Friday, February 27, 2015

A simple model

So the US economy is not, in fact, falling off a cliff...just yet.  Although durable goods orders are notoriously noisy, yesterday's solid print should assuage at least a few fears about the recent soft tone to some of the data.  That core CPI managed to beat expectations was icing on the cake, as the dollar and US yields both jumped smartly after the releases.   As Hannibal Smith used to say, "I love it when a plan comes together!"

Of course, it wasn't all pony rides and lemonade.  Weekly claims were quite a bit higher than expected, albeit in the context of seemingly interminable snowy, nasty weather for much of the country.  Still, the decline in claims seems to have stalled a bit recently; although it's probably too early to read too much into it, it nevertheless remains a development worth watching.

Every so often, Macro Man likes to take a step back and look at data in its unadulterated form- no rates of change, moving averages, or anything like that, just the level of the underlying data.  When looking at the level of durable goods orders, ex-transport, you can see the recent soft patch; put into context, it doesn't yet look particularly abnormal or worrisome.  Certainly the loss of momentum is nowhere as severe as it was in 2012.


Perceptive readers will note that durables are basically at the peak level of the last cycle, whereas the SPX is comfortably above it.  How, then, do these orders figures compare with other data?   Macro Man assembled a chart showing nominal retail sales, the ex transport orders noted above, and industrial production, scaling each series to 100 as of February 1992.  As you can see, the relative fortunes of the 3 data sets vary starkly.


As the title of the chart suggests, these three series capture the changes in the economy quite well.  Consumers have continued to spend (note that retail sales are substantially above the level of the pre-crisis peak), but not, it would appear, on goods made in the US.  This is hardly a stunning revelation, of course, but it's nice to see it demonstrated so sharply in a single chart.

This got Macro Man to thinking.   Retail sales, like the SPX, are very comfortably above pre-crisis highs, IP is marginally so, and orders are basically at the level.   What would happen if we regressed these 3 series against the SPX?  The results are set out in the chart below.

As you can see, the relationship is generally quite good, with an r-squared of .88.   Note that to some extent that should be expected, insofar as the entire time period was in-sample and your author regressed levels rather than changes.  Nevertheless, it's interesting to note that the divergence between the current level of the SPX and that suggested by sales, orders, and IP is larger than  it has ever been over the past couple of decades.

To a large degree, of course, that is a function of QE/easy monetary policy/low bond yields/low discount rates.   One would naturally expect, ex ante, that stocks should look a touch rich to exclusively growth-based indicators given that global policymakers have begged investors to move out the risk curve for more than half a decade.

Naturally, equities also benefit (and suffer) from leverage, both on a corporate and investor level.  Indeed, generally speaking the amplitude of changes in stock prices dwarfs that of changes in the underlying data, so it may well be the case that a simple linear regression is a decidedly imperfect tool.

To mitigate the impact of leverage, Macro Man ran the same regression, but on the natural log of the SPX to smooth the swings in stocks relative to the economy.  Upon obtaining model output, it was a trivial matter to reconvert the data back into SPX terms.  The results of this study are below.

This model suggests a closer fit between the current level of stocks and that implied by growth data (and a closer overall fit, with an r-squared of 0.93), though it still views equities as nearly 10% too high (when using current stock prices.)  However, "mispricings" of this magnitude are fairly ordinary; indeed, the same model suggests that stocks were undervalued by a greater amount in the run-up to the crisis.  That very fact should tell you everything you need to know about relying exclusively on growth-based indicators that take no account of financial conditions.

So what have we learned?  A very simple growth-based model suggests that US stocks should indeed be at all time highs, albeit at levels lower than those currently prevailing.  Introducing a liquidity term would indubitably close that perceived valuation gap; indeed, in Macro Man's own, more robust equity model, liquidity factors explain almost all of the ex ante expected return of the SPX.

As long as liquidity remains ample, growth doesn't necessarily need to roar to justify current if not higher prices.   If and when the tap gets closed off, on the other hand, simple indicators like these can provide a rough and ready guide to how deep the correction might be if we were to revert to using growth rather than easy financial conditions as the primary valuation metric.

Wednesday, February 25, 2015

Something for everyone

Janet Yellen's testimony yesterday had something for everyone (except owners of puts, natch.)  Of course, these days 'balanced' outcomes seem to mean 'dovish', as markets are clearly placing the burden of proof upon hawkish developments to justify market pricing.   Given that we're closing in on 9 years since the last rate hike in the United States, that is probably a justified posture.

To be sure, there were some things that did sound outright dovish.   The familiar mantra that there is room for further improvement in the labour market was trotted out; at times, one wonders if Yellen would be saying that if the unemployment rate were 0.5% ("when we say full employment, we mean full!")

The comments vis-a-vis inflation and foreign risks were not particularly surprising, given that they echoed the tenor of the minutes.  While some might paint as dovish her emphasis that the removal of 'patient' does not necessitate a tightening within the next couple of meetings, from Macro Man's perch it makes a lot of sense.  The more options they give themselves, and the freer they are from the tyranny of this silly forward guidance, no doubt the more comfortable they will be.

On the other hand, Yellen sounded quite confident that the net impact of lower oil is solidly positive, a point that seems to be in dispute in some quarters.  Moreover, she offered a gentle reminder that the risks posed by Johnny Foreigner are not all to the downside. 

All told, Macro Man saw absolutely nothing to dissuade him from the view that the first tightening will come in September.  Indeed, if anything some of his concerns about an earlier June tightening were mollified somewhat.  While it is perhaps not a surprise that ED's have rallied and flattened as a result,  they remain too high, in your author's view.   Should the rally continue, he will look to add to shorts.

One thing that Macro Man is mindful of is that March often has a nasty way of reversing the trades that have worked in the early part of the year.   The dollar and equities are both obvious candidates to exact harm on the marketplace.   A sell off in both coinciding with the start of ECB would be knowingly explained as a "sell the fact" phenomenon (ex post, of course) by the usual armchair savants.

Per Monday's post, your author is still sitting tight, for the time being.  However, if ED's continue to rally, it would appear to him that they would offer a superior near term return than the dollar.  Put another way, if they were 'right', then the USD value would likely be quite 'wrong.'

Markets generally do offer something for everyone; you just have to know when and where to take it.


Monday, February 23, 2015

How ya left?

So Greece is not, after all, leaving the euro....yet.  The recent agreement was as uninspiring as it was unsurprising, a classic example of the type of can-kicking that has led us to this point, some 5 years after Greece first descended into chaos.

That both the arguments and the solutions have not moved on tells us quite a bit about the situation; the interests of the Greeks on the one hand, and the Troika (or, to cut to the chase, ze Germans) on the other, are implacably opposed.   Neither can credibly give ground on the areas of fundamental dispute: the Greeks, because they literally cannot afford to pay and there is no realistic hope of changing that dynamic, and the Troika, because to forgive debt would open a Pandora's box that would likely result in the end of a few political careers.

Perhaps justifiably, the euro has essentially yawned at the news of the agreement; after all, Greece seems to go through showdowns quicker than some people go through bottles of shampoo.  And so how are we left?

* The dollar remains off of its highs...but not very much so

* The SPX and DAX are at all time highs

* Indices in Madrid and Milan, on the other hand, are at or below levels prevailing last June

* The US economy seems to be in a bit of a soft patch after several quarters of stellar growth

* The recent spate of horrible weather in the northeast doesn't seem likely to improve that in the near term

* The US short end is too low to add to shorts but too high to take profit on existing ones

* Crude oil seems to have stabilized, for the time being


* The ECB cranks up the QE machine soon

* The Fed seems unwilling to cause pain to anyone except owners of volatility

For Macro Man, it's a bit of an uninspiring confluence of factors- for the time being at least.  To be sure, it's always easy to find reasons for equities to go down...but then again, it's also easy to find reasons for them to go up- at the moment, it's hard to find much conviction.

As such, your author could easily see himself sticking with his positions- a modest EUR short, owning some downside and small steepeners in ED's- without doing much by way of adjustment this week.  It's one of the more refreshing aspects of trading for one's self- there is no implicit pressure to do something for the sake of doing it, such as one often finds on a professional trading floor.

More thinking, less doing.  That's the power of the home office!

Thursday, February 19, 2015

A multiple choice quiz

Yesterday's minutes reveal that the Fed is:

a) Justifiably concerned about the lack of global demand

b) Ignoring nascent signs of recovery in Europe, so get ready for another U turn

c)  Tick watching the dollar TWI

d) Proving that when push comes to shove, they don't have what it takes to leave ZIRP

e) Clueless

f) Actually "Funny Money" from the comments section, so JBTFD; heck, JPTFO!

Wednesday, February 18, 2015

An update on leverage (sort of)

Following on from a conversation that he had over the weekend, Macro Man got to thinking about a post he did last summer on the financial leverage in various segments of the US economy.  He thought it would be useful to update the charts with another couple of quarters' worth of (presumably leverage-enhancing) data, and so he did so.

Alas, it appears that there has been a substantial benchmark revision to the flow of funds data, as updating the feed from FRED led to a radical shift in the data pulled for one key segment of the economy- nonfinancial corporate business.

To be sure, overall leverage looks broadly similar when expressed as a percentage of GDP; it peaked during the crisis and has been steadily receding since, albeit at levels that are still eye-watering by historical standards.  Overall, the revisions were fairly modest, but pointed to a bit less leverage than previously thought.


Households continue to delever, aided by low rates and, recently at least, low oil prices.  This trend has continued since the previous update; judging by the tepid tone of retail sales recently, little has changed.

So, too, is the drill with financial corporations, as anyone currently or formerly employed by a bank, or seeking to use the balance sheet of such an institution, can attest.  At least the regulators must be happy....


Obviously, the Federales have taken up the slack as households and banks delever- clearly, little has changed about the stock of Treasury debt over the last couple of quarters.


Which brings us to nonfinancial corporates, the starting point of this analysis.  In the original post, corporate business was notable for increasing its stock of liabilities as a percentage of GDP to record highs.   This kind of made sense, with rates low, earnings yields high, and demand for corporate credit brisk, it was a perfect opportunity to gear the balance sheet a bit to increase EPS through buybacks (as well as stuff like pay for the fracking infrastructure.)

Macro Man was keen to see what the Z1 had to say about the increase in the middle of last year, when he saw this...


The whole narrative was sacrificed on an altar of data revisions.   If anyone who's been parsing the figures (which admittedly came out a couple of months ago- your author's been a bit slow to update this) has a good explanation, Macro Man would love to hear it.

In the meantime, it's hard to know what to make of this, as the magnitude of the revision renders the data literally unbelievable.  As the saying goes, there's lies, damned lies, and statistics.....

Friday, February 13, 2015

Which is more likely?

That the Michigan consumer sentiment survey.....



...the Conference Board measure....


....and even the OECD index of US consumer sentiment...



...all agree, and are wrong.....or that US consumers all have spreadsheets where they can input their fuel costs in real time, assess their disposable income and compare it with their forecast income based on wages and energy price assumptions, and immediately tailor their spending habits to the forecast disposable income stream (along with any shift in savings preference), thus rendering the retail sales figures an accurate rendering of the current state of the consumer and a useful signpost to future economic activity (or lack thereof)?


Wednesday, February 11, 2015

Near term bottom or the pause that refreshes?

What are we to do with the euro?

Macro Man has been running short for some time now, doing a little trading around as circumstances warrant.  After the excitement of the past few months, however, recent price action has been downright boring, with tight ranges and little net daily movement.  The question naturally arises whether EUR/USD is trying to form a near-term bottom, or whether this is the pause that refreshes as the pair gathers steam for the next down-leg.



To be sure, recent rumours from Greece have ostensibly turned more positive, as evidenced by yesterday's eye-watering 8% rally in Greek stocks.  Then again, someone once noted that those types of rallies don't occur in bull markets.

Either way, yet another postponement of the day of reckoning does little to suggest any reason to buy the euro beyond short-term profit-taking.   A six month-postponement simply means another date at the danse macabre over the summer.

Kicking the ball further downfield hasn't worked for the Greeks since 2004, and (to repeat a joke made by TMM), hasn't worked for them against the Germans since the Golden Age:



Obviously, a few days of sideways price action does little to dent the underlying thesis behind a short euro position.  Frankly, news of a short-term extension for the Greeks doesn't, either.  That said, it somewhat bemusing that the euro has largely shrugged off both the US employment data and the consequent back-up in rates.

For now, Macro Man is going to stick with his position, which is, after all, manageable.    A little short-term boredom is a lousy reason to trade out of a winning position, particularly when the prospect of a parity party looms somewhere down the road....