Thursday, May 17, 2007
Spring is here! The sky is blue (OK, well not here in the UK), equities are on fire (most major indices are at or near multi-year highs), and EM is a no-lose proposition (just look at Brazil.) Now’s the time to sit back and reap the rewards of globalization, ample liquidity, and the worldwide shortage of risky assets, isn’t it?
Perhaps. Then again, perhaps not. Regular readers will know that Macro Man, while broadly constructive of risk assets medium-term (as demonstrated by the stellar returns of the beta portfolio), has been tormented on and off all year by concerns over complacency and a desire to market-time a correction in the alpha portfolio. The devil of worry is perched on his shoulder once again, whispering into his ear about all the reasons to expect risky assets to dump. After pointing to the calendar and murmuring well-known investment clichés, the devil whispers the following ten things that grab Macro Man’s attention:
1) The divergence of the SPX and VIX: a warning sign or proof that longs are already hedged? Only time will tell.
2) Gasoline prices have surged recently, now topping three bucks a gallon. The inverse correlation between gas prices and stock market return has been pretty strong over the past few years; the recent run-up in petrol suggests equities are due for a (potentially steep) correction.
3) The US housing market isn’t getting any better. Sure, starts beat expectations yesterday, but permits fell sharply. The high levels of inventory and lack of labour force reduction also suggest that homebuilders haven’t taken the full hit from the market slowdown yet. Consumption, meanwhile, is likely to face a slow-burn headwind for the next several years as ARMs get reset and finances get squeezed.
4) Bill Gross and PIMCO have stopped worrying and learned to love the bomb (or at least the carry trade.) It may be cruel to suggest that the capitulation of a high profile bear can be used as a market timing device, but Stephen Roach’s temporary climbdown from his mountain of angst last May provided a clarion call to de-risk portfolios entirely.
5) Bonds, somewhat to Macro Man’s chagrin, are trading poorly and look to be breaking down out of a long term triangle. A push to 4.90% or 5% US ten year yields would likely squeeze the goolies of risky assets, at least temporarily.
6) Gold has already broken down through a fairly obvious support line. Macro Man does not subscribe to the view that gold strength has represented concerns over the world’s welfare; rather, he believes it has been symptomatic of the excess liquidity sloshing around the global financial system, as well as an alternative play on dollar weakness. Gold’s failure, therefore, may be a warning signal that the ocean of liquidity is experiencing a little turbulence.
7) Perhaps monetary policy may actually get tight elsewhere in the world. Yesterday’s BOE inflation report intimated that 5.75% is a done deal, and obviously one rates go there the risk exists that they could rise further. The ECB, meanwhile, still looks on course to put up rates to at least 4.25%, while Germany can evidently take it, other countries in the Eurozone may struggle.
10) Macro Man’s equity p.a. has started to lag the broad market after eighteen months of solid outperformance. He tends to overweight things that he (thinks he) understands, such as financials and energy. Over the last couple of weeks, however, his portfolio has gone down when the broad indices have gone down but failed to rebound with the broad market. Is he the victim of noise and/or sector rotation, or is something more sinister afoot?
All these factors are weighing on Macro Man’s mind. He is not quite prepared to layer fresh risky asset shorts or hedges in the alpha portfolio, but he is not far from doing so. The first order of business, however, is to jettison the pesky oil position; commodity alpha has cost Macro Man more than a million bucks this month, turning his May from spectacular to mediocre. UPDATE: Macro Man is tired of waiting with fingers crossed, so he scales out of the balance of the CLZ7 long at 68.30. The WTI - Brent spread is therefore closed at a $1.30 discount.