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CCTrack April Investment Letter – Learning from the Rain
Just as each snowflake is said to be different, each drop of rain also has unique properties
(despite the fact that the constituent components are shared among rain drops). Similarly,
every single market event is unique. Just as trillions of raindrops refract light to make up a
rainbow, markets react across the board to movements when the cup overflows. There must be
a lot of evidence of an economic turning point for it to matter to markets. That might be the
lesson for April—the rain of Q1 US GDP at 0.7% missed the expected growth mark of 1.1% and
the revision of Q4 GDP up to 2.1% just didn’t matter. Economic data must reach a higher bar
than other news, particularly politics (where even rumors of war can matter far more than
facts). This means that April momentum may be more important than its implied volatility or
actual growth.
The most significant market-moving event in April was again political. Surprisingly, the EUR
wasn’t the main mover (despite the French first-round election), nor was the USD (despite
weak GDP and the failure of Congress to pass healthcare reform and a budget). Rather, the
movement of the month was in CAD/GBP where the snap election call from UK Prime Minister
May for June 8 drove up hopes for a larger Tory majority and softer Brexit deal, while US Trump
trade policies driving tariffs on Canadian lumber and dairy proved too much for the CAD.
Neither of these moves were driven by a surprise economic outcome. In fact, the Canadian
economy looks robust compared to the UK one and growth differentials, which have helped
explain currency movements, have lost some power. The carry trade continues to drive
emerging markets, but the rise of political concerns over economic ones remains a dark cloud
on such money flows.
When predicting weather, predictions must consider the temperatures and winds from other
regions. So, too, FX market participants watch implied volatility from other currencies to predict
movements in local terms. The most interesting story of April—that of the French election—
proved to be the event that renewed faith in polling. While Brexit and US election polls proved
wrong, French election polls were accurate, leading to sentiment that the French care so much
about their politics as to not lie to pollsters unlike the Brits or Americans. This may be more fluff
than fact but the notable lack of reaction in the EUR volatility market is notable. The outlook
for the second round suggests that traders believe more in polls than preparing for a 50%
binary risk—volatility of the EUR has shifted from 29% for the first round to 12% as we move
towards the second round on May 7.
What seems clear about the reaction of the market to the French election is that political fears
have lessened as the market has gotten used to uncertainty and continues to see central
bankers as supporting risk taking. The shift in volatility from April 21 to April 24 reflects lower
levels of volatility and volatility skew, signifying less uncertainty as to outcomes for the EUR.
The election risk for the UK might be quite different given the expectation that PM May is
expected to win easily and the debate is merely about the margin.
Looking at the month of April as a whole, markets were concerned with politics. Ongoing
uncertainty over Trump trade policy has led to Mexico and Canada being focal points as NAFTA
undergoes renegotiations. There was a referendum in Turkey that proved positive for the
currency, while political upheaval in South Africa had the opposite effect. Politics may not
matter to the pipeline of cash entering into markets but destination shifts accordingly and the
rise in political-related volatility has led to carry driving some currencies higher on the list.
For the month, our strategies continued to react to the market’s lower volatility despite
political uncertainty. SkewTrack suffered while trending markets, particularly in equities, drove
CTATrack gains. Strong showings in fixed income and equities lifted ParityTrack performance.
The lessons of April are clear even through their rain of political uncertainty. Tail-risks are
building up in positioning across many markets but fear factors are low and momentum modest
making other factors far more important for investing now.
Regards,
Bob and Ron
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