445 Capital: Post Brexit

Currency

After plunging more than 10% in two days after Brexit (Graph 1), USD/GBP is currently trading at $1.2988/£, a level we haven’t seen since 1985. While a degree of aggressiveness returned to equity and bond markets across the globe, elevated put skew in European currencies and banks (Graph 2), as well as peripheral sovereign CDS (Graph 3), indicate further risks of economic and/or political disintegration in the region.

Amid heightened risk aversion, JPY gained against a basket of currencies (Graph 4), but the BOJ’s intervention and a reversal of risk appetite may depreciate the JPY/USD pair in the near term. These risk factors promoted me to liquidate short Yen positions (YCS) and seek other venues to deploy capital.

Equity

S&P and DOW lost, but promptly recovered and reached their records within twenty days after Brexit. They both exceeded previous record highs and continue to expand multiples. These elevated levels seem to imply longer-than-expected accommodative monetary policies and more liquidity injection from central banks around the world. Because of high multiples and geopolitical risks, I’m generally avoiding outright price risks by investing in spreads between companies within financial (e.g. MS vs. GS), consumers (e.g. HD vs. SWK), and sectors against indicies (BMY & MCRB vs. NASDAQ).

Bonds

According to DoubleLine, over $12 TRILLIONS of world bonds are priced with the negative yields. German, Swiss, and Japanese 10-year bonds are currently trading in the negative territory (Graph 5). In July 2016, the yield on 20-YEAR Japanese debt fell below zero for the first time (Graph 6). Since then, developed countries’ government bond yields slightly increased; but widespread adoption of unconventional monetary policies, including large-scale bond-buying programs and negative deposit rates, are causing money to pour into safe havens. Bill Gross said “Global yields lowest in 500 years of recorded history…. This is a supernova that will explode one day.” If Japan serves as a leading indicator, it seems prudent for central banks to start normalizing monetary policies, but the hedge fund guru, Ray Dalio, believes current asymmetric risk profiles warrant more patience from the Fed. Nonetheless, attractive investment opportunities in bonds seem to be rare at current yields.

Commodities

Oil continues to slide amid rising dollar and bearish fundamentals (e.g. elevated inventories). I believe a good entry point is not too far ahead for WTI and crack spreads, but for now oil and its products seem to be range-bound, and I’m staying away from the oil complex for the time being. Natural gas, however, might offer reasonable volatility this winter, as its supply-demand dynamics tightened over the summer. This sentiment was validated by hedge funds’ largest bullish position in U.S. natural gas for more than two years. Before diving too deep in the space, one must realize the current forward already priced in a colder-than-average winter. If I had to pick a place to park money in the commodities complex, I’d choose natural gas via seasonal spreads and softs.