Obama probably wanted to spend much more, he didn’t. And this is one of the reasons the U.S. economy experienced its weakest post recession recovery. Just look at that chart above. Over the past three decades there has never been a government spending decline of that magnitude.

Now I realize many of you will probably be saying “good - that’s what’s needed. The idea of increasing spending to solve a problem of too much debt is ridiculous. The reason for the anemic recovery is that we didn’t cut enough.” Which brings me to solution number two.

In an environment of over-indebtedness, the economy will naturally try to correct through the private sector paying down debt. But over the past half dozen decades, we have been muting regular business cycle declines through overly easy monetary policies. This has encouraged too much borrowing. We have piled more and more debt on the problem. The trouble is that we have done this for so long, the consequences of allowing the cycle to play out has become catastrophic.

Have a look at the total U.S. credit outstanding (minus financial firms) over the past few decades.

See the slight leveling off in 2007? That is the horrific debt de-leveraging that caused the greatest financial crisis since the Great Depression.

So far all those economists of the Austrian ilk, I acknowledge that if the government and the Federal Reserve would allow the natural business cycle to operate, we would have debt destruction that would cause the financial system to reset. After this event, the economy would be all set to grow again. Yet this reset would make the 2008 credit crisis look like a warm up. We would have 1930’s style breadlines.

I don’t buy for one second that the public has the stomach to sit through this type of event. Maybe when the problem of over-indebtedness was smaller, we might have done it. Perhaps in the 1980’s, or maybe even the 1990’s when Greenspan first brought the irrational exuberance problem to the fore, but not today. The pain that would accompany a true debt destruction reset would be too immense. The amount of social upheaval and instability would probably mean the end of the Western world as we know it.

We can’t grow our way out the debt problem, and we certainly can’t allow it to reset through a cleansing business cycle flush, so what’s the solution?

That leaves the one tried and true solution. For thousands of years when societies have gotten in trouble with too much debt, they have solved their problem by printing their way out of it. To think the modern day situation will be any different is naive.

Yeah, sure there will be moments when governments flirt with the idea of prudent monetary and fiscal policy. But those periods will be fleeting. Faced with moribund growth and a steadily increasing debt burden, at the first sign of trouble they will quickly turn on the presses and resort to the time old tradition of inflating away their debts.

Which brings me to the end game. There are many forecasts for a 2008 style collapse. The consensus is that eventually the debt burden becomes too big to bear, and the next Great Depression rolls in.

I don’t think that is how it plays out. Most traders hedge for the previous crisis. Visions of 2008 still fill the nightmares of investors. This explains why “gurus” like Carl Icahn have long presentations where they advocate hedges that worked so well in the last crash.

But what’s going to happen the moment things look dicey again? The governments and Central Banks will inflate. We saw it with BREXIT. We saw it with Eurocrisis of 2011. In fact, governments are becoming more and more quick to step on the gas pedal. They realize the costs of over inflating are far less than the costs of delaying.

Now you might have philosophical problems with these responses. For the longest time I railed on about the dangers of irresponsible monetary policies. It got so bad that on my ski trips, my pals banned me from talking about Greenspan’s reckless behaviour.

Yet today, I have come around to the idea that the debt problem is so pervasive, there is only way one forward - inflate. We are going to end up there anyway, so let’s just inflate away the burden and restart with a system that prevents this from ever happening again.

All of this talk is just that though - talk. As traders we need to concern ourselves about what is, instead of, what should be.

I don’t really care to argue about the morality of these decisions. The internet is filled with idiots shouting their opinions at the top of their lungs. The last thing you need is one more.

But I want to leave you with this idea. Given the enormous debt problem, the notion we will pay it back in real terms through growth, or even more improbably, the idea of allowing a massive debt destruction event to reset the system, is unrealistic. Any economic weakness will be met with more printing, and more stimulus. Maybe governments allow one or two quarters of weakness. It might even drag on for a year. But then as sure as day follows night, they will inflate again. They simply cannot afford not to.

They will do anything (and everything) to ensure the financial system doesn’t implode on itself. They will engage in massive Quantitative Easing programs. They will venture out to buy risky assets. They will even take interest rates to negative levels. It is only a matter of time before they are simply dropping cash right into individuals bank accounts.

I wish I could take credit for this, but it was Bill Fleckenstein who said it first. They will keep printing until the bond market takes the keys away.

Many market participants are worried about the economy rolling over. Although I understand it would cause some declines in financial markets, what would be the end result? Central Banks would ease, governments would spend, and they would find a way to prop everything back up again.

I am not smart enough to know if we are going to get another cyclical dip that is met with more easing over the next few quarters. If I had to guess, I would say this is probable - especially in the US. I am not predicting the medium term squiggles. But if this sort of decline were to occur, it would not be the big one.

The true end game won’t come from weakness, it will come from strength. What happens when economic growth picks up and causes inflation? Given the massive indebtedness, Central Banks will be loathe to raise rates enough to cool inflation. This will only cause more inflation.

Eventually we will hit a point where governments will be unable to raise rates because it would crush their balance sheet, yet inflation will dictate rates be higher. This will be checkmate. Governments will have no moves. Inflation will soar, the yield curve will steepen (to record wides), and the inflationary reset will be upon us.

The end game won’t come from a recession, it will come from a boom that gets out of control. I know that it a non-consensus minority opinion, but it’s always the story that no one is expecting that ends up being the problem.

Carlson Capital: Border Adjustment Tax Would Lead To "Global Depression"

In their latest quarterly letter, Carlson Capital"s Black Diamond Thematic Fund (which was up 9.27% in Q4 and up net 19% in 2016) portfolio managers Richard Maraviglia and Matt Barkoff, who unlike Carl Icahn, Stanley Druckenmiller, Dan Loeb and most of the market, turned rather bearish weeks into the Trump victory, warn that “we may be looking at the grisly spectacle of stagflation”, echoing ongoing warnings from virtually all major banks that the market is wildly overpriced:

If the economy slows down against expectations it will have little effect on the upward direction of inflation. The rationale of inflation was cost-push and supply side constraints not demand side stimulus. Thus, we may be looking at the grisly spectacle of stagflation with the equity market on the highest cyclically adjusted valuations ever.

The two PMs are especially concerned about an imminent stagflationary episode, coupled with a concurrent recession, for the following reasons:

"Based on rising commodity prices and the more than one hundred percent year-on-year increase in crude oil, also an (OPEC) supply issue, we expect inflation to rise quite sharply perhaps as high as five percent over the next year. Anytime over the last thirty years that oil has risen one hundred percent year-on-year and long end interest rates are up one hundred percent year-on-year with a strong dollar, the US economy has slowed down often into recession. It squeezes consumer real purchasing power, slows real consumer spending at a time when export growth could slow given uncertainty over new, undecided policies and a less competitive currency. This is a global phenomenon; Japan has an extremely low unemployment rate too. The Eurozone and UK CPIs are destined to accelerate also."

Needless to say the fund is bearish, and here is the reason why in its own words:

Politics and history feature heavily in our thinking as we begin the year. We see a variety of factors that could cause macro deceleration just at the moment when investors have been dragged kicking and screaming into cyclical positioning, a place in which they are not truly comfortable. We further see much more dramatic risk from China. The combination offers attractive optionality to defensive positioning that is now under owned and attractively priced. As it relates to the Trump rally, we could argue that there were several drivers. The first was seasonality into year end. The second was the enforced bond-equity rotation which we suspect could be over in the short term. Third, fourth and fifth would be policy themes: corporate tax reform, infrastructure spending and broad deregulation. It was notable that in his first press conference there was no mention of any of these but rather unprompted criticism of the pharmaceutical industry.

Setting aside intra-market rotations, we note that hedge funds are really long the market right now. Recent CFTC data showed large US futures buying by hedge funds. Net futures positioning is now above the 80th percentile. Recent prime brokerage data showed net leverage +6.5 percent above the trailing twelve month average and is now close to a twelve month high.

In short, euphoria: "Sentiment is bullish; inflation is deemed to be a good thing despite the points we have made here. The Merrill Lynch Survey shows that we are in the euphoria stage:"

As it remains a constant topic du jour the hedge fund also touched on China, saying "monetary policy is tightening as interest rates in China have risen by almost one hundred basis points since the US election. Rising interest rates have caused a slowdown in corporate bond issuance. We would expect that Chinese New Year starting on January 27th will cause a further spike in rates.

Due to the pressure that rising interest rates will have on GDP given China’s leverage will reach three times GDP by 2018.

Thus, if China remains committed to a stable currency, it means tighter economic policy and downside to data now that government fixed-asset investment has begun to fall back to pre-February 2016 stimulus levels. The simplest way to observe this is through Shanghai house prices, which have just turned negative.

Carlson also has some thoughts on the current rate hiking cycle, which it views as further justifying the fund"s bearish posture:

Prior letters have been focused on the Fed and the implications of the rate hike cycle. These implications have not gone away, but have perhaps been forgotten and the path will be difficult to reverse. Regardless of current opinion, the truth is that tightening cycles almost always cause multiple contractions. The only exception was a six month period at the beginning of the chart below in 1987…

Next, some market observations: "we note that the market is rising on ever-decreasing breadth. In the second week of January when the averages made new highs, only 3.5 percent of securities closed at a fifty-two-week high. This was one of the smallest readings in decades. The average over one hundred years is almost fifty percent. The last two times breadth was this weak was in July 1999 and March 24, 2000."

Unlike Horseman, which suffered a big drop in the last two months of 2016, Carlson is boasting with a nearly 19% return for 2016 despite "a short beta position of 34.5%."

The fund remains short. We produced a return of 18.95 percent net of all fees in 2016 despite averaging a short beta position of 34.5 percent on average throughout the year by capturing important rotations based on our macro analysis. This amounted to a 3.34 Sharpe ratio for the fourth quarter and 1.64 for the year. We see more of these alpha transitions to come going forward but expect that we can also capture beta at some point in the first quarter of 2017. Volatility is here to stay and we also expect to be somewhat volatile and accept it as a cost of doing business and will attempt to control risk as much as possible while expressing our views.

Finally, and as the title suggests, the biggest risk according to Carlson"s PM is the US trade deficit, and specifically how the proposed Border Adjustment Mechanism would impact both the global economy and stocks:

We cannot overstate the impact of a declining US trade deficit and this is why we spent a large part of the letter discussing it. If the border adjustment mechanism is implemented as proposed we think it will cause a global depression and a major equity market decline. It is still unclear whether it will happen but at the very least we expect that US trade policy will put downward pressure on global growth. When this becomes apparent commodities will correct meaningfully and we will reinvest in inflation beneficiaries. Until then we are short cyclicality with what we assess to be tremendous risk-reward optionality through semiconductors, industrials and miners.

Full letter below:

Kyle Bass Hints What The "Greatest Trade He Has Ever Encountered" Is

Heyman Capital"s Kyle Bass, who as we reported two weeks ago returned an impressive 25% in 2016, spoke to Bloomberg TV"s Erik Schatzker and likened President Donald Trump’s trade and tax policies to gasoline which will accelerate an economic "restructuring" - a polite word for crash - in China.

Discussing a topic he has been particularly focused on since late 2015, Bass said China has “recklessly built a system that’s going to need to restructure and that just so happens to be metastasizing right when Trump becomes elected. This is a fire that’s been smoldering and it’s now starting to burn, and Trump is just more gasoline." As he put it later "in lifecycles, what Trump is going to do, he is going to speed everything up." That statement is absolutely spot on, on many different levels as we will soon find out.

Bass also said that imposing tariffs on Chinese imports could have “profound consequences” for the nation’s economy, where credit over the last 18 months has grown by $6.5 trillion while deposits have grown by half of that, or just $3 trillion, "so credit is growing exponentially, China has to fund enormous moves in credit growth just to keep in roughly the same place. We call it running to stand still."

He mocked "the idea that China is now the driving economic power in the world" calling it "illusory or somewhat of a fallacy" and as we reported in early January, confirmed that "it’s safe to say that the Asian theater is where we’ve been focused.”

Aside from China, Bass echoed recent favorable remarks by both Ray Dalio and Stanley Druckenmiller about the impact Trump would have on the US economy, which he said would now focus on labor over capital, and the resulting increase in capital investment could to a jump in productivity, all of which is happening near full employment and when combined with tax repatriation, will be "extremely stimulative" but also be inflationary. The impact will be “positive for the United States and slightly negative for the rest of the world,” he said. “But it’s not the globalist nightmare, in my opinion.”

As he says, if you need to boil it down into a soundbite: "short rates, dollar strong", but the question is how do you get to pay for cutting the corporate tax rate, to which his answer is that a border tax - or "taxing the trade deficit" - is the "only way to pay." However, if various retail-affiliated lobies such as Nike and WalMart offer enough resistance, Trump may simply enforce tariffs.

When asked how he played the election, Bass said that he waited until the results started coming in and found the market"s initial reaction to a Trump victory as irrational, and that just like Carl Icahn, he took on very "pro-growth" positions in currencies and rates in "huge amounts" later that night, in what ended up being an "easy trade."

* * *

But what we found most interesting is a section discussing inflation in Germany and German Bunds, in which he may have dropped a hint to help us identify a trade he previously dubbed the "greatest risk-reward profile ever encountered." Recall in his year end letter, Bass said the following:

One opportunity in particular has the greatest risk-reward profile we have ever encountered in our decade of being a fiduciary. As investors of ours, you are positioned to take advantage of one of the world’s greatest macro imbalances.

The trade Bass may be refering to is the same "short of a lifetime" first brought up by none other than Bill Gross in April of 2015, namely shorting German bunds, and which promptly crashed just days after the Gross prediction almost two years ago.

Why do we think so? Because when Shatzker asked Bass if "there are any natural Trump trades right now" Bass" response was quick and to the point:

"Real rates in Germany are at the lowest level ever right now. Inflation in Germany is spiking. It’s not even moving in a linear fashion. You have even seen members of the ECB and the Bundesbank speak today about the fact that I think we are going to see inflation running much hotter than any of the central banks thought it would. Therefore I think the move in bonds is just beginning."

It sounds that Bass now in agreement not only with Gross, but also Jeff Gundlach, who in his recent public webcasts has continued to hammer the thesis that shorting German Bunds has huge profit potential, and if indeed Bass sees the Short Bund trade as the greatest opportunity of his career, the Bund crash and VaR shock observed in May of 2015 may be imminent once again.

* * *

The rest of the Bloomberg interview, predictably, focuses almost entirely on China, where the crash thesis is well-known (if not the timing), and Bass expounds on the various ways one can play the upcoming crash, although - like any smart hedge fund manager - he won"t explicitly state for the record that he is short the renminbi or other Asian currencies. Toward the end, Bass takes an interesting detour in which he praises the Russian economic response to the recession of 2015 in what appears to be a decidedly bullish outlook on Russian assets, and when Shatzker proposes summarizing the Bass interview by saying "short China, long Russia", Bass responds "that"s a good place to start"

Watch the full interview below:

Carl Icahn Praises Trump Speech: "Our Dangerous Slide Towards Socialism Is Over"

Having used words never before heard in a Presidential inauguration address:

bleed, carnage, depletion, disrepair, flush, Islamic, ripped, sad, rusted, sprawl, stealing, stolen, subsidized, tombstones, trapped, trillions, unstoppable...

President Trump has face criticism for his no-holds-barred speech - confirming his stance as an anti-establishment "America First" president. Trump advisor Carl Icahn told CNBC on the afternoon of the inauguration...

"Donald surprised me coming on so strongly about the establishment. I admire him for doing that."

"I admire him for not just trying to say, "Wow. Let"s smooth it over. Let"s be buddies." I mean, he came on extremely strongly and he"s giving you a look at what the future, I think, is going to be."

Icahn, Trump"s special advisor on regulatory reform, said he expects the 45th president of the United States to take a confrontational approach, to some extent. Yet he argued that may be a good thing because it will promote change.

"I think you have to break up this establishment. You have to stop the perception which we have in this country that the government is at war with business, that the government doesn"t like business and that"s what you"ve had for eight years with Obama," Icahn said.

But his tweet this morning is perhaps the most succinct confirmation of what just happened...

.@realDonaldTrump ‘s brilliant inaugural speech, defying worst critics, leaves no doubt our dangerous slide towards socialism is over.

— Carl Icahn (@Carl_C_Icahn) January 23, 2017

Indeed!

The Following Words Had Never Appeared In An Inaugural Address, Until Today

That Trump"s inaugural address was provocative is putting it mildly. Nowhere was this more obvious than in the initial reaction of the Financial Times. Consider the following excerpt:

For most presidents, a first inaugural address has been the occasion to set out a personal vision of the American idea. You do not necessarily lose points for failing to set out policy in granular detail. You are playing mood-music, making it as stirring as possible and positioning yourself in the grand flow of American history: reminding your audience of an essential continuity. Mr Trump’s theme was the opposite. From his first words, he stressed discontinuity: that his presidency would be a break.

“Today’s ceremony, however, has a very special meaning because today we are not merely transferring power from one administration to another or from one party to another, but we are transferring power from Washington DC, and giving it back to you, the people.”

That audience-shaping attempt, at least, had the right idea. Mr Trump made a lot of play with the second and first-persons plural: “This is your day”; “We will bring back our jobs.” But he positioned his “great movement” in a way that suggested not that the Washington government was the expression of democracy but its enemy. It was an unusually rancorous, backward look, given what he said about unity and solidarity. It was a dismissal of, rather than a humble doffing of the cap to, history.

[R]ewarmed like a tray of unappetising leftovers, were the familiar slogans of the campaigning Mr Trump. “The forgotten men and women of our country will be forgotten no longer.” “America will start winning again, winning like never before.” “All talk and no action.” “America first, America first.” They were greeted with what, at least on the television relays, sounded like distinctly halfhearted applause.

And here — during his sporadic attempts at the high style — were some awkwardly half-formed figures of speech. To say “we stand at the birth of a new millennium” sounds grand but, unless you have a 1,000-year regime in mind, if you can say that in 2017 you can say it any time you like. “We are one nation and their pain is our pain” would have worked if “they” had been specified. It wasn’t.

He spoke of “rusted-out factories scattered like tombstones across the landscape of our nation”; of how “a new national pride will stir ourselves (sic), lift our sights and heal our divisions”; of how “a new vision will govern”; of how “we will shine for everyone to follow”; of how “the wealth, strength and confidence of our country has dissipated over the horizon”. Each of those phrases is intended to resonate — but each, like a bell cast with a fault, makes a slight clunk.

And the punchline:

The speech’s most memorable phrase was “American carnage”. As well as being, unfortunately, the title of a thrash metal tour a few years back, it is memorable because it sounds slightly wrong. You want an audience to associate pride, dreams, prosperity, unity, freedom, hope and suchlike with the word “American” — not “carnage”.

Etc.

While we won"t comment on the FT"s visceral reaction to the speech (full transcript here) - clearly the establishment mouthpiece was not happy with the words that came out of Trump"s mouth - and while readers can make up their own mind about Trump"s address, we do want to point something out.

Like everything else about him, Trump"s speech was indeed a break from established tradition, and nowhere was this more obvious than in the selection of words that had never appeared previously in any US inaugural address.  Some of them: bleed, carnage, depletion, disrepair, flush, Islamic, ripped, sad, rusted, sprawl, stealing, stolen, subsidized, tombstones, trapped, trillions, unstoppable.

The full list is below.

Indeed, the speech was so unorthodox it even stunned Trump advisor Carl Icahn. As he told CNBC, "Donald surprised me coming on so strongly about the establishment. I admire him for doing that." 

"I admire him for not just trying to say, "Wow. Let"s smooth it over. Let"s be buddies." I mean, he came on extremely strongly and he"s giving you a look at what the future, I think, is going to be," Icahn added.

Icahn, Trump"s special advisor on regulatory reform, said he expects the 45th president of the United States to take a confrontational approach, to some extent. Yet he argued that may be a good thing because it will promote change.

"I think you have to break up this establishment. You have to stop the perception which we have in this country that the government is at war with business, that the government doesn"t like business and that"s what you"ve had for eight years with Obama," Icahn said.

We have yet to see if Trump will indeed follow up with his promises, or his belligerent speech. We do have one last question, however: did Trump really "borrow" a part of his address from... Bane?

Wait... what!?#Inauguration pic.twitter.com/zs8rx1MjMc

— Jahova (@JahovasWitniss) January 20, 2017

What "The World's Most Bearish Hedge Fund" Thinks Of The Trump Presidency

October was not a good month for the "world"s most bearish hedge fund" Horseman Global Management, which suffered another steep drop, losing 5% in the month, and down 5.5% YTD. Absent a rebound in the last two months of the year, Horseman is set to have its worst year since 2009. Alas, with Horseman"s net exposure a whopping -84% (if fractionally more bullish than the -100% recorded in early 2016) as a result of an equity short and a bond long, November does not appear overly promising for the fund"s investors. Unless, of course, the market swoons as both yields and the dollar continue surging (as DB warned), and Horseman does have the final laugh.

That, however, would be surprising considering that some of the most prominent billionaire mega-bears, such as Carl Icahn and Stanley Druckenmiller, both quikcly flopped to bullish in the aftermath of Trump"s election, on just one catalyst: more debt resulting in more stimulus, and (hope) for more growth.

Yet Horseman refuses to change its thesis. Why? Instead of guessing, here is the answer straight from the "Horse"s mouth" - the following excerpt from the latest letter to investors by CIO Russell Clark lays out what the gloomy hedge fund believes will be the outcome from a Trump presidency.

Your fund fell 4.96% last month. Losses came from the bond book, the forex book and the short book. The long book made money.

First Brexit and now the Trump triumph has left many supporters of open liberal economies despairing. They feel that the world is turning in on itself and that perhaps a darker less safe world is emerging. And perhaps they are right.

But in many ways, the great western democracies of the world, the UK and the US are working as they should. It is plainly obvious that large parts of the population in both the UK and the US feel that the system has not worked for them, and they have voted for change. And those voters have had their voices heard and change is on the way.

Undemocratic regimes in the rest of the world look on in either horror or bemusement at the changes in the UK and US and congratulate themselves that their system is so safe and stable. And yet, the reality is that if the political system cannot provide the change that people seek, then eventually and inevitably, revolution becomes the only option for change. And revolution always extracts a very high price on those that have been in power.

When thinking about a possible Trump victory, I perceived that the USD could be very weak, and that this weakness would lead to treasuries also being weak as foreign investors dumped their holdings. What has happened is that domestic US investors have reappraised their views of US domestic growth upwards, and have dumped treasuries to buy equities, and the US dollar has been very strong.

While the stated aims of the Trump administration are very pro-growth, to me the actual effects seem likely to disappoint. Plans to allow more drilling will be dependent on a much higher oil and gas price. Scrapping car emission standards whilst good for SUV makers, will unlikely reverse the falling demand for cars due to high levels of auto debt. Lower taxes and more infrastructure spending may well be bullish for growth, but need to be balanced against the sell-off in the long end of bonds, which will have a negative effect on housing and with DR Horton reporting weak numbers makes, I feel growth will disappoint in the short term.

The more apparent of the negative aspects is that higher bond yields are starting to cause some financial pressure in Hong Kong and Chinese interest rates. If a trade war, becomes more likely, then a large Chinese devaluation also becomes more likely. Furthermore, the Trump win makes the break up of the Eurozone far more likely in my mind.

After Brexit, being short equities and long bonds was a fantastic trade for a week or two, but then reversed quickly after, causing severe pain for those that had reacted to the market quickly. I think the Trump win has seen many investors sell defensive positions and buy cyclical positions. I suspect they will come to regret that. Your fund remains long bonds and short equities.

* * *

Steepping away from Trump, here is Clark"s asset allocation and sector breakdown, and what appears to be a wager that Trump is about to end the record wave of industry consolidation in a move straight out of Teddy Roosevelt"s playbook:

This month losses in the short portfolio, in particular from the European and Japanese banks and the automobile sectors, were partially offset by gains in the banks and oil sectors in Brazil and the defence contractors in the long portfolio.

In the US the value of announced mergers and acquisitions (M&A) reached $337 billion in October, making it the biggest deal-making month ever. 2015 was the biggest M&A year ever globally with total deals of about $4.3 trillion dollars (source: Bloomberg). High M&A activity may give the impression that the economy is robust, but in our opinion it merely reflects a sluggish economic environment as companies struggling to grow their revenues and profit margins organically, and turn to mergers and acquisitions instead.

QE monetary policies have supported M&A activity by allowing ample availability of funding, as investors searching for yield are eager to buy corporate debt and drive credit margins lower.

M&A activity causes a decrease in the number of firms and an increase of their respective market shares. This can result in significantly reduced competition between firms. In economic theory, when a few large firms dominate a market there is the potential to engage in collusive behaviours such as deliberately joining together in cartels in order to increase prices. In extreme cases a company that becomes too dominant develops the power to influence market price, run competition out of business or not allow competitors to emerge. Once enough other companies are bankrupt or bought off, the remaining company can stop improving its product, lower the quality and raise prices as much as it wishes, because consumers have no choice.

It has been argued that some companies with large market shares can employ what game theorists call a “trigger strategy,” whereby they signal to their competitors that if they lower their prices, they will start a vicious retail war. If a rogue player refuses to play the game, it becomes the target of an aquisition, not because it makes great products, but because owning it allows an oligopolist to raise prices.

Another detrimental effect of low competition to the consumer was illustrated by an article in The New York Times entitled ‘Arbitration Everywhere, Stacking the Deck of Justice’, about the rise of private arbitration clauses in consumer services contracts, which allow large companies to avoid the court system and prevent consumers from joining together in class-action lawsuits.

The Herfindahl-Hirschman index ("HHI") measures market concentration by industry and is used by regulators when reviewing mergers, values between 1,500 and 2,500 are defined as “moderately concentrated,” while values above 2,500 are defined as “highly concentrated”.

The US beer market has a high HHI of 2696, it is dominated by one large producer, whose current market share is 46%. The company recently made a large acquisition, but subsequently was forced by the Department of Justice to sell part of the acquired business as the combined market share of 70% would have resulted in almost monopolistic conditions.

At the turn of the 20th century, Teddy Roosevelt became president. He realised that for capitalism to maintain popular support, the monopolists and oligopolists of his time had to be taken on, and his presidency was driven by Trust busting. This set of policies looks set to re-appear.

The fund maintains short positions in airlines, banks, and certain consumer staples, primarily because we think that margins will remain under pressure due to the macro-economic environment and specific sectoral issues (please refer to Russell Clark’s Market views). These are not monopolistic sectors, however they are concentrated, should competition increase at some point, stock prices could de-rate even further.

Finally, here are Horseman"s Top 10 long positions as of this moment. Alas, the far more useful, top 10 shorts, are not public.