Friday, June 01, 2007

May post-mortem and a busy start to June

Contrary to all expectations, May looked an awful lot like April. Buy and hold strategies in risk assets delivered handsome returns, while attempts at market-timing proved generally fruitless. Alpha may come before beta in the Greek alphabet, but not in the hearts and minds of investors in the current climate.

All told, however, Macro Man had small ground for complaint. May was the best month in the history of the blog portfolio, and a couple of notable alpha shockers were offset by some successful punts elsewhere (who else can boast of making money being short BRL?), and of course the stellar returns from the beta positions. All in, the portfolio returned 2.55% in May, taking the year-to-date return on the notional $100 million capital base to 5.9%.

Regular readers will be unsurprised to see that the beta portfolio returned a handsome 3.2% last month. Macro Man did not execute a single beta trade in May, as the portfolio remained long equities and FX carry during the entire month. The equity beta return was excellent, though not quite as high as in April, generating a profit of 2.1% las month. Despite all the headlines that FX carry receives, last month was really the first of the year in which it excelled, producing a profit of 1.1%- more than the prior four months put together.

The alpha return was hampered by the WTI-Brent spread albatross, which cost Macro Man a cool $1 million last month. However, Macro Man takes some solace in the fact that he recognized that things were going horribly wrong, even if he dithered a bit with the exodus. That Dec WTI now trades at a discount of greater than $2 to Dec Brent confirms that he was correct to press the 'eject' button. That trade, combined with a small loss on the Goldcorp position, combined to cost Macro Man just over a percent of P/L.

Equity alpha also contributed negatively, though not a much as you might think. Macro Man's short 1490 calls hedged away more than half of his equity beta return. However, he compensated through the purchase of DAX calls and especially Brazilian equities (the long leg of the Brazil asset allocation trade.) The homebuilder/SPY relative value trade more or less broke even on the month. All in, equity alpha cost Macro Man 0.23% of performance- it could have been a lot worse.

Fixed income alpha more than compensated for the equity alpha losses- and this with steep losses on US bonds. The positions at the front end of Europe combined to generate a modest P/L, but the real stars were short Asian fixed income: the JBM7 short and 1 year SGD payer positions combined to add nearly 80 bps of alpha. All in, fixed income trades generated 0.33% of return.

Finally, FX alpha also contributed positively. While the long EUR/USD position from April was rather costly, Macro Man more than compensated by taking nearly a percent of alpha out of short EUR/TRY. Meanwhile, the long USD/BRL call position lost money but the strip of 10 year one touches made a bit. All in, FX alpha contributed 0.24%, while the alpha portfolio as a whole dropped 0.66%. Were it not for the horrible crude trade, alpha would actually have made money.

Now that May is in the bag, we can turn our attention to June. We can dispense immediately with rumours of Chinese capital gains tax hikes, since markets appear to be firmly in dip-buying mode. Today sees a veritable deluge of data out of the US, with the much-dreaded employment report, PCE, ISM, and Michigan consumer confidence data released.

It's not difficult to construct a scenario where the data provides mixed signals and anyone who trades today ends up regrettign the decision. Perhaps today will finally be the day when construction employment takes a more meaningful hit. Looking at a long term (27 year) chart of constrution employmnet, the current cycle is conpicuous in its lack of labou shedding- and this despite record-negative contributions to economic growth from residential construction.

ISM risks, meanwhile, must surely be skewed to the upside after yesterday's GDP and Chicago PMI data. Earlier in the year, Macro Man sketched out a scenario where Q1 would see a deep inventory unwind that would represent a trough in activity for the year. That scenario appears to be playing out, as yesterday's GDP suggests upside risks for inventory building in th current and coming quarters. The exuberance of Midwest manufacturers is particularly notable in that regard.

Whether strong data will lead to a further selloff in Treasuries is another question. 10 year yields are rapidly approaching extremely formidable resistance courtesy of a 20 year trend line between 4.90 and 5.00. Macro Man will therefore stick to his bond longs, but a break above 5.00% will force him to reconsider (and, incidentally, perhaps finally put a damper on risk assets, if only temporarily.)


Caravaggio said...

Good going. Your blog is a joy to read. Keep up the solid work Macro Man (your name sounds like a superhero.. I guess your special power would be the ability to generate large quantities of alpha!).

Macro Man said...

Thanks for your kind words. Sadly, no sign of any super alpha-generating powers at the moment....

Agustin said...

Macro Man. Kudos for the blog & the results! I still think that your views on interest rates and risky assets are too simplistic. Let me put it this way: interest rates can increase for "bad" reasones (inflation expectations, budget deficits) and for "good" reasons (capex boom, innovation). How do we know? By looking at spreads. Despite the rise in Treasury yields, spreads are generally ... declining! Take CDS spreads, Treasuries vs. Moody's, or plain Treasuries vs. inflation-indexed Treasuries: the story is the same -- and it is a bullish one. Regards, Agustin (

"Cassandra" said...

Agustin, If I might take the liberty of paraphrasing you, you seem to be suggesting that increasing interest rates are not presently "bad" because liquidity decision-makers (of all variety) are choosing to purchase financial assets (thereby diminishing risk spreads) creating a bullish virtuous (!?!?) errrr circle , rather than say spending them on "things" such as a new water treatment plant, bacccarat crystal, a nautilus machine, public transport, a new Saturn IconoclastMobile or a fleet of new 787 Dreamliners, where expenditure on the latter would presumably cause a rather dramatic vault in price indices, wages and wage-demand-expectations, interest-rates and interest rate expectations, causing a rather unvirtuous rise in real interest rates and associated destruction in liquidity. Is that about right ?

Agustin said...

Cassandra. Suppose that participants in the credit market get new --and very positive-- information about the state of the (global) econommy. It is not unreasonable to think that pricing power at corportations would improve. How would spreads react? Well, they would most likely go down: sell Treasuries, buy corporates. Perfectly logical to me -- and not necessarily bearish in terms of risky assets such as stocks. This is one way to look at the current situation.

Go stoicists go! (I used to read Seneca myself). Regards, Agustin.

Macro Man said...

Agustin, I'd concur that not all rises in market interest rates are created equal, and that a growth-driven rise is more benign than an inflation driven rise.

That having been said, a sufficiently large rise in government yields, even if not accompanied by a deterioration in credit, can still exert a downward influence on equities- if for no other reason than asset allocaton rebalancing (i.e., maintaining benchmark weights in equities and fixed income.)

If recent trends continue, I'd expect a fairly healthy asset allocation flow at quarter end, selling equities and buying bonds in the US and Europe- perhaps there will be a trade there in a few weeks.