April 27, 2012
Some of this may initially be hard to grasp as it deals with a market I have not traded in quite some time. It also involves an instrument most people are not familiar with. Hopefully, I can explain the basics and this trade will be as clearly logical to you as it is to me…
Virtually ALL economic forecasts are off the mark.
I would almost consider that to be a fact.
I would also say they quite frequently miss by MANY, MANY, miles.
Let’s face it. Ninety nine percent of economic forecasters TOTALLY missed predicting The Great Recession. Only a handful predicted the Dot Com Crash, and the same was true for the Great Depression.
On the flip side, ninety nine percent of forecasters could not have dreamed the Dow would have DOUBLED since March, 2009…or, for that matter, correctly predicted ANY major move I’ve seen in my 32 years around the markets. Sure, there are always a few guys who get it right…But the analytical masses? THEY DON’T.
The truth is, any of us could create an endless list of absolutely backwards economic
or market forecasts for as far back in our own lives as we want to go…
So why should anyone expect current forecasts to be accurate? And I am not just talking about some Joe Blow Economic Forecasting Unit. Whether it’s the Fed, or the IMF, or the World Bank or whatever upscale outfit you want to name, they ROUTINELY don’t get it right.
This is not to say that everything they do is wrong…There is a lot that gets done right…Nor is it to say these are all stupid people…but when it comes to accurately, consistently, predicting the strength or weakness of the economy, the overwhelming majority of forecasters quite often miss the ENTIRE target, and especially when it probably counts the most, that is, when some really big “surprise” is on the horizon.
So what good is this “knowledge” that “nobody knows”?
This newsletter is not about the Stock Market, but let’s start with this…The Dow is dead on its highs. As a function of talking head gibberish and the seemingly eternal forecasts that “the economy might start slipping again”, or “isn’t growing fast enough”, or “job growth is too slow”, there is essentially ZERO enthusiasm for buying the stock market. THE DOW IS MAKING NEW 4 YEAR HIGHS, AND IS NOT THAT FAR FROM NEW ALL TIME HIGHS…but do you hear a WORD out there about WHERE it’s going? Do you hear anything even beginning to approach excitement…anybody even close to screaming, “You GOTTA buy it. It’s headed for 15,000!”, or something along those lines? Folks, it’s a buy. STILL…But that’s not the point here…What IS the point is I think ALL the opinion suggesting the economy will need some sort of life support for another few years is hogwash. As I pointed out in a recent newsletter using a number of economic charts (“You too can be an economist”, http://www.crokerrhyne.com/newsletters/04-17=12.htm) , I think anyone who thinks the economy isn’t seriously on the move has their head in a bucket…that basically any economic indicator you want to check points toward nothing but acceleration…and furthermore, for many reasons, I BELIEVE WE ARE IN THE BEGINNING STAGES OF A MAJOR, WORLDWIDE, ECONOMIC BOOM…AND IT IS BEING LED BY THE USA.
MY PREMISE IS THE ECONOMY WILL BE RECOVERING SOONER AND FASTER THAN THAT SAME 99% OF EVER-WRONG FORECASTERS ARE ANTICIPATING…that THIS year, beginning with the 2nd Quarter, will end up with FAR stronger growth than any of those guys are expecting…AND this “unforecasted” growth is going to result in interest rates, both short and long term, beginning to rise LONG before anyone expects them to…which is the basis for what I believe has created an incredible futures markets opportunity.
Short December 2013 Eurodollars
The chart following is of Eurodollar futures going back to this contract’s inception of trading in 1982. THIS IS NOT THE EUROCURRENCY. The Eurodollar Rate, which is what the Eurodollar futures contract is based on, is the interest rate paid on Dollars deposited in banks outside the United States. If, for example, you walked into a bank in Singapore with $100,000, and wanted to deposit them as dollars (not convert to the local currency), and earn interest on them, you would be paid the current Eurodollar Rate…I would also note the “euro” in this contract also does not refer to Europe, although the term may have originated there…In any case, the important thing to understand is the Eurodollar Rate is essentially the internationally accepted standard interest rate for 90 day Dollar deposits (this is, by volume and open interest, the biggest futures contract on the planet)…and these rates, like everything else of value in the world, go UP and DOWN…
If none of that makes sense to you, here is the bottom line: When short term rates start to rise, this contract will go down…and with the contract size being $1,000,000 of 90 day money, every 1% rise in interest rates means a change of $2500 per futures contract (every tick is $25).
(INTERNATIONAL SHORT TERM INTEREST RATES)
This next chart shows two different Eurodollar contract months…
In blue, you have the JUNE 2012 contract, reflecting about where short term rates are as of today’s close. At 99.52, this implies a 90 day interest rate of .48% (100-99.52), or about 1/2%.
In red, you have the DECEMBER 2013 contract, which is the current market’s assessment of where this same rate will be 18 months later. With this contract at 99.35, the “expected” rate in December, 2013 is .65%, or roughly 2/3%.
IN A NUTSHELL…BOTH OF THESE CONTRACT ARE BASICALLY TRADING AT THE SAME PRICE AND THE MARKETS ARE ESSENTIALLY SAYING (TODAY) THERE WILL BE NO CHANGE IN SHORT TERM INTEREST RATES BETWEEN NOW AND DECEMBER, 2013…I THINK THIS CHANGE…IN A BIG WAY.
Before I go farther, get a look at these two contracts…
TO NOTE: THIS CONTRACT GOES DOWN WHEN INTEREST RATES GO UP
IN PLAIN ENGLISH, BY ASSUMING RATES WILL NOT CHANGE, THE EURODOLLAR FUTURES MARKETS ARE BASICALLY REFLECTING THE WELL WORN (AND I BELIEVE IN ERROR) FORECAST THE ECONOMY WILL BE WEAK FOR AT LEAST ANOTHER 18 MONTHS.
IN PLAIN ENGLISH, I THINK THIS WILL NOT BE THE CASE AND I BELIEVE THIS CONTRACT WILL START TO REFLECT MUCH STRONGER THAN ANTICIPATED GROWTH ANY DAY NOW…
AS THE SHEEP REALIZE THE ECONOMY IS NOT ON WEAK LEGS, INTEREST RATES WILL BEGIN THEIR INEVITABLE RISE (IN MY OPINION, BEGINNING NOW) AND THIS CONTRACT WILL GO DOWN, AT A MINIMUM, TO THE 97.50 AREA, MEANING 2.5% 90 DAY INTEREST RATES….AND IT WILL PROBABLY HAVE DONE SO LONG BEFORE WE GET TO DECEMBER, 2013.
97.50 IS 235 POINTS, OR $5875 A FUTURES CONTRACT FROM HERE, WHICH REPRESENTS THE POTENTIAL “REWARD” IF YOU TAKE THIS TRADE.
The RISK? If all things remain the same, if the economy continues to merit .5 % short term rates until December, 2013, this contract will probably then be trading about where the current June contract is today, or 99.52. As the December, 2013 contract is currently at 99.35, with every “tick” being $25, you would then be down 17 ticks, or $425 a contract…I have to state that if things REALLY got bad, and I am talking about the whole world totally falling apart, this contract COULD in theory trade even higher than this, but somewhere under 100 would have to be the ceiling as rates cannot go below zero…To be specific, if short rates went to .25%, putting this contract at 99.75, you would be down 40 ticks, or $1000 per futures contract…But I realistically don’t think it can get any worse than that…and furthermore, if for some unimaginable reason this were to occur, I just don’t think they could stay there…In other words, if you back the position, my guess is it would eventually come back from the “unimaginable” level of 99.75… But let me be clear…I think .25% rates WOULD mean the world economies, equities, businesses, cities, etc…you name it, had TOTALLY GONE TO HELL…and the few bucks you might lose here would be inconsequential to what you would be losing everywhere else…
At any rate…I do believe this contract is a big Short with major potential and well defined risk parameters…
Here are the numbers on this trade…simply displayed…This is pretty black and white to me….
If I am even close to right, and the realization sets in, at any time BEFORE December, 2013, that the USA and World Economies are NOT as weak as the ever wrong economic community would have you believe, this trade should start working. Period. As ever, I may be dead wrong about all this, but I do believe this trade is ready to start working NOW, or I wouldn’t be recommending it.
Here is another perspective…
And there are even options that go that far out…Just put the money on the table and truly forget you own it…
I think $560 for 20 months is a little money for a LOT of time to see something big start happening…
All of the previous charts have been on a weekly basis (each line = one week’s trade). For what it’s worth, here is a daily chart of the December 2013 contract…
So here’s the wrap up:
I think the ever backwards talking head/economic community is WAY off the mark. ALL I hear everywhere is “Potential Top” in stocks. Again, it is dead on its highs and there is NOBODY (relatively) talking it higher…YOU KNOW THIS…They all hate it…THE STOCK MARKET, often an excellent barometer of future economic activity, IS GOING UP.
The world economy is on the upswing. I swear, every day I read something about this or that new factory, here or in China…It also seems like I see something every day about some major international corporation DOUBLING or TRIPLING their capacity in China TO MEET CHINESE CONSUMER DEMAND…And Real Estate here in the USA? When you get down to it, the only real dog we’ve had in the economy equation IS beginning to pop…Ask anybody in commercial or residential real estate…I talk to a number of people across the RE spectrum and I am hearing comments and sensing attitudes like I haven’t witnessed in YEARS…And I don’t need to tell you that Technology is going nuts…Or that if you hit the streets on the weekend, there is traffic and activity everywhere…
I AM TELLING YOU. IT IS IN YOUR FACE. THE ECONOMY IS BEGINNING TO HUM…AND IF YOU THINK INTEREST RATES ARE JUST GOING TO SIT HERE AT NOTHING (!!!)...Well, maybe I will look be the one to look like an idiot six months from now, but I think you need your head examined…
All the Fed has said is, “It might be necessary to keep rates low for a long time”. Believe me (if you dare). They won’t…And again, as I’ve said many times before, THE MARKETS WILL START MOVING RATES HIGHER LONG BEFORE YOU HEAR ANYTHING ABOUT IT FROM THE FED…AND I SAY THAT DAY IS ANY DAY NOW.
GET SHORT THIS EURODOLLAR CONTRACT. GET SHORT TREASURY BONDS. GET LONG THE STOCK MARKET.
Over and out…Pick up the phone and call me. THIS IS A GREAT, GREAT IDEA…
And if the strangeness of this Eurodollar contract befuddles you, but you get the general idea, do give me a call. I promise you I can clear up any gray areas.
Old Hack Bill (sometimes wise)