Wednesday, June 20, 2007

Swede Emotion

It's pretty rare for Sweden to be the focus of financial markets for more than a few minutes, but such has been the case today. The Riksbank announced its interest rate decision this morning and delivered the expected 0.25% increase. However, the accompanying statement was modestly hawkish, hinting at a future rate path slightly higher than that priced by markets. The SEK, erstwhile market whipping-boy and funding currency extraordinaire, promptly rallied a percent, erasing all of the EUR/SEK of the previous week.

Are you listening, SNB?
Meanwhile, a Finance Ministry Report concluded that Sweden's $25.1 billion in FX reserves were excessive and that "the need for currency interventions is limited for the foreseeable future." The report recommended that the Riksbank cut its exposure to foreign currencies over a period of a few years.

Are you listening, PBOC?

Elsewhere, the June BOE vote on rates was surprisingly close at 5-4. Swervin' Mervyn King was on the losing side of the ledger for the second time in his career. This makes a July hike more likely, obviously, and perhaps could sightly raise the terminal rate that's priced into the strip. Macro Man continues to believe that the higher rates go, the harder they (and the economy) will eventually fall, but concedes that that theme is on the backburner for the time being.

A few days ago Macro Man opined that bonds could catch a bid at the expense of stocks as pension funds rebalanced their portfolios into quarter end. He decided to perform a quick and dirty study to see if he could capture this in past performance data.

He took total return performance fitures for the S&P 500 and 7-10 year Treasuries for the past thirteen years and compared the retuns of equities and bonds. Arbitrarily selecting the last two weeks of a calendar quarter as a period most likely to see rebalancing flows, he compared the quarter-to-date outperformance of stocks versus bonds with 10 trading days remaining in the quarter with the relative performance in the last 10 days of the quarter.

The results were mixed. The average quarter-to-date equity outperformance of equities with 10 days left was 1.6%; the average outperformance over the last 10 days was -0.53%. In other words, on average, bonds have outperformed stocks over the last ten trading sessions of the quarter since 1994. This would appear to confirm Macro Man's prior hypothesis.
However, digging deeper suggests that there may not be much in it. Despite the figures cited above, the correlation of QTD equity outperformance with ten days left with outperformance over the final ten days is positive. A glance at the scatter chart above suggests that any evidence for a firm relationship is tenuous at best. Moreover, of the 53 quarters in the study, only 27 have the "right" sign if Macro Man's hypothesis is correct. In other words, equity out (under) performance through the first 2 1/2 months of the quarter is met with equity under (out) performance in the final ten trading days just about half the time. It doesn't get more inconclusive than that.

Perhaps there's data to be had at the extremes? After all, equities have outperformed bonds by 10.5% so far this quarter, the seventh best showing since 1994. Again, performance data from the other six is inconclusive. While equities did indeed underperform bonds during the final ten days of the quarter in four of our prior datapoints, the two in which they did not were doozies, as stocks bested bonds by at least 4% in the span of two weeks.

As a result, Macro Man is forced to admit that after a cursory inspection, he cannot reject the null hypothesis that the final ten days of a quarter will not reverse the pattern of the prior two and a half months. The usual disclaimer, of course, applies: this study was not exhaustive, was not meant to be exhaustive, and if anyone knows of a more rigorous study on the same subject, by all means pass it along!


Anonymous said...

Sort of fishing here, and not particularly strong in stats, but would you get something a little different, if you plotted performance of bonds and equities relative to each other by quarter and quarter sub-periods (instead of each relative to 0)?

As an overall average, the differential outperformance of equities in the first 13 weeks, or bonds in the last 2 weeks, each relative to the respective complementary period is:

1.6 % - (-.53 %)= 2.03 %

Meaning for example that the relative performance of bonds improved by 2.03 % in the last 2 weeks of each quarter, relative to the first 13 weeks (i.e. from underperformance to outperformance), on average.

What happens if you plot this function by quarter, or does it amount to the same thing? Somehow I suspect you get something different.

Macro Man said...

It pretty much amouts to the same thing. The average deviation from that 2.03% baseline is of course zero, since it is measuring the same thing. Bonds have outperformed that baseline 28 times and underperformed it 25 times, which again is indicative of "nothing there."

James said...

Hey Macro Man,

Saw this comment on RGE. "If SAFE et al start treating government bond markets like they do currencies, then expect to see a lot of unhappy bond managers out thre over the next few years...."
Could you please elaborate further?

Macro Man said...

Since CBs became hegemonic players in foreign exchange markets, beginning in 2004 and intesifying in 2005 and 2006, the performance of currency funds and traders has deteriorated markedly, to the point that mnay of the sundry performance indices are negative for the past three years.

Part of this is because they have helped reduce currency volatility to seemingly zero, part of it is because they have contributed in pushing currencies away from commonly perceived 'fair value', and part of it is because of their inscrutable and occasionally aggressive trading style has made it difficult to trade EUR/USD, for example, with anything but a very near term time focus.

While the first two are also factors involved in bonds, the latter has, to date, been largely absent. CBs arbitrarily deciding to shift the trading range in EUR/USD has been an apparent feature of currencies for three years. Recent price action and flow in the Treasury market suggests that they are now adapting that trading style to bonds. Trust me, it ain't fun to swim in the waters where those sharks reside...

James said...

Its not very comforting and I think it really raises long term questions about "free markets" and the allocation of resources. I was talking to my father about these issues at breakfast this morning. We're both members at the CBOT and as much as I'm happy about the interest in the exchange these issues make me worry about the future.

Anonymous said...

Here, Here James! Why hasnt any of the business press or commentators raised this question. Frankly it has astonished me. I can understand investors keeping mum if they precieve a constant bid coming from the SWF's (I have my own reservations about that perception). Last I checked, Governments buying private assets the world over is decidedly not free markets and global capitalism marching on.

James said...

Its not an issue until someone makes it an issue. Macro Man participants on this blog are probably way ahead of a lot of people. I dont know if the link will work, but this was an article I found from Dr. Faber's site about CB's as portfolio managers and HF's. Its a good read. If not its on his site under additional contributions. in these matters.

"Cassandra" said...

MM - All this talk of SWFs as asset managers misses the big-picture point (though Rozanov at Setser's asked the right question "where will it lead"), which in my mind is inflation. That the liquidity continues to grow, stopping in the CB/SWF coffers before the on-journey to asset purchases only diminishes or partially throttles its velocity, but whatever asset purchases they journey towards ultimately has trickle-down and cascade effects in the real economy - the direction which is rather obviously inflationary (for a taste just look at simplest case of US Bond market distortion and subsequent house-price bubble and USA household and govt consumptive binge courtesy of BoJ/PBoC).

Macro Man said...

I have put some of the points mentioned above- that FX reserve managers are free riding the global financial system while maintaining closed domestic markets, which takes the levers of monetary policy out of central banks like the Fed, which is ultimately inflationary (if one doesn't look at ultra narrow inflation measures- to policymakers on both sides of the Atlantic.

I find that the closer these individuals are to "the ground", the more of he above thesis they buy into. Ultimately, however, their seems to be a belief that China will not do anything that will ultimately disrupt its economic well-being, including destroying or causing major ruptures in the markets in which it currently trades/invests. So there's a ways to go yet before push comes to shove, sadly.

Anonymous said...


It is equally difficult to understand the similar wholesale abandonment of the trade union movement in the U.S. after 1980 for a 'better' utopia. The decision not to make mention of it all looks completely coherent, even if a loser, to me.


Anonymous said...

Well, CB, I agree with you. I have zero expectation for wholesale coverage, but nary a peep from the BIS, FT and their brethren?

Macro Man said...

Funnily enough, I've just noticed that the IMF has announced that it is updating its currency surveillance program to include the proviso that " a member should avoid exchange rate policies that result in external instability ".

All well and good of course, but if China doesn't wish to play ball, like they (and the US, among others) don't play ball with global environmental agreements, what's the IMF gonna do?

Anonymous said...

re-word and re-phrase the same prviso and issue anew in a year and.........cry.