In a world of cold metrics and glossy brochures, there’s something reassuring about hearing it from the horse’s mouth. There’s nothing like seeing a manager laying out their approach and sentiment toward the markets to get a sense of what kind of trader they are. That’s why we love to see messages like the one we received from Atlantic Capital Advisors principal and managing director Andrew Taylor. With keen insight on QE3 and what comes next, we thought we’d share some of his musings:

This has been a very nice run for us recently, which warrants some thoughts given the current environment. After having gone through a flat period trading last year, where central bank monetary easing and political stimulus kept asset prices inflated in an economic environment where deflation would have occurred naturally. So much of what we do is look for divergences and potential moves from one equilibrium point to another, regardless of underlying rationale whether they are micro or macro in nature. The new paradigm for me has been the increased importance of macro factors that can overwhelm the micro, and is somewhat reminiscent of early 2005 and the influx of capital into commodities via index funds. Most commodity traders are not used to a rising tide lifting all ships. With inflated prices, excess liquidity and bearish outlooks, we see declining volumes, reduced participation and increase in the breadth of limited yields to markets other than fixed income. The trend of market manipulation is firmly in place and I don’t ever remember a time of so much price (mis) management, the result of which has been to essentially force the market to under price risk, as traders are forced to ignore the dark side of binary risk.

Now we have a situation of political impotence (and an incredible disregard of the fiscal cliff) creating a vacuum that the Fed appears to be desperately trying to fill. To a hammer everything looks like a nail, so even though the QE process is having less marginal impact, we get more QE. Even though we had a buoyant stock market and the effect of monetary easing on unemployment is questionable, I wonder about QE3 (or QE5 for those who include LTRO and Twist). In addition, excess reserves at the Fed are approaching $1.5 trillion and now we have ongoing Fed balance sheet expansion with transfer of MBS, so the likely motivation of the Fed in my mind is more focused on TBTF bank balance sheets and that’s not a pleasant thought. […]

At Atlantic we tend to trade volatility/risk from the long side, so central bank “enforced” price stability is not necessarily a good thing. However, I see increased probability of price instability going forward, as ultimately the market will do what it needs to do to adjust commodity supply/demand. So we will likely see significant price moves (aka pops, explosions, crashes and convulsions), as excess capital sloshes around the monetary system (who knows how much will find its way to Main Street). This should be supportive of returns in an environment where the hunt for yield is desperate enough to underestimate risk in other assets. […]

To borrow a phrase from a terrific old TV show, “let’s be careful out there…”

Thanks and regards,

Andy Taylor

Atlantic Capital Advisors LLC