All posts by Adam Button

Adam Button is a Montreal-based strategist for ashraflaidi.com, former chief currency strategist at XForex and head of markets at CEP News.

The trend is deflation, not the other thing

The most misunderstood phenomenon in macro economics in the past decade has been deflation

It’s a story that has been missed by almost everyone.

In short: Moving manufacturing and  has allowed companies to reap tremendous profits but consumer prices have been sticky. As a result, a bubble in retail square footage has formed. Over time, it will slowly correct as companies compete for consumer dollars. It’s the great unseen long-term trend in developed economies.

Don’t believe me? Visit a dollar store and marvel at the quantity, quality and complexity of the things you can buy there. In addition, realize that dollar store margins are around 32%, meaning it’s only costing the company 68-cents to get those items on the shelves.

Today’s evidence the trend to lower prices is accelerating: A UK 99-pence store has just cut its prices to 97-pence.

On Thursday, US CPI is expected to fall to 1.3% y/y — the lowest since 2010.

US CPI yy
US CPI yy

This post was originally featured at ForexLive.

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The massive US bubble that no one talks about

My belief that we are in a long-term cycle of disinflation and deflation is one of the things that sets me apart. I have written about this theme frequently and wanted to preserve some of my commentary here. This was originally published Dec 5, 2012 at ForexLive.

The US has a massive oversupply of retail floor space.

Retail square footage per capital globally
Retail square footage per capital globally

The US has 23 sq feet per capita of retail space (but as much as 46.6 sq feet). It’s difficult to come by reliable numbers, but that compares to 14 sq feet in Canada, 6.5 sq feet in Australia, 2.3 sq feet in France and 1.1 sq feet in Italy.

It’s no coincidence that the spike in retail floor space coincided with the rise of cheap imports. The US has embraced globalization more than anywhere else.

The retail pharmacy business perfectly illustrates the change.

A pharmacy used to be a little shop that dispensed prescriptions. They have grown to 20,000 sq foot (1900 sq m) stores where you can get anything.

Conventional wisdom says get people into the store and you can sell them anything but there is more to it. It’s about margins. Cheap Chinese goods have made retail margins incredibly attractive.

Goods that once cost $4 to manufacture and sold for $10 now cost $0.50 to manufacture and still selling for $10. The rise in retail square footage has been all about ripping off consumers who have been slow to adjust.

This is part one of a series. In part two I will talk about how the coming years will be payback time and the enormous ramifications for the economy.

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The change in China that could suffocate the global economy

Note: Since I rarely update this blog, I will be using it to preserve and highlight some of my favourite posts from ForexLive. I’ll start with this one from April 24, 2013:

People in Beijing don’t wake up and check the daily weather forecast; they check the air pollution index so they know what face mask to wear.

China air pollution April 23, 2013

This shocking series of pictures were taken on a ‘clear’ day. The air is described as a noxious soup. Blow your nose and it’s black.

The problem didn’t happen overnight but air pollution indexes are up 30% in 2013, and that’s if you believe the government numbers.

Chinese officials are trying to curb pollution without hurting economic growth but those goals may be incompatible.

Change could come any day. Chinese politicians live in Beijing and their children are breathing the same air and getting sick. An unusual weather pattern could hit Beijing and cause a spike in pollution that sends hundreds of thousands of people to hospitals. That could be the tipping point for radical change and the consequences for the global economy are impossible to predict.

Bloomberg should add Chinese air pollution indexes to their tickers. Today’s readings aren’t high but half the day was still worse than living in an airport smoking lounge.

The prevailing winds from China blow toward the Pacific ocean but occasionally they shift Northward and Japan and Korea are covered by smog, and they’re increasingly unhappy. If a 10,000km ocean buffer didn’t separate California from China, the United States would never tolerate being poisoned by the people taking their jobs.

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10 great trading lessons from Colm O’Shea in Hedge Fund Market Wizards

People are always asking me to recommend books about markets and trading. I have read many and there are many more on my list but for inspiration, readability and insight, few books can match the Market Wizards series by Jack D Schwager.

The latest is Hedge Fund Market Wizards, published on May 29, 2012. I want to talk about the great lessons in the first chapter, which is with macro trader Colm O’Shea. Most of the chapter can be read for free at Google books.

This chapter repeatedly resonated with me because we have a similar trading style and outlook. Let me share some of the best insights.

  1. Policy makers don’t understand that they are not in control. It’s not that speculators are in control, either, but rather that fundamentals actually matter.
  2. If you read the Financial Times, it’s all there. You don’t have to be a brilliant economist, you just have to realize when something matters.
  3. Implementation is the key to everything.
  4. Never underestimate the ability of people to be optimistic and believe that everything is going to be okay.
  5. What is important to the market is not whether growth is good or bad, but whether it’s getting better or worse.
  6. This is what strikes me about really good money managers — they don’t get attached to their ideas…. I recognize the world as I find it and I am flexible enough to change my mind.
  7. He views trades as hypothesis’ on what’s happening in the world
  8. You have to embrace uncertainty and risk
  9. Don’t set stops based on your pain threshold, set them based on the hypothesis. Start by deciding where the market would have to go for me to be wrong.
  10. Perseverance and the emotional resilience to keep coming back are critical because as a trader you get beaten up horribly.

I explored another comment O’Shea made about the madness of current economic thinking in a post at ForexLive.

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Bank of Canada Could Emphasize CAD Sweet Spot

Thursday’s Bank of Canada rate decision will be rightly overshadowed by Greece and the pending US and Canadian jobs reports on Friday but once the short-term smoke clears, the central bank will have outlined the case for a long-term CAD rally.

Economists and the market see no chance of a rate hike on Thursday, leaving the overnight rate at 1.00%, where it has remained since September 2010. The market is also pricing in almost no chance that rates are any different next March than then are right now.

The decision will feature no clear guidance on rate moves in the near future but will offer a clear indication that policymakers have seen improvement. The Bank of Canada forecast 2% growth this year but with European risks minimized and US economic trajectory improving, the consensus is moving higher.

New risks have emerged from Iran and China.

The run-up in the price of oil convinced US leaders that a war with Iran would be too costly at the gas pump. As a result, crude prices are coming down to levels that remain favorable to Canadian energy exports without stifling US spending.

Chinese leaders lowered growth estimates to 7.5% for this year after nearly a decade of sandbagging the market with 8% forecasts. The BOC is unlikely to be swayed by the change because it has also been accompanied by pledges to increase imports and lower import tariffs.

With inflation pressures low, the Bank of Canada has the luxury to wait until at least mid-summer before the market will start asking hard questions about raising rates but Thursday’s decision will be an opportunity to show that hikes are visible on the distant horizon.

Aside from more upbeat commentary, the BOC may change its key language on when the economy is anticipated to return to full capacity, or when the output gap will close. The current forecast is the third quarter of 2013. If that comes down, CAD will rally.

Even if the BOC decision is less-rosy than I anticipate, I see the Greek PSI deal proceeding as expected with the potential for upside surprises in US and (especially) Canadian jobs data. This should underpin continued Canadian dollar strength.

I shared more thoughts on CAD with a Reuters reporter in a story today: http://www.reuters.com/article/2012/03/07/markets-canada-dollar-bonds-idUSL2E8E7G2920120307

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A look at the USD/CAD chart

I have been recommending USD/CAD shorts at ForexLive for the past month based on the break of the wedge from September to mid-January.

The trade worked wonderfully at first, quickly falling from the 1.0150 entry point to below parity.Last Monday, Feb 20, the decline looked like the start of another leg down but the pair has since rebounded 100 pips after falling as low as 0.9907.

Another look at the chart is in order.

d

The pair has been trapped in a 09907 – 1.0052 range for the entire month of February — less than 150 pips. As a trend-following trader, that’s a tough way to make money.

The low coincides with the late-October low of 0.9895 and it will take a close below there to re-establish my utmost confidence in shorts. It’s also a good entry point for someone who is not in this trade.

At the same time, I have to be prudent and protect my profits. I’m putting a stop at the Feb. 16 high of 1.0052, locking in a roughly 100 pip profit.

I’m patient with trades that are in the money, but five-weeks is a long time even if the carry is positive. The run ups in oil and stocks haven’t been the negative shocks I expected for this pair.

The upcoming LTRO is a major event risk and I am expecting major volatility. If I get stopped out here, I will look to establish yen shorts as that is a trade I have been pushing for the past three weeks.

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Incredible time to buy EUR/CHF

It’s not often that a trade comes along with so much upside and so little risk. Buying EUR/CHF at 1.2050 is one of those trades.

I didn’t think we would see 1.2050 in EUR/CHF this year and I’m sure it won’t last. My money says 1.25 is coming with 1.30 not far behind.

The SNB didn’t institute a peg to give it up 4 months later. These are serious people and all the credibility of the institution is on the line. With the situation slightly more stable in the eurozone at the moment, it’s all the more reason to be hold the peg.

The SNB releases balance sheet data later today and there are rumours of a hike in the peg. Don’t wait.

It’s not often that I’m extremely confident in a trade but if it goes bad, it’s only 50 pips. My stop is at 1.1999, no exceptions.

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Fleshing out USD/CAD

I’m torn about USD/CAD.

For months, I’ve been looking to buy any weakness in the pair but the daily chart has broken a ‘wedge’ pattern to the downside.

My base case if for a rally to 1.12 around mid-year but I won’t fight the technicals.

It’s time to take a step back and evaluate.

Some of the reasons for my expectations for a rally:

1)      Interest rate differentials. The BOC has held rates at 1.00% since Sept. 2010. If any economic weakness materializes, a drop back to 0.25% is likely. The Fed, meanwhile, is already at zero and policymakers have set a high bar for QE3.

2)      Commodity prices. It’s not shaping up to be a good year for commodities, especially if gold is excluded. Europe is headed toward recession, US construction is virtually nil and China’s growth is slowing. These factors may be priced in but I still see downside, especially with the risks from banks, brokerages and fund redemptions.

3)      The threat of crisis. The longer the world remains at the edge of the abyss, the more likely it is that something pushes it over the edge. Europe, China, the US, the Middle East, Russia – each presents a multitude of risks in 2012.

4)      US growth may see USD gains. We know that the USD will outperform CAD on safe haven trades but surprising US growth will not necessarily flow into commodities. If growth is driven by tech and the automotive sector, Canada may be left out.

5)      There are risks in Canada. Housing prices in Canada have detached from reality. Several provinces are nearing budget crisis. Trade disputes are a risk. RIM is probably done.

But that is all old news. Here is some of what has me worried.

1)      Oil. The tension in Iran is once again solidifying Canada as North America’s oil supplier. It is also driving up prices. With investment returns at nearly zero everywhere, some big money might flow into Alberta oilsands.

2)      US stimulus. I often repeat: the US will never do austerity. Instead, more spending is likely on the way, with commodity-intensive infrastructure projects likely to benefit. At the same time, such projects will keep the US deficit high, removing any USD benefit.

3)      A US bank failure (but not a crisis). After what happened at MF Global, it’s clear that nothing has changed. I wouldn’t be surprised to see a blowup at a major US financial this year. The surprise is that it will be quickly contained by the government (perhaps before the news even hits the market) and that would weigh more on USD, especially once talk of regulation re-ignites.

4)      Growth. Canada historically lags US growth. If the US posts a strong first half, there will be a lag before the market appreciates that growth will spill over to Canada.

5)      Mark Carney (BOC Gov). He seems to have a good sense of the risks facing Canada and has consistently fretted about housing. If the US starts to grow, he will beat the Fed on raising rates. If the US falters moderately, he may sacrifice rate cuts in order to control housing inflation.

I’m going to let it sink in for a few days but I’m on guard to sell soon, likely on a break of 1.0050.

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