Here’s what we’re reading and working on this week at Epsilon Theory.
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What’s Happening in the Chinese Financial Sector?
I think the blow-up of Chinese asset manager Huarong ($42 billion in outstanding debt!) and the recent tightening of Chinese monetary policy are the biggest stories that NO ONE is talking about.
Here’s a Bloomberg article on Huarong. It’s a classic fraud like Greensill, only much bigger. The Chairman/CEO was executed (!) in January for his crimes, and now the company has suspended its earnings report. Huarong bonds are trading at 52. LOL.
As for China tightening and IG spreads widening, I’m shamelessly stealing this chart of the effective yield on China investment grade credit issuers from a note ET contributor Brent Donnelly wrote last Friday.
Money quote: That move from a 2% yield to a 3% yield comes in a maximally benign global risk environment with risk parity en fuego yesterday. That makes it even uglier.
Fact check: TRUE.
Stock Trading by US House Members
ET Pack member Brad forwarded this website that focuses on stock trading by US House Reps. Some crazy data here, like the fact that Gilbert Cisneros made nearly 700 separate stock trades in 2020 in his PA. LOL. Talk about a degen.
Economics in Nouns and Verbs
An academic paper by W. Brian Arthur at the Santa Fe Institute. As the Pack member who recommended this to me described it, “a small rewiring of my brain happened when I read it.” https://arxiv.org/abs/2104.01868
“Standard economic theory uses mathematics as its main means of understanding, and this brings clarity of reasoning and logical power. But there is a drawback: algebraic mathematics restricts economic modeling to what can be expressed only in quantitative nouns, and this forces theory to leave out matters to do with process, formation, adjustment, creation and nonequilibrium. For these we need a different means of understanding, one that allows verbs as well as nouns. Algorithmic expression is such a means. It allows verbs (processes) as well as nouns (objects and quantities). It allows fuller description in economics, and can include heterogeneity of agents, actions as well as objects, and realistic models of behavior in ill-defined situations. The world that algorithms reveal is action-based as well as object-based, organic, possibly ever-changing, and not fully knowable. But it is strangely and wonderfully alive.”
When I read the abstract for this paper I thought it might be awful, but it’s actually VERY thought provoking and has a lot of links to narrative theory. And yes, there’s an ET note on that:
The Bear Case for Inflation
Here’s the Q1 2021 Hoisington letter, hot off the press: https://hoisington.com/pdf/HIM2021Q1NP.pdf
I like Lacy a lot. But I think the long bond is his hammer and everything becomes a nail. Specifically, I get the debt trap concern, but I think this is mechanistic and tautological (over a long enough time period), so that you end up minimizing/downplaying expectations, common knowledge, and more pressing macro factors, like a reversal in globalization.
Volatility Suppression and You!
And finally, a full thread from the ET Forum this week …
@Spotgamma has a *great* post up that I think would be of interest to the pack. *IF* they are correct, when the current volatility suppression regime has its inevitable hiccup, it’s going to be quick & violent. To the downside. https://spotgamma.com/remember-gamma-squeezes/
Key takeaway: “This implies that the cost of buying options is cheaper relative to any point this quarter, and likely since February of ’20.”
Would love to know what the pack thinks. I am in agreement with spotgamma & am looking for reasons why they are wrong. I can’t find any, which concerns me that I’m missing something obvious.Paul
Interesting. Intellectually, I understand the dynamics of options trading, but like all equity-focused PMs I am actually just an options dilettante. I don’t have a good “feel” – or any feel at all, really – for immersive options trading, so I don’t know if gamma squeezes are for real or if they’re the slightly more cerebral equivalent of the risk parity boogeyman that gets trotted out whenever markets go down for whatever random-walk reason.Ben
I trade options as a pro for a small boutique fund. First, I concur with Ben that so called “gamma-squeeze” might be the most suitable ex-post narrative justification for sudden, unexpected rally or dip after they happened. Recently they have also become the hallmark of some well-known head quants like Nomura’s Charlie McElligott or JPMorgan’s Marko Kolanovic who can be legitimately regarded as trustful “missionaries” in the Street. Secondly, it is still true that under certain circumstances – for instance in coincidence with monthly or quarterly multiple technical expirations- such forced buying or selling by dealers around some key flip-from-positive-to-negative Dollar Gamma levels can be able to throw the market over the cliff by a sort of self-fulfilling prophecy mechanism. Just my two cents though.Bob
I have nothing to offer on the dynamics/mechanics of options per se. I do have a view on what it means to have an exploitable feature of a game come into the common knowledge of a crowd intent on disrupting the established order.
Whether it was directly, indirectly or not at all caused by the options play – the power of the Options Artefact has become legend and many new, creative minds will be looking at options and their underlying leverage, not in accordance to the established lore, but as a new toy/weapon to deploy in creative and unusual ways.
My expectation is that over the next 12-24 months we are going to see some unexpectedly creative uses of systemic hidden leverage by the r/wsb crowd in an effort to mess with the system. If my experience in prior MMORPGs is at all relevant (and I think it is) – god help the system. Its in for a wild ride.Zenzei
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Every item in this email is a discussion thread on the Epsilon Theory Forum – a safe space to speak your mind, a safe space to find like-minded truth-seekers. We’re not crowd-sourcing ideas for being better investors and citizens, we’re pack-sourcing them.
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