Editor’s note: Below is an interview with Peter Tchir, founder of TF Market Advisors. This Q&A went out to subscribers of our “10 Things You Need To Know Before The Opening Bell” newsletter on Wednesday morning. Sign up below to get the newsletter and more of these interviews in your inbox every day.
BUSINESS INSIDER: Is there a single most important market price to be watching right now in terms of gauging the prospects for the global economy?
PETER TCHIR: We are watching China closely. In particular, we are seeing signs of stress in some of the Chinese funding levels which concerns us, especially as they are experiencing their first corporate bond defaults. We don’t believe in the decoupling argument.
BI: The focus this week is on the Fed. What do you think will be the next Fed story to move markets?
PT: I think we will shift from “taper” — which will continue, according to the current schedule — and start discussing timing of the first rate hike. This will destabilize equities, and we could see signs in the FOMC projections that they release.
BI: What is the scariest thing going on in ETF land?
PT: A proliferation of small ETFs. They don’t have the diversification and are too specific. ETFs are best when they represent “beta,” are liquid, and provide access to the market. In fixed income, products like HYG let investors trade beta. BKLN lets investors trade the loan market, which isn’t really accessible in any other way. I don’t like the small funds that are too specific.
BI: What is the most exciting trade out there right now, in your opinion?
PT: Sadly, the trades that I see as most exciting are AAA CLO bonds which are extremely cheap as investors lack the institutional knowledge to get comfortable with them. They offer the best risk/reward in income products and are one area I would like to see an ETF. AAA CLOs pay Libor +150 compared to 5-year investment grade floating-rate bonds which are more like LIBOR +30 (which hasn’t stopped FLOT from growing to almost $US4 billion).
I am scared to say this, but I like selling credit default swaps. With Russia still an issue, I would hold off, but CDS have performed extremely well and are very liquid — at least in the CDS indices I would use. They are cleared now, which helps reduce counterparty risk, and transparency has increased since SEFs have launched. We are still double the pre-crisis spread levels, so there is room to get good income and possibly price appreciation. Stocks and bonds are back to pre-crisis levels. PIMCO uses them in at least one of their ETFs, so it is conceivable that over time we will see some CDS-based ETFs.
Finally, I am looking at China. FXI could be interesting. We aren’t ready to pull the trigger, but this is getting reminiscent of Italy and Spain last summer, when the best potential returns were available before everyone else fell in love.
BI: Which developments in global financial markets, if any, would you flag as most concerning for risk appetite?
PT: The lack of volatility. Volatility is something that hedge funds need to thrive. Lack of volatility leads to leverage, which leads to problems. We are potentially sowing the seeds of our own destruction as this extended rally, with low volatility, is creating a mentality where positions get riskier and larger, and historically that ends badly. We might have a long way to go to get the leverage back to 2007 levels, but it is something we are watching closely, and even the CLOs that we like are part of that growing, and troubling trend.
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