09.30.2013
By Terry Flanagan

Asset Managers Eye Fed

Recent U.S. Federal Reserve announcements have caused market gyrations around the world, and the volatility will continue to be an impetus for deploying strategies that capitalize on pricing inefficiencies in global capital markets.

“For the past five years, we’ve seen central banks flood struggling economies with an enormous amounts of stimulus, to dampen the crisis of 2008 and 2009 – and this can almost be thought of as crack cocaine for the market,” said Chris McGuire, chief investment officer for Chicago-based Phalanx Capital Management.

“When the Fed stops their (stimulus) moves and interest rates go up, the flight of capital into reserve currencies and out of emerging markets like those in Southeast Asia will create problems and increase volatility,” McGuire stated. “The greater the chaos, the greater the opportunity for derivatives traders – we thrive on chaos,” he added.

When the Fed  announced in June that it was prepared to begin reducing its monthly asset purchases known as quantitative easing, shock and panic erupted and the markets became more unruly, thereby creating distortions and price inefficiencies, McGuire stated.

“That’s the stage when we have opportunities to identify cheap options – mispriced convertible bonds, or distortions in relative value situations in the market,” he said.

As the managing member of Phalanx’s leadership, McGuire brings 20 years of specialization in derivatives and depth of experience through numerous market cycles to managing the firm’s Japanese and Asian strategies.  “The Japanese economy has caught everybody’s eye in the last 12 months, with Abenomics and the aggressive moves Japan has made to devalue their currency,” he noted.

“Japan is in a big bull phase and we see more coming. It will overshoot to the upside after a couple of years, and the equity market will ‘rubberband’ back,” he suggested. “At some point in the next two years, there will be a peak, then a pullback,” McGuire said.

Japanese companies profited from the currency devaluation of some 25% in the past year, but they have not been as innovative at new product introductions as some other countries in the region, in McGuire’s estimation.

Other emerging economies in Southeast Asia, which are very export oriented, such as Indonesia, the Philippines and Hong Kong, are also greatly influenced by the money flow and actions of the U.S. Fed.  “When it slows, we’ll see a flow of capital away from emerging markets, and heightened volatility and price movement across the globe,” said McGuire.

Phalanx works closely with its counterparties to assess and identify under- or over-valued securities, and risk management is an ongoing priority. “We’re always investing in risk management, always kicking the tires on our systems to develop and evolve,” as change is constant, he told Markets Media.

Challenges include the “overregulation” of the options industry, “but we have to roll with the punches,” McGuire stated. “That’s increased our compliance and regulation costs significantly.”

Focusing on the market landscape from a buy-side perspective, McGuire will be a panelist at the Markets Media Chicago Trading and Investments summit on October 24th. He said other overarching themes on traders’ minds, besides the timing of the Fed’s next moves, are conditions of any potential recession in China which would have huge global impact, and constant concerns emanating from the Middle East and geopolitical effects on oil prices and global asset classes.

The name Phalanx Capital Management is derived from the Greek word for a legion of soldiers and “to us, it means one person may lead, but there are two more backing up the leader; there’s strength in numbers,” said the asset manager.

 

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