Monthly Observations
June 2018 Issue

EMMA Program was down 4.6% in June and up 5.4% YTD.

Market participants have apparently been desensitized anew since the meltdown in February. US equities, especially the tech sector, have been acting like a safe haven asset. Amidst the competing voices from the administration about trade wars there is a pattern – since Trump measures himself by polls and the stock market, every time it takes a hit he would send someone to calm the market down, effectively giving us a Trump put. But for how long?
Lately we have picked up lots of warnings about debt. For example, more than half of new corporate bond issues are rated junk; corporate loans are increasingly packaged and sliced into tranches to be sold to “sophisticated investors” similar to mortgages in the last decade; 20% of companies have debt service obligations exceeding cash flow. And worldwide, companies are spending >100% net profit on share buyback and dividend with borrowed money. In a rising yield and inflationary environment, the cost of borrowing (to finance operations or buyback shares) will be higher, bond market will be less accessible, and debt service will be costlier. Net outflow from stock funds also hit a record in June. All this doom and gloom stuff are not yet showing up in force, so we have to keep dancing while the music is playing.
We made some fairly consequential mistakes in June. First being bottom fishing in the grains sector right before the trade war escalated. Second, we underestimated the effect of the OPEC meeting and supply outages, then got hit by Trump’s tightening of Iranian sanction enforcement. Looking at the relative performance of various commodities since the risk-off sell-off in February, we can see that basic metals especially auto-related platinum and palladium took the biggest hit; copper and soybean tanked along with US-China tariff escalation; the dollar gained from European politics and trade wars. The one place this tension did not show up is precious metals, which had effectively been checked by rate hike prospects and strong dollar, decoupling it from risk.

We are not alone in getting disoriented in this transitional market. Goldman Sachs says the commodity bull market will continue but Morgan Stanley says the opposite in light of recent developments. The strongest major commodity right now is oil. It is in a solid uptrend and since it is an input to all the other commodities it provides some support for others. Our short term positioning follows the logic of dollar strength, relief bounce for grains post-tariffs, further breakdown of basic metals, and a temporary softening of oil/gasoline. We continue to long volatility, given the favorable reward/risk profile at current levels.
For those of you in oil & gas, check out this piece I wrote for Midstream Business magazine about Canadian pipelines. I've become a contributor now so I expect to publish something every so often.
Lastly, EMMA program is currently open to investors. Please let us know if you'd like more information.

Jeff Lee, CTA

Kronos Management, LLC
Copyright © 2018 Kronos Management, All rights reserved.

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