Tuesday, June 19, 2007
Market lethargy remains well-entrenched across a number as asset classes. That US equity indices closed within 15 bps of flat and EUR/USD had a peak-to-trough range of 45 pips yesterday is a pretty good indication that summer markets have arrived; perhaps it's time to crack on with that reading list!
However, as noted yesterday, Macro Man finds the current benign and, dare he say, complacent, environment unsettling. "Investors" have apparently decided to throw risk at EM assets of virtually every stripe; after all, in a period of low inflation, and with bond yields seemingly having put in a top last week, what else could go wrong?
The answer is plenty.
Macro Man is beginning to wonder if 2007 isn't shaping up as some sort of Bizarro version of 2006. Consider what we saw in 2006:
* A market driven by concerns over exteral imbalances in late winter/early spring, with carry trades performing horribly
* Stocks take a pummeling in the spring as liqudity is withdrawn on inflation concerns
* Stocks put in a stunning reversal in late June and rally strongly through the end of the year
In 2007, what have we seen?
* A market obsessed with carry and contemptuously dismissive of current acccount considerations in late winter and the spring
* Stocks rally strongly in the spring even as interest rates rise on rising growth prospects
The final leg of the Bizarro juxtaposition in 2007 would be a surprising reversal in equities some time around now. Will it happen? To be honest, Macro Man does not know. Could it happen ? Absolutely. And the catalyst could (finally) be that well-mined source of angst and worry, the US housing market.
Many (though not all) commentators have concluded that the worst is past for residential construction, with some even forecasting a positive growth contribution from the sector by the end of the year. Frankly, this seems absurd. Homebuilders have yet to even shed reported labour payrolls after a sharp rise in the previous few years; surely some rationalization of the workforce is a prerequisite for a bottom?
Consider also that the NAHB index continues to plumb new depths, registering a sixteen year low last night at 28. The weakness in the index suggests that res construction as a percentage of GDP could/should dip below 4% from the curent 4.5%. Today's housing starts data will provide a clue as to whether this may be taking place.
And let's not forget our old friend called "structured credit." Unless Macro Man has been asleep at the wheel, he hasn't exactly noticed that the wave of long-overdue ratings downgrades has hit the wires recently. Somewhat ominously, the most toxic of the on-the-run ABX indices is now plumbing new lows (though admittedly the higher grade indices haven't moved.) Should this continue, or if the ratings agencies ever (gasp) downgrade already-underperforming CDOs, then perhaps the risk trade will finally come under pressure.
So there we go. Macro Man has found a defensive trade that he can buy into with gusto. He'll look to add to his short XHB exposure by spending $100k or so of option premium on puts. He'll look to buy 1200 August 31 puts this morning before the housing data; last night's closing price was $0.75.