Wednesday, December 27, 2006

10 observations from the middle of nowhere

1) Just when you think that BAA cannot possibly get any worse, they make an absolute pig's ear of managing difficult weather conditions over the holiday weekend. Flying out of the major London airports is rapidly becoming as pleasant as a root canal. Expect the UK government to force BAA/Ferrovial to sell either Gatwick or Heathrow.

Macro Man is spending his holidays in the middle of nowhere, otherwise known as an extremely rural location in that forgotten area known as the middle half of the Unites States. The following things have struck him so far:

2) Someone forgot to tell the locals about the housing market collapse. There appear to be new houses popping up everywhere, yet Macro Man has yet to see a 'for sale' sign on an existing home. Upon making discreet enquiries as to the state of the local market (again, extremely rural, but an hour's drive from a major metropolitain area), he was told that it was 'neither booming nor in recession'- in other words, what a lot of the broad house price indices are showing for the US as a whole.

3) Macro Man will take the 'under' for US December retail sales. He and Mrs. Macro did the shopping for the kids in a Toys R Us a few days before Christmas, and actually had a pleasant experience. Crowds were minimal and they barely had to queue at the check-out.

4) Cable, of which Macro Man is long, is painfully overvalued. Macro Man was chagrined to see an item that he bought in the UK for GBP449 on sale in the US for $499. The dollar sell-off appears to be running out of steam, and this comparison really underscores the degree to which sterling is overvalued. Macro Man will look to sell out his long GBP/USD position at 1.9750.

5) Who says Americans don't have a sense of humour? Observed on a billboard in front of the local liquor store: NEW ITEM FOR THE HOLIDAYS: IN-LAW TOLERATOR. They appeared to be doing a roaring trade.

6) If you were in doubt as to whether the rise in energy prices has had an impact, consider the sign in front of a local petrol station: GIVE THE GIFT OF GAS! ASK ABOUT OUR GIFT CARDS. When gasoline is given as a gift, you know it has become a precious commodity.

One of the Macro clan had to make an unexpected visit to the local doctor to treat the flare-up of a chronic condition. This afforded Macro Man an opportunity to compare and contrast the US health care system with that of the UK.

7) Before you can even make an appointment, a US doctor wants to know your insurance details so he can get paid. Whatever happend to the Hippocratic oath? Moreover, the fact that one still has to fill in details with a clipboard and pen suggests that the productivity miracle has yet to reach the medical profession.

8) That having been said, the price was not unreasonable. The doctor was picked out of the phone book, so it was truly a random sample. The cost for the consultation was $65, a price that Macro Man willingly paid. He suspects that if a similar charge was levied for visits to the NHS in the UK, the service would improve dramatically.

9) Waiting for a doctor in the US is just as miserable as waiting for a doctor in the UK, but the reading material is better.

10) What was really quite interesting is that the doctor in the US, despite being picked out of a phone book and knowing that the Macros were but temporary visitors in this location, seemed more interested in treating the root source of the chronic malady than the doctor in the UK. The consultation with the doctor lasted substantially longer than in the UK, and the diagnosis was one that the Macros had not previously received from their UK NHS doctor. (The condition has not been sufficiently serious to merit consultation with a specialist.) Much to Macro Man's surprise, the doctor provided a week's worth of free drugs to treat his family member's condition. Macro Man was left with the impression that for those that can pay, the American system provides a substantially superior level of care to the UK. Not altogether unsurprising, in the end.

Sunday, December 24, 2006

Happy Holidays

Friday, December 22, 2006

Risky business

Is the risky asset sell-off beginning? As he heads off on holiday, Macro Man's financial distress seismograph is beginning to twitch. OK, some of that may be related to the execrable performance of the portfolio over the past couple of weeks, but the tremors emanating from popular EM and low liquidity trades is peculiar.

Obviously, the Thai fiasco sent the proverbial cat amongst the Asian equity pigeons. Today, however, has seen the ratings agencies drop a couple of hammers: S&P has downgraded Iceland, and Moody's has downgraded Hungary.

Now, it really begs the question of what the hell these guys have waited for, as 3pm London time the working day before Christmas is perhaps the worst possible time of the entire year to deliver this news, unless these guys wanted to make a market impact. But hey, they are ratings agencies- they're whiter than white, right? Right?

In any event, those long ISK in particular have found their Christmas stockings stuffed with lumps of coal, as EUR/ISK rose 4% at one point today, though has subsequently retraced a bit. The HUF downgrade was not altogether unexpected, though the timing of course leaves something to be desired.

In any case, Macro Man cannot help but think that today's downgrades raise the spectre of something akin to what we saw last spring. NZD, the flightless bird, remains airborne despite slowing growth. An unwinding of risk trades will bring it back to earth. Macro Man will therefore raise a shotgun and take aim, selling 20 million NZD/USD at 0.6992 spot basis (0.6977 to 2 February).

Thursday, December 21, 2006

Endangered species?

So New Zealand GDP was indeed worse than expected. The NZD should suffer here; if it doesn't, it may actually present a nice opportunity. Every pip that the kiwi doesn't fall now may well represent 3 pips that it falls in January. Remember, the kiwi is a flightless bird, so it can't stay in the air forever.

Wednesday, December 20, 2006

Thai'ed up

It appears that the Thai generals are quick studies, and the swift reversal of the THB lockup for equity investment appears to have staved off a crisis. The trade of the year was SETI straddles, it appears, as the volatility in Thai stocks and, to a lesser degree, those across the region has been punchy, to say the least.

The moves in Thailand are probably more interesting from a macro than micro perspective, insofar as they demonstrate that policy mistakes can still have a material impact on asset prices and, by extension, investment performance.

With activist central banks in Europe and Japan, a potentially protectionist US Congress, and China continuing to accrue reserves at a farcical rate, the potential for policy mistakes in 2007 remains ample. Indeed, one could argue that the one significant bout of volatility observed in 2006- the May/June risky-asset meltdown- was the result of a policy mistake by the Fed, namely Bernanke's late April speech in which he appeared to indicate a willingness to fall behind the inflation curve. The subsequent meltup in inflation breakevens and gold then prompted a bout of substantial hawkishness to regain credibility, which sent risky assets sharply lower.

For now, the equity rally may have a bit more juice in the tank, though it does appear to be looking a bit tired. The dollar is getting interesting again, however, and Macro Man wonders if we won't see a meltup in EURUSD and EURJPY between now and the new year. Certainly no one has told the NZD that the dollar was correcting higher; while Macro Man has made nothing from the long side, at least he didn't act on an earlier impulse to short it.

Liquidity is clearly poor at the moment as traders, including Macro Man, squeeze in some last minute shopping. Macro Man is on holiday between Christmas and New Year but will of course check in every now and again. In the meantime, he wants to see both equities and the euro perform before considering whether to lighten up for 2007.

Monday, December 18, 2006

Land of confusion

Macro Man's IT department is currently residing in the land of confusion, so the P/L is unavailable today. However the "better reboot" crowd aren't the only ones scratching their heads.

On the basis of the last two months' price action, one would have thought that Friday's goose-egg CPI data would have seen both the dollar and bond yields screaming lower. And while that was the market's first impulse, the stunning reversals seen Friday afternoon must raise the spectre that the bond bull and dollar bear markets may have run their course.

Not even reported interest from Voldemort has been able to staunch the tide of dollar strength, and suggests that the depth of the dollar short was more considerable than commonly supposed. As such, caution remains warranted on the postion, and a failure of EUR/USD to bounce over the next few days may well warrant a postion reduction.

Strangely, however, the NZD remains a bastion of strength, despite the underlying dollar recovery. Macro Man would be lying if he said that he understood exactly what's going on there, other than perhaps a naked grab for carry. With key GDP data looming later this week, however, the kiwi may be ripe for a collapse. Stay tuned.

Elsewhere, triple withcing passed without incident on Friday and equities continue to drift higher today. Closing the DAX and Aussie shorts was the right decision, but sadly Macro Man has maitnained a short DIA postion, partially offsetting the SPH7 long. This will have to be trimmed on a pullback.

Overall, markets should be relatively quiet this week, as traders spend more time on Amazon than they do on markets; perversely, next week could provide more excitement as people adjust risk for 2007 in limited liquidity conditions.

Friday, December 15, 2006

Twas the night before....the day after?

The dollar continues to correct higher today and is rapidly approaching "put up or shut up time." Today's CPI release may tell the tale, as a move below 1.30 will incur substantial amounts of pain. Macro Man will sell EUR 30 million at 1.2970, as there is no point being a hero.

On a lighter note, a poster highlighted a little poem going round this morning from someone who appears to be giving the market all the attention it deserves - i.e. very little. Perhaps you have to trade foreign exchange to truly appreciate it...

Twas the night before Christmas
And all through the land
The euro was bid
By invisible hand

The bids were all layered
A bit lower with care
In hopes that BOK, Russia,
And SAFE would be there

The carry trades nestled
As snug as could be
Why worry with VIX
Single digits, can’t you see?

But then on the desk
There arose such a clatter
I answered the phone
To see what was the matter

When what to my wondering
Eyes should appear
But an FX broker
And two pints of beer

I could tell from the motions
And gestures he made
He didn’t just want to talk
He wanted to trade

More rapid than eagles
His ideas they came
And he whistled, and shouted
And called them by name

“Now Nokky! Now Stocky!
Now sell dollar yen!
The pound’s overvalued
I’ll say it again!

The dollar is toast!
There you go, now I’ve said it!
So buy RKOs
And I’ll get sales credits!”

And then, in a twinkling
The phone rang some more
The broker that called
Was, quite frankly, a bore

As I started to yawn
And was looking around
Down the phone his ideas
They came with a bound

They were rubbish, each one
Because he didn’t know
That the only important thing
These days is the flow

Central banks- where they bidding?
And please- no more games.
Can we quit calling these guys
By ridiculous names?

“Long term real money”
Or “Quadruple A”
We get a new nickname
Just about every day

The broker was plump
And one of those dudes
Who spends most of his nights
Getting stuck into the booze

A wink of his eye
And a twist of his head
When I asked for a price
Soon filled me with dread

And then, sure enough
His offer had shifted
And when I asked why
He said “we just got lifted”

So I thanked him (politely)
And hung up the phone
(But only after I’d had
A sixteen minute moan)

And so, there you go
There’s ’06 in the bag
A year that’s seen
Very few customers brag

Let’s hope that ‘07
Brings a better day
And that all of the central bank
Guys go away

To give us free markets
And more volatility
Is it just a dream?
Or a real possibility?

And so let me wish you
‘Ere I start drinking beer
Happy Holidays, all
And I’ll see you next year

Thursday, December 14, 2006

Portfolio post-mortem

The good news:

Trimming short equity and short dollar risk was the right thing to do.

The bad news:

The remaining equity longs aren't big enough to offset the losses from short equity and dollar positions, taking the since inception P/L fairly deep into the red.

Why has the dollar strengthened so much today? The simple answer is the market has digested the last week's worth of data and concluded that maybe the sky isn't falling after all. Of course, if Voldemorts of the world has decided to pay 1.32 or 1.33 for an infinite amount of euros, this wouldn't have mattered. However, it looks like the sinister bid has been pulled for the time being, and weak dollar shorts are getting chucked out.

Is this the big turn? It's too early to say. It's worth noting, however, that the Citibank technical analysts have gone long EUR/USD again today- given their red-hot performance of the past several months, Macro Man is inclined to follow along by maintaining short dollar risk here.

Adding to a losing position is not Macro Man's cup of tea, so he won't be doubling down on short dollar risk. Nevertheless, he has a sneaky suspicion that there remains a spurt higher in EUR/USD before the end of the year and wants to be along for the ride.

Elsewhere, Goldilocks appears to have the three bears in some sort of figure-four submission hold. Equities are roaring, bonds drifting lower, and FX carry remains uber-bid.

The SNB cut its inflation forecast today but then moaned about CHF weakness. Uh...fellas, do you think there's a correlation there? Tonight's Tankan survey in Japan could prove to be either gasoline or a wet blanket on the en fuego FX carry trade. Tonight will tell the tale.

The sooner Macro Man finishes his work on the 'beta-plus' FX carry basket, the better. However, December means Christmas lunch season, and Macro Man's presence on the desk will be spotty ove the next week, after which he retires for a well-deserved year-end break. Hopefully the carry study can be completed and posted by then. If not, at least it's something to look forward to in the new year!

Portfolio surgery

Per recent comments, Macro Man jettisons the following losing trades:

* Buys back USD/TWD at 32.425 for 2 Feb

* Buys back the Aussie equity short at 5570 on XPZ6

* Buys back the short DAX position at 6606 on GXH7.

The former will not perform in a pro-carry environment, while the equity indices have both broekn resistance at 5500 and 6500 on the cash indices, respectively.

Wednesday, December 13, 2006

Fun with statistics

Today's retail sales figures looked strong across the board, surprising both Macro man and the market. Fixed income has not liked the data at all, with the ten year yield climbing to its highest level since Thanksgiving.

The breakdown was strong, peculiarly so (building materials up 1.8%?!?!?!?) This will no doubt lead some (David Rosenberg at Merrill, perhaps?) to suggest that the data was actually quite weak, and provide some piece of data to "prove" it.

Of course, it has often been said that you can prove anything with statistics. The state of retail in the US is no exception. Consider the chart below. It shows three separate measures of retail sales.

The orange line is at all time highs: happy days are here again!

The blue line has corrected off its highs and shows signs of basing: neither the end of the world nor party time.

The red line shows a sharp deceleration towards the lows: uh-oh!

So what gives?

The orange line is the indexed level of total retail sales in dollar terms: sales are indeed at all time highs.

The blue line shows y/y retail sales indexed: basing, perhaps. but skewed by base effects and data in the past.

The red line shows the 3 month on 3 month rate of change indexed: evidently falling off the edge of a cliff! (albeit with base effects of its own via the weak September reading)!

So choose your poison.

Are you an economy bull? Point to the orange line.

An economy bear? Point to the red line.

A soft landing aficionado? Point to the blue line.

So remember the next time that anyone shows you economic "evidence" via a ccouple of simple charts: if you look hard enough, you can prove anything with statistics.

Wednesday bullet points

* The Fed statement was perhaps slightly softer than Macro Man was expecting, though Lacker's continued dissent prevented it from being too dovish. Nevertheless, thee was nothing in it to seriously threaten bonds ors equities. The strip continues to look like the best place to 'trade the Fed.'

*Macro Man was shcoked, SHOCKED that weak domestic demand and lower oil in October led to a substantial improvement in the trade deficit. For those keeping score at home, the deficit on both a headline and ex-oil basis was the best in more than a year. Maybe the weaker dollar is finally having an impact! In any case, it would be slightly ironic if, in a quarter in which the dollar has sold off for 'strutural reasons', next exports were to be the largest positive contributor to GDP.

*The DAX/SPX trade has gone horribly, horribly wrong. After trading down to 4.47 on a cash basis 2 weeks ago, the ratio has surged back towards its highs at 4.61. A close at or above 4.62 or a DAX close above 6500 will probably require somne position adjustment to stop the bleeding.

*The death of FX carry has been greatly exaggerated. The antipodean currencies are trading very well indeed, while JPY and CHF have been smoked on a cross basis today. As such, it is time to jettison Taiwan. Macro Man will do so overnight.

*In fixed income land, JGBS are entereing interesting territory, having rallied sharply over the last few days. If cash yields dip again tonight, Macro Man will be tempted to sell some, despite his general pessemism on the Japanese economy. JGBs have been range-y for much of the year, and Macro Man isn't sure we've seen enough to break. In the UK meanwhile, the market is pricing in at least another rate hike from the BOE. While yesterday's inflation data may well have shaken Mervyn King and co., Macro Man believes taking base rates to 5.5% would be foolhardy and swiftly reversed. If the short sterling strip sells off much more, there will be the possibility of an interesting spread trade with the US.

Tuesday, December 12, 2006

Stock studies extended

Markets have gone into lock-down mode ahead of today’s FOMC announcement (and, to a lesser degree, the US trade data.) Most trades appear to be closing rather than opening risk, although yesterday’s bullish candlestick patterns in the likes of EUR/USD and cable have moderated (though not eliminated) some of the concerns arising from Friday’s mysterious dollar rally. The relief rally was partially spurred by none other than Easy Al Greenspan, who has gone all Sakakibara on us by commenting on currencies after his time has past. Regardless, the major source of Macro Man’s misery at the moment is the SPX/DAX spread, which probably requires a full-fledged reversal in stock prices to come back into the black. For what it’s worth, Macro Man expects the Fed to acknowledge an economic soft patch, to note that housing is seeing some signs of stabilization, but to maintain the bias to tighten. Jeffrey Lacker clearly shouldn’t vote for a rate hike, so Macro Man favours the end of his dissension. However, it is probably a close call.

Following yesterday’s post, Macro Man had a couple of requests to extend the study further back, if possible. Luckily, he managed to lay hands on P/E data going back to 1968. The results of the extended study were interesting, particularly as the 1970’s were a period of extremely high inflation and extremely low P/E ratios. The results of the study appear to confirm that the 2% threshold of Treasury yield over earnings yield is a consistently effective sell signal, with improved return/risk ratios in the 1980’s 1990’s, and 2000’s.

The model never had a chance to ‘sell’ in the 1970’s or late 1960’s however, as the S&P 500 earnings yield traded at a healthy premium to Treasury yields for much of that period. Equity multiples got crushed in the 70’s due to high inflation, while bonds traded much too rich until Paul Volker resolved to stamp out inflation.
Source: Datastream,

As a result, there are a couple of ‘premium buckets’ where equity market performance is mediocre. This largely reflects equity market weakness in the late 1960’s, and then again during the first oil crisis in 1973-74. While Macro Man could probably add some sort of inflation filter onto the study to explain the weakness of stocks despite their apparent cheapness 30+ years ago, that smacks of data mining. He is therefore left to conclude the potency of ‘buy signals’ may be less than that of ‘sell signals’ (i.e., when Treasuries yield >2% more than the S&P 500 earnings. Fortunately, the ‘value filter’ equity beta model is long by default, with only the sell signal in place as a market-timing device.

Source: Datastream,

Equity weakness in the 1970’s notwithstanding, extending the time frame of the study by an additional 18 years has done little to alter the underlying conclusion that there appears to be a strong correlation between the Treasury ‘yield premium’ and subsequent stock market returns. Applied since 1968, this value filter strategy would have doubled the returns of a simple buy and hold strategy, excluding transaction costs and dividends.

Source: Datastream,
While there were no applicable signals in the 60’s or 70’s, the strategy has consistently improved passive performance over the past 25 years. Notably, the strategy would have kept one out of the market during the 1987 crash, as well as during much (though not all) of the aftermath of the dot-com bubble a few years ago. Notably, the performance this decade with the filter moves from slightly negative to comfortably positive.
Source: Datastream,

Is it the answer to guaranteed returns? No. But as a ‘beta plus’ strategy on which to overlay portable alpha, it doesn’t look half bad.

Monday, December 11, 2006

Beta release

Ouch. There’s no other word to describe it. Over the last 24 hours, virtually everything that could have gone wrong, has. The dollar bet has gone from super to supine, courtesy of Friday’s inexplicable late-day dollar surge that has thus far followed through on Monday. The DAX, meanwhile, has handily beaten the S&P over the last few days, taking the spread trade (un) comfortably into negative territory.

Macro Man was not particularly surprised that the dollar corrected; after all, December 2004 and 2005 saw corrections from the underlying trend. What was surprising was the manner in which it corrected, with seemingly bullish, Voldemort-driven price action swiftly reversing into a free fall. Ultimately, this could be a healthy phenomenon, shaking out a few weak dollar shorts and setting the stage for acceleration of dollar weakness into year end. Perhaps tomorrow’s Fed meeting could be a catalyst if Jeffrey Lacker returns to the ‘on hold’ fold and the statement is perceived as dovish.

However, the losses prompted Macro Man to put on the thinking cap over the weekend. What is the appropriate ‘default’ setting for a macro portfolio? After all, it is pretty difficult to scratch out 10% in pure prop trades without taking sufficient leverage to risk substantial drawdowns. The recent press accorded to Goldman’s Absolute Return Tracker suggests that it should be possible to create an underlying beta portfolio on top of which to lay a series of portable alpha prop trades.

Of course, there is an argument to be made that that is what many hedge funds currently do, without the portable alpha overlay. Nevertheless, if one can develop a passive strategy that generates a consistent return, it provides a handy tailwind from which to leverage one’s particular area of expertise.

An obvious starting point is equities, which are more volatile than bonds or currencies and deliver higher nominal returns. Macro Man’s interest was piqued by a recent debate about the utility of P/E ratios in market timing. Macro Man decided to investigate a relatively naïve market timing strategy based on S&P 500 trailing PE ratios.

The essence of the strategy is to be fully invested in US equities when they are relatively attractive, and out of the market when they are not. Macro Man used trailing S&P 500 p/e ratios since 1986 (the earliest available in Bloomberg), inverting them to generate a trailing earnings yield reading. He then compared this earnings yield with the prevailing yield on 10 year Treasuries. The initial analysis seemed to suggest that when Treasury yields are substantially higher than earnings yields, equities underperform. When the difference is smaller, equities seem to do OK. What is curious is that Treasury yields are currently priced at a discount to earnings yields, a clear anomaly over the past 20 years!

By this reckoning, equities look cheap. Or, to put it another way, Treasuries look expensive, thanks to central bank and pension fund bids. However, eyeballing a chart is a pretty lousy way to demonstrate a relationship, so Macro Man dug deeper. He broke the UST – SPX yield differential into different buckets, comparing the return characteristics of each bucket. The results, displayed in the table below, appear to demonstrate a clear relationship between the bond-stock yield differential and S&P 500 price performance. (Note that Macro Man compared each day’s price return with the yield differential as of the previous day’s close.)

This is an approach similar to that of the so-called Fed model, except that it does not purport to determine the degree of over/under valuation of the stock market. All this approach does is determine whether the market looks attractive or unattractive. There appears to be a crucial level in the yield differential of around 2%, whereby stocks offer an attractive rate of return below that level and an unattractive rate of return above the level. So Macro Man devised a simple trading strategy wherein he is long the S&P 500 if the yield differential is below 2 and out of the market if it is above 2. The results, displayed below, are impressive. By getting out of the market when valuations look extreme, Macro Man improves the return/risk ratio of the buy and hold strategy from 0.58 to 0.86.

Now, this analysis did not include transaction costs, but then again it did not include dividend returns, either. Macro Man believes that the latter are substantially higher than the former, so if anything the returns on the strategy are understated. Note also that the strategy was out of the market during the 1987 crash and for much of the 200-2202 sell-off. This looks like a fairly reasonable starting point for a macro beta strategy. Over the coming days (and perhaps weeks), Macro Man will look at other passive beta strategies, such as the FX carry trade.

Saturday, December 09, 2006

Curiouser and curiouser.....

No one that Macro Man spoke to had any clear idea why the dollar staged such a dramatic and forceful rally late in the day on Friday. Some suggested that Paulson's "strong dollar" comments had an impact, but in reality these were no different from the witterings of Paul O'Neill or John Snow before him. Other opined that the Treasury sell off had an impact; while this might explain the euro's retreat off of its highs of the day, it doesn't really explain the catastrophic collapse.

There was evidently a motivated seller out there, but no one admitted to seeing the flow. Was it a hedge fund ram job? A big technical trade? A large fixed income switch? These are some of the explanations Macro Man has heard. The ball is now back in the court of Voldemort and his cronies, and dollar shorts (including Macro Man) are left licking their wounds and wondering if this is the end of the line, or just a temporary hiccup that is a buying opportunity. Either way, this market just gets curiouser and curiouser....

; while

Friday, December 08, 2006

Summon Harry Potter!

Voldemort is all over the place today!

Identity crisis

Imagine Macro Man’s surprise when he observed his name splashed across the front of the latest edition of Bloomberg Markets magazine. Like J.D. Salinger, he treasures his privacy very dearly. However, he can safely confirm that he is not, in fact, Peter Thiel, erstwhile PayPal honcho and current hedge fund manager. Macro Man’s identity remains safe after all....

The past 24 hours have not been especially kind to the portfolio. Despite a 25 bps tightening and relatively hawkish commentary from Mr. Euro, the DAX performed strongly even as the S7P 500 floundered. As such the spread position has faltered badly. Elsewhere, profit-taking in the dollar and some stop losses in EUR/GBP have eroded much of the month’s currency trading profit, essentially taking the portfolio back to flat on the month.

Today, of course, sees the release of nonfarm payrolls in the US. The data has become more and more useless recently, as the underlying trend of payroll growth comprises a smaller and smaller percentage of the statistical error in the series. Macro Man prefers to watch the unemployment rate, which is more trending and less prone to peculiar outliers. That having been said, the October data may have witnessed just that, with a strange dip in the unemployment rate down to 4.4%. Macro Man expects that to correct back up to 4.6% today, which should undermine the dollar to a degree. The impact on equities is less obvious, however, and bears watching.

Last night saw the release of a slew of data in Japan, almost all of it negative. Q3 GDP growth was revised down from 0.5% q/q to 0.2%, machinery orders rose by a lower than expected 2.8%, and the economy watchers survey slipped below 50 for both the current and forward looking components. Only bank lending figures provided any modicum of comfort, rising by a slightly greater than expected 2.1% for adjusted y/y lending. On the other hand, the benchmark revision to GDP suggested that the trend rate of growth over the past few years has been substantially lower than previously thought.
Despite this, the hot rumour in Tokyo is that the BOJ is itching to tighten rates this month. Perhaps they know that next week’s Tankan will be strong, but it still seems a strange decision in the face of such consistently weak activity data recently. Moreover, in the grand scheme of things, it shouldn’t really matter if they hike in December or wait a month or two for the data to improve before pulling the trigger in Q1.

There is some suggestion that they wish to tighten rates early to put the kibosh on carry trades. Perhaps there is some truth to this, but if so, Macro Man believes that they are barking up the wrong tree. Although it seems to be an article of faith amongst non currency specialists that the yen carry trade is massive, Macro Man believes that it is relatively modest in size. Moreover, he also thinks that tightening rates by 100 bps will do little to disturb such carry trades that are extant. Look out next week for a deeper analysis of the subject. In the meantime, we are left to wait for this month’s sacrifices at the altar of statistical insignificance, the nonfarm payroll and Michigan consumer sentiment surveys.

Thursday, December 07, 2006

Is the dollar about to undermine the stock market?

It’s been a nervous start to the day as markets shift risk ahead of the ECB rate decision/press conference, a slew of Japanese data tonight, and of course tomorrow’s employment situation report in the United States. Macro Man dodged a bullet in New Zealand, where a hawkish RBNZ caused the kiwi dollar to spike to its highest rate since January against the “big dollar.” Fortunately, the remaining currency bets have thus far proven sufficient to offset the losses from the short equity beta, though those profits are dwindling as Macro Man types....

At this juncture, liquidity (as measured by the ability to trade a given size with a given transaction cost) is beginning to deteriorate across a number or markets. The propensity for outsized or wacky moves grows larger by the day; one need only consider what happened to gold and the yen this time last year for an indication.

The dollar sell-off, while extremely modest in an absolute sense, seems to have garnered an unusual amount of press over the last few weeks. Part of this may be down to the extremely low levels of volatility prevailing over the summer and autumn, so that a 5-6 figure rally in EUR/USD seems like a massive jump. Some of it, however, already appears to be looking for a crisis that doesn’t really exist. To wit, there is an implicit (or even, at times, explicit) assumption amongst many commentators that the distress in the US housing market must necessarily manifest itself in other markets as well. The abject failure of equities to crumble has frustrated both stock market and economy bears, so a weakening of the dollar becomes the preferred vehicle through which to transmit systemic distress. No doubt many folks expect the weakness of the dollar to eventually filter through into lower stock prices, a la October 1987.

Macro Man struggles mightily with this interpretation, even though it would ultimately benefit the P/L quite a bit. For one, the magnitude of the dollar sell-off from 1985 to 1987 was sufficient to prompt a G7 agreement to prop the dollar. The dollar has sold off substantially less on a percentage basis from its high earlier ion the decade.

More significantly, twenty years ago the market had gotten progressively more expensive, as measured by the earnings yield. Since 2002, meanwhile, the earnings yield of the SPX has risen steadily and now exceeds the yield on both US treasuries and many categories of corporate debt. Regardless of what one might think of the future trajectory of corporate earnings in the US, it is difficult to construct an argument that the market has been anything but cheap for the last several years.

That value anchor is one of the major reasons that Macro Man does not expect the stock market correction, when it comes, to be anything but a correction. Moreover, it is not unreasonable to expect the dollar sell-off to peter out early next year, much as it did in 2004 and 2005. At some point, surely, Voldemort will realize what he’s buying; after all, how can one have complete confidence in the euro as a store of value when even the bridges on the notes are fake!

Wednesday, December 06, 2006

Wednesday bullet points

* The P/L has taken a hit overnight as equity markets continue to perform strongly. Blogger is once again having upload problems, so Macro Man cannot post the usual update at the moment, but the strong start to the month has now dwindled to zero. If the ECB tomorrow and employment data on Friday do not prompt a correction, another option overlay may be required to decrease the short beta temproarily.

* The dollar has staged a mini-recovery this morning against the euro, as profit-taking and a breach of reputed central bank bids has let to a retest of the November closing rate. However, further CB bids reportedly lurk below, so Macro Man will take advantage of this dip at 1.9645 (1.9648 to Jan 4) to buy the £10 million versus USD that he thought about yesterday. Interesting comments from the French small business minister: "France must stop moaning about the euro." Too right!

*Aussie GDP disappointed overnight, registering a quartely gain of 0.3%. However, the revisions to prior data suggest that the Q3 number was not quite as weak as the headline would suggest. Nevertheless, this is another in a string of Q3 data that suggests that the rest of the world has yet to decisively decouple from the US economic soft patch.

*Iceland reported a Q3 current account deficit equating to an annualized rate of 24% of GDP. Could this be a catalyst that the current account trade is going to come back into vogue? Macro Man cannot help but notice that NZD is underperforming badly today. Macro Man is coming very close to pulling the trigger on a sale of NZD/JPY.

Tuesday, December 05, 2006

If non-manufacturing ISM is 53 or below....

...Macro Man will buy £10 million verus USD at best. If not, he will wait.

A cautionary tale

The impressive resilience of equity markets has surprised Macro Man and dented the monthly P/L. Following on from Friday afternoon’s late rally, the S&P 500 put in a truly impressive rally yesterday, confounding expectations that “recessionary” data would submarine risk assets. In fact, today’s non-manufacturing ISM is markedly more important than Friday’s number, given the weight of services in the US economy. We’ll see if the market notices.

Today, Macro Man has a story to tell. It is the story of a nation that is a consumption based society. The country routinely runs current account deficits in the mid-single digits as a percentage of GDP. It is a country where housing is no longer affordable to the common man; the latest Demographia survey of Anglo-Saxon housing markets reckons that this country is the most unaffordable in the survey. It is a country that is in the midst of a bust in housing activity, and that has sustained a significant deleterious impact from changing weather patterns in recent years. For some reason, however, the central bank in this country has insisted on putting up rates this year, despite all of the above factors clearly signaling that recession is around the corner. Yet somehow, the stock market in this country has rallied 14% in 2006- clearly a sign of either paramount foolishness or blatant market manipulation. Surely it will all end in tears! The name of the country is, of course...


As the chart below demonstrates, building approvals have fallen more than 25% over the last three and a half years; surely the type of long, drawn-out retrenchment in building activity that the entire world fears for the US.

Sure enough, Australian consumption did sag in 2004-05, enough to put the RBA on hold but not enough to foster a rate cut. Over the past year and a half, however, consumption growth has picked up smartly, despite the lack of rebounding in building activity. Indeed, the economy has recovered to the degree that the RBA has hiked rates 0.75% this year, despite a horrific drought that is taking nearly a percent off of annualized GDP growth over the next several quarters.

As the chart below suggests, the Demographia survey suggests that Australia is THE most unaffordable Anglo-Saxon housing market (the rating represents the cost of a home as a multiple of median income.) The US, while clearly expensive in aggregate, is the second most affordable country in the survey, behind Canada.

Source: Demographia

What this masks, of course, is the dichotomy between the coast (the most expensive markets in the entire study) and the interior (the most affordable markets in the entire survey, and affordable in an absolute sense.) A clearer sign that there is no unified “US housing market” would be difficult to find.

Source: Demographia

Does all of this mean that the US is guaranteed to avoid recession, or that Australia is guaranteed to slide into one? Of course not. Macro Man brings up the parallels simply to suggest that the US housing story is not, after all unique (other than the fact that most mortgages are fixed rather than floating rate), and that a period of subtrend growth resulting from a housing market adjustment does not necessarily produce either recession or even rate cuts.

Monday, December 04, 2006


It’s been a quiet start to the week, with stocks, bonds and currencies consolidating after Friday’s explosive moves. The equity consolidation was perhaps foreshadowed by the recovery of US equities into the close on Friday, a move for which Macro Man has not heard a satisfactory explanation. Nevertheless, the portfolio has started the month on the front foot, with the currency and stock index positions contributing strongly. Macro Man took a bit of EUR off the table on Friday, and will look to re-establish on dips early in the week. The main event of the week is, of course, on Friday, with the release of the market-moving but statistically insignificant non-farm payroll numbers. Of interest to Macro Man will be the unemployment rate, as we probably need to see that inch back towards 5% before the Fed would seriously contemplate a rate cut.

A phenomenon that Macro Man is encountering with increasing frequency is the market’s infatuation with the notion of decoupling. While it is fairly clear that the US has slowed, many economists remain happy to forecast above-trend growth in Europe, Japan, and of course China over the coming quarters. Central bankers in Europe and Japan appear comfortable with the notion, as evidenced by recent comments from the ECB and BOJ governor Fukui’s reported campaign to push through a December rate hike.

While the jury is still out of European growth after next month’s VAT hike in Germany, Macro Man is somewhat surprised at how upbeat the market appears on Japan. When one considers the hype over the sub 50 ISM, one wonders why no one has focused on the Japanese leading indicator, which would suggest that a manufacturing recession is in the pipeline:

Machinery orders also suggest at least a stagnation in industrial output, which would obviously have implications for capex. Meanwhile, while everyone waits for the US consumer, run over by the housing market, to squeal in pain, it is the Japanese consumer that has rolled over and died...

Moreover, one cannot read a piece of FX research without seeing a reference to Japan’s REER being at 20 year lows. This begs the question: if the yen is so cheap and consumers aren’t spending, why isn’t Japan’s trade surplus any higher?

Ironically, if Macro Man’s fears on Japanese growth prove correct, this could be a bullish outcome for the yen if it forces Japanese retail to rein in their selling of the domestic currency. Next week’s Tankan will provide clues as to whether the US and Japan de-couple or instead prove to be an odd couple vis-à-vis the rest of the world.

Friday, December 01, 2006

Macro Man sells 10million EUR/USD at 1.3342

Take profit. 1.3361 for Jan 4 date.


The pictures below speak for themselves....

Given the Economist’s execrable track record of forecasting, is it time to take profits on the dollar short already? Some people evidently seem to think so, as the buck is back, for this morning at least. However, in contrast to prior episodes where dollar weakness has gone tabloid, Macro Man remains of the belief that positioning is modest and tailwinds (i.e. central bank and corporate sales) remain strong. So Macro Man is going to give the position a chance to keep performing.

Indeed, given its size, the short equity position is a source of more worry than short dollars at the moment. So far it has paid off, but Macro Man is concerned that an upside surprise to US data would be construed as equity positive, as it would reduce the hard landing tail risk to equities. Given the markdown to ISM expectations after yesterday’s Chicago number, risks surely point to a stronger than expected national release. After all, not every district has an industry in such dire trouble as the auto sector in the Midwest.

From a risk/reward perspective, Macro Man favours playing a topside surprise through fixed income, despite being recently chucked out of a short bond position. Jan 94.75 puts (March future) at 3 ticks look a good bet from a risk/reward perspective, especially as 3m LIBOR remains 5.37%. Macro Man therefore buys 20,000 at 0.03, giving him a ratio strangle.

November closed on a good note, as short dollars, short Aussie/German stocks, and long US and energy stocks all paid handsome dividends. The only bummer was a compression of the Dec 07 WTI/Brent spread, which kept the November P/L just below 1%. However, Macro Man still likes the trade, and thus stays in. The long EUR/USD position was also rolled out to Jan 4; over the next couple of weeks, the short Aussie futures will need to be rolled to March, assuming the position is kept.

There’s lots more to consider that will have to wait for next week: the peak in the US profit cycle, the return of deflation to Japan, and the incredible disappearing house-price crash. Meanwhile, Macro Man can watch his screens in anticipation of hearing that holiday music when he returns home this evening.