5 “Constanza Trades” for 2017

In the spirit of this being the first day of Festivus https://en.wikipedia.org/wiki/Festivus I’d thought it would be fun to share “Costanza Trades for 2017 ” which come courtesy of Zerohedge.

For those unfamiliar, George Constanza was the lovable loser on Seinfeld who so distrusted his own instincts and lack of lack that he decided since every decision that he has ever made has been wrong, he is going to start doing exactly the opposite of his initial instincts and usual actions.  And much to his pleasant surprise his life, everything from dating to work, starts meeting with success.

And believe it or not this approach has real and constructive applications to the markets and trading.  Not only a fun exercise for exploring both sides of an issue, from a market opinions, to chart reading to sentiment readings being aware of the counterclaim is good way to test the validity of your own thesis.

On a simpler fashion, we all know that some of the best trades and biggest money can be made by being a “contrarian.”  That is by doing the opposite of what is the prevailing view.  So, without any further ado I give you Zerohedge’s “Constanza Trades” for 2017 http://www.zerohedge.com/news/2016-12-22/here-are-costanza-trades-2017

1.    Short S&P’s

This is about as consensus as you can get.  I saw a list of 17 sell side firms’ 2017 year-end targets and all 17 of them had bullish objectives.   The average target was 2366 with a 2350 median which would be roughly 4% higher than here (they really went out on a limb there).   Even some of the most well-known perma bears have capitulated bullish recently.

Instinct: Trump will reflate the economy via tax cuts and fiscal stimulus; repatriated Dollars will go to share buybacks; there is still a high amount of cash on the sidelines and real money still is underinvested in equities.

Costanza: there is no guarantee Trump will follow through and/or be able to institute any of his campaign plans; bonds are getting more attractive especially to pension funds that are closing their funding gap; geopolitical risks are rising.

Estimated probability of Costanza being right: 20% in 1H, 40% by year end.  This is so consensus that I am worried about being long.  That said; it is true that large asset managers who rotate their book about as quickly as the Titanic could turn have still not fully bought into this rally.  Therefore, if Costanza does prove right, it will probably be later in year once the rotation is complete.  We expect dips to be get bought very quickly in the beginning of the year.

It is hard to argue with this bull trend in SPX…

2.    Long UST’s/front end flatteners/short breakevens

All three are essentially the same idea so let’s just combine it.  The fixed income market slowly started to sell off in the summer as Brexit risks faded and global growth improved.  Trump was the big kicker that got the reflation theme running on his pro-growth policies that will also lead to more supply.  That got rates, curves (2s10s), and breakevens all moving higher in tandem.

The market is now very positive on forward growth and inflation prospects, and remains positioned for a more aggressive Fed as specs are still at or near record shorts in Eurodollars, Fed Funds, and 5yrs.

Instinct: Trump will reflate the economy via tax cuts and fiscal stimulus; Fed to be more aggressive in 2017; foreign central bank selling; increasing long end issuance; potential for ECB and BOJ to taper

Costanza: there is no guarantee Trump will follow through and/or be able to institute any of his campaign plans; bonds are getting more attractive especially to pension funds that are closing their funding gap; geopolitical risks are rising; composition of the Fed shifting to more dovish; still yield seekers around; long-term demographics .

Estimated probability of Costanza being right: 50%.  I could actually see this potentially working out later next year.  If you look at the long-term chart of US 10yrs, there is the potential for a move up to 2.90% and still be in its long-term down trend that is probably largely due to the aging demographics of the US.  I have been arguing that we have witnessed a regime shift and all the reasons for the short trade instinctively make sense; improving growth/inflation even before the election, Trump stimulus plans, etc., but the sheer crowdedness of the trade should concern us all.  However, much like equities, there are still many large Real Money types that have long standing UST positions that need to be sold. This makes it a coin flip but I could see a move higher in rates first and then back into the long-term trend lower.

3.      Long EURUSD

The Euro/USD cross has mainly been driven by the Dollar side of the equation as interest rate differentials has moved in favor of the USD.   You could sprinkle in Italian Banking issues and general European political risk but it has really been about the Dollar this year.

Instinct: interest rates in the US will keep moving higher widening the differential between Europe and the US taking the Euro lower.

Costanza: growth has been pretty good in Europe; the slow ECB taper could start to move differentials back towards the Euro crowdedness of the trade should concern us all.  However, much like equities, there are still many large Real Money types that have long standing UST positions that need to be sold. This makes it a coin flip but I could see a move higher in rates first and then back into the long-term trend lower.

Estimated probability of Costanza being right: 30%. The central bank divergence theme is alive and well as the US remains in a tightening bias while Europe will be stuck keeping rates unchanged for 2017.  However, Costanza could win if Trump fails to boost growth and the Fed once again does not realize their dot plot.  So it is not impossible for the Euro to rally but the divergence theme should keep it under pressure once again next year.  Add in the political risks as there are elections in France where the Euro critic Le Pen has a somewhat legit chance of winning.  There is also elections in Germany were Merkel and her party will be in big trouble given the recent attacks in Munich allegedly by a migrant.  The political undertones in Eurozone are certainly not working in the Euro’s favor.  Lastly, the Euro just broke a major long-term trend support line.  I think we should stop talking about parity and start talking about 0.9000.

 4. Long Gold

Gold has been declining since Brexit risks faded over the summer and the depreciation really gained momentum once Trump won the election.  It is moving because real yields and the US Dollar have been rising which makes its 0% yield useless in this environment.

Instinct: US Dollar and real yields will continue to appreciate taking Gold lower.

Costanza: Geopolitical risks are rising with US/China; inflation is picking up; the market has priced in a more aggressive Fed so there is a lot of downside if the Fed proves to be more dovish than expected

Estimated probability of Costanza being right: 30%.  I find the Costanza reasons to be weak.  Yes there are geopolitical concerns but they will get sorted out via trade wars not military wars.  Gold has not been a good inflation hedge, so that leaves only a disappointing Fed as the reason why it could go higher much like the Euro and thus the same probability.   Note that Gold is coming up on a very important long-term trend line.

5.   Short Oil 

The OPEC and non- OPEC production cuts really changed sentiment.  It went from a global supply glut story to one of more balance if not slightly imbalanced if demand picks up as expected.  Specs have gotten very long, and now it is a matter of will OPEC member stick to the deal and will US Shale increase production at these more attractive levels?

CFTC NYME Crude Oil Net Non-Commercial Futures Positions…

Source: Bloomberg

Instinct: OPEC and non-OPEC members will cut production as agreed to keep the market balanced; demand picking up

Costanza: OPEC deal will not live up to the agreed upon production cuts; US Shale production increasing; producers happy to hedge above $50; Dollar strength will put pressure on oil

Estimated probability of Costanza being right: 60%.  I can see Costanza getting this one right.  While I think OPEC will more than likely keep the cuts as they said they would, this trade could work simply because US supply comes back online.  In fact, it is already happening.  The switch has been flipped on.   Additionally, this could be a very good sneaky Dollar long proxy.  How can oil keep rising if the Dollar is going to appreciate?

And with that, I wish you all a very terrible Festivus and miserable New Year!

— Steve Smith

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