One of our larger accounts rang me this week to ask what we thought of the geopolitical situation and how we were positioning for this.

Where? I asked.

Well, there’s the Ukraine, we really need to let them fight it out, he replied. What a desperate situation. And then there’s Greece: that’s an intractable one isn’t it? And then ISIS and that conflagration.

Our investor warmed to his topics but, after he had finished speaking I told him I was worried about other things.

What?

My two biggest concerns are lack of depth in markets and concentrated positioning.

What do you mean?

Well, on the first point, one of the consequences of the Global Financial Crisis was to place much stricter limits on banks’ activities and capital ratios applied to each activity. The sum consequence of these measures is to drive banks out of proprietary trading and to severely restrict their market making activity. Fund managers talk obsessively about liquidity but, in truth, liquidity in many markets is a mirage. Last year we witnessed a bizarre phenomenon in the US Treasury market that was termed the “fall fall” by FT columnist #James Mackintosh. The UST gapped down in a way no participant could remember having ever happened before. For a period of time there was no other side to the market. If that doesn’t give you the heebies nothing will.

The consequence of this is that market corrections will be violent.

On the second point, there are a number of interlocking themes that have played very well in the past two years but are now quite crowded.

For instance?

Almost everybody is bullish on the US dollar, bearish on the euro, European growth, Emerging Markets, China and the mining sector. Positioning is about as extreme as I’ve ever seen it.

Sometimes fund managers’ greatest risks are to themselves and this is one of those times.

Note: This week, Cerno Capital portfolio managers have materially reduced US dollar positioning and eliminated bearish positions in Emerging Markets and Industrial Metals and the Australian dollar. New positions in European cyclicals have been introduced to portfolios.

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