Monday, April 30, 2007

Just another brick in the wall

Another week, another reason to worry. Macro Man is beginning to feel like the teacher in the old Charlie Brown television specials: an annoying background noise as the stars of the show (in this case, risky assets) carry on their conversation.

The latest brick in the wall of worry comes from Turkey, where the presidential elections were disrupted by a statement from the military on Friday evening and mass demonstrations on the streets of Istanbul over the weekend.

The situation presents an odd cocktail of gripes: while the average Turk on the street agrees with the military about the importance of maintaining a secular government, no one particularly wants to see the generals get involved with determining the outcome of democratic elections. Regardless, the market outcome has been predictable- gaps lower in the Turkish equity, bond, and currency markets, followed by almost immediate dip-buying from investors eager to purchase riskey assets "on sale."
The complacency implicit in the dip buying is particularly telling given the horrible seasonality of EM assets in May. And if Iceland could trigger an EM meltdown last year, why not Turkey, a much bigger market, this year?

That the Dow has risen in 19 out of 21 days for the first time since 1929 underscores both the favourability of the recent market environment and the potential danger posed by a deterioration of conditions. Not that Macro Man is forecasting a 1929, 1987, or even a February 27 outcome for equities; however, it continues to seem prudent to maitain a relatively defensive posture and have plenty of room to add risk on dips.

Macro Man has to shake his head, though. His sale of SPM7 calls has to date been undone by what is literally a once-in-a-lifetime straightline rally in equities.


Charles Butler said...

You're far from the only one that's on the wrong side of that one in some form or another. Who woulda thunk?

First impressions here are that the U.S. doom and gloom story and its European opposite have finally reached the saturation point - for the time being.

Macro Man said...

It's irritating, to be sure, but in the grand scheme of things I cannot complain too much. Despite being on the wrong side of equities, alpha wise, and having been run over in the WTI/Brent trade this month, I'm still in with a decent shout of notching a 1% month, thanks to the beta positions and the SPY dividend that I am getting tonight.

I have to confess, though, that I am fighting the urge to buy puts on EPP.....

Anonymous said...

How does one assess complacency? One could argue that in a world with excess demand for financial assets (we can argue if this is driven by excess savings or a shortage of assets but the outcome is the same), the returns from beta exposure should outstrip the gains from alpha (which at best are unchanged, at worst are lower given increased competition driven by new entrants, i.e. new funds). Is this complacency or a reflection of macro fundamentals? Perhaps the complacency comes from the agents doing the excessive saving? If so, then macro trends suggest that the world will get more complacent before it gets less. I'm sure that this kind of debate occurred before most financial crises, but my sense is that the true test of complacency is when the debate is over with the optimists declared the victors... We don't seem to be quite there yet...

Macro Man said...

Anonymous, I would concur that the macro picture is one where demand for financial assets considerably outstrips supply. This, it seems to me, is a natural and logical conclusion in a world where the proceeds of enourmous trade imbalances are plowed back into financial markets.

As you intimate, a buy and hold strategy for risk assets is likely to generate solid nominal returns. However, this does not imply that there is no room for market timing and that drawdowns are a thing of the past.

Alpha, it seems to me, now consists of anticipating the occasional modest drawdown, reducing portfolio beta on the way down, and re-adding portfolio beta on the way back up.

What has been tiresome (for me, at least) is that even the degree of modest drawdown appears to have been substantially reduced over an observable period of time. Last May was not so long ago, and there waas an ample volume of irrational decision making on display.

This year, markets appear to be driven by robo-traders who are preprogrammed to add sequentially larger amounts of risk on any dip. Such behaviour works great until it doesn't, of course.

I suppose it's our job to ensure that we stay in the game until diverting from buy and hold becomes a more viable proposition.

Despite being run over by my crude trade and the short SPC calls, the alpha portfolio is only back to flat on the year- plenty of room and time to get back in the game...