Condemned

George Santayana’s quote that “those who cannot remember the past are condemned to repeat it” has become an oft-repeated cliché in financial markets. Yet the underlying message still resonates, particularly in an environment like the current one.

Many of the people that Macro Man speaks to in the market claim that “no one’s been hurt” by this week’s moves and that the current “low” levels of risky assets represent a “buying opportunity.” Gee, Macro Man must be the dumbest guy in the market, because his P/L dropped 2% between Monday morning and Wednesday morning (though it recovered a bit by close of play- see below.)

Or is he?

The HFR macro hedge fund index dropped 3% on Tuesday, the worst daily return in the (relatively short) history of the index. It looks like Macro Man wasn’t the only one with a big beta position!

So can daily damage like that be absorbed and shrugged off as if nothing happened? On the basis of market behaviour yesterday, yes. Macro Man cannot help but wonder, however, if we are condemned to repeat history. Consider the remarkably consistent price action in the US equity market during the past few springs.

In March 2005, for example:

1) The S&P 500 cratered through its 55 day moving average, dropping 5.3% from peak to trough.
2) It then rebounded, re-testing but not breaching the moving average.
3) It then dropped another 4.7% peak to trough
4) It then re-tested the moving average again, failing once more
5) However, the subsequent low was higher than the previous low
6) It then rallied, finally breaching the 55d average and moving higher over subsequent months

Compare that to May 2006:

1) The S&P 500 cratered through its 55 day moving average, dropping 6.1% from peak to trough
2) It then rebounded, re-testing but not breaching the moving average
3) It then dropped another 5.5% from peak to trough
4) It then re-tested the moving average again, closing above it one day, but ultimately failing
5) However, the subsequent low was higher than the previous low
6) It then rallied, finally breaching the 55d moving average and moving higher over subsequent months

This week, the S&P 500 has cratered through its 55 day moving average, falling 4.9% from peak to trough. Are condemned to repeat the past? The degree of complacency in the market makes Macro Man concerned that the answer is ‘yes.’ If so, the next couple of months might look something like this:

February results are in, and the portfolio recovered sufficiently to best January’s return. The drawdown from the peak was substantial, of course, but ultimately Macro Man is happy to have notched a second consecutive positive month. 0.9% per month might not be sexy, but it’s better than nothing.

Tuesday’s lurch killed the beta portion of the portfolio, but the alpha portfolio actually did quite well. All in, the alpha portfolio returned 1.66% in February, more than offsetting the -0.71% return from the beta portfolio. FX carry beta was actually slightly positive at 0.09%, while the equity beta portfolio returned -0.80%.

Ironically, the alpha portfolio returns were the other way around. FX alpha trades subtracted 0.42% from over all returns. However, all other alpha categories were positive. Equity alpha trades made 0.74%, fixed income alpha bets returned 1.16%, and commodity bets (including the Goldcorp position) contributed 0.19% to portfolio performance.