Friday, August 24, 2007

The scarlet (or is it the green?) letter

Macro Man was surprised to read recently that “everyone” expects a W-shaped pattern for risk assets; e.g., the current bounce to fail and lead to a re-test of the lows, which should then be bought. While this is a pretty accurate description of his own forecast scenario, the amount of pushback he’s received left him with the belief that it was not a commonly-held view.

He is curious to find out more. So please, if you have a second, participate in the poll below, wherein a V implies that the current rally keeps right on truckin’, a W is the Macro Man scenario, and a lambda (Λ) implies that the current bounce fails and morphs into a new bear market for risky assets.


Anonymous said...

I've been trading a long time and have many friends on both sell and buy side. I am guessing almost 80% believe in the W scenario.
It makes me very uncomfortable as we run risk of either never getting it or we overshoot to downside

Robert said...

I am surprised by the fact that both retail and the pros are in agreement (based upon the poll) that the lambda result is the most likely.

Not what I would have expected.

Macro Man said...

What I find troubling is that the V-shaped option is far and away the least popular, which means that most people expect another dip.

I find it difficult to believe that today's much better than expected US data is necessarily good for risk assets in the short term. I mean, surely the bar for Fed easing just got raised?

Linda P. said...

Last year it seemed like everyone was looking for a retest of July's lows....and the market never looked back

Macro, don't you think people would prefer to vote as "finance pro" ? :) I mean, the media calls the retail investor the "dumb money" so often....

Anonymous said...

MM do you still think being short gamma into sep expiration is a good idea given this evidence?

Macro Man said...

Linda, I think it's useful to disaggregate the views of those people who spend all day perched in front of screens, and those who live in the real world. I don;t mean to pass judgement one way or another, and indeed I do think it is useful to observe where there is disagreement between the two.

Anonymous, I am much happier being short upside gamma than downside gamma, for sure. Given that my two biggest risk positions are long SPX through the beta portfolio and long FX vega through the alpha portfolio, a bit of short upside gamma in equities acts as a bit of a hedge against those other positions.

Charles Butler said...

V already seems to be failing for lack of interest. W? Well yeah, maybe. But most markets are already having bit of a time making much of a dent in the early-August pause. And the churn at the top of today's aborted knee jerk?

Bill said...

You didn't have a choice for "W" with the first leg already happening on Aug 3?

I'm more than slightly annoyed with the crowd demanding/expecting a retest of every bottom. I would think that "V-bottom" corrections occur more frequently than 7% of the time ...

"Cassandra" said... about the "w" with the second upleg failing to break out and subsequently evolving into the lambda breakdown? I guess that would just be an "inverted-w"

Macro Man said...

In fairness, Bill, all-in it's 15% of the people expecting a V. But that still seems low. The preponderance of respondents expecting a lambda, or perhaps Cassandra's upside-down W (also known as an M!) fits more with the sort of views I am hearing both in this space and in the office.

My own expectation for a re-test of the bottom is simply based on my experience- the V-shaped recovery tends to be the exception, not the rule.

Phrased another way, it seems unlikely that we can go from a period of very low volatility to a period of very high volatility, straight back to a period of extremely low volatility. Factors both macro and micro strongly suggest that realized volatility should be higher in the future than in the past.

To me, part of that suggests another lurch lower rather than cruising higher. Things like FX carry come to mind as a risk asset that, despite its bollocking in August, nevertheless remains expensive. Why shouldn't it at least try to go lower again before the DOTW resume power?

Bill said...

All due respect, but I think either the point has been missed, or that y'all implicitly define retests as making higher lows on lighter volume.

If one accepts that a retest could incur a lower price low or involve higher volume, then the correction from May 2006, the correction from Feb 2007, and the current one! all had a retest.

This one made a low on the 3rd and did its retest last week, with climactic volume and what I would call capitulation, with some notable exceptions, like Cassy, Beary, et. al.

Anonymous said...

Your poll doesn't give any indication of either the timeframe or the "why" of an expected move. My vote for a lambda is more of an intermediate term forecast. I'm a retail investor and I fully admit that I have no clue of what will happen in the next week or month or quarter. (which is why i read this blog!) However my view of US is that this was the second punch (the first was in Q1)in a series that will eventually take down the US consumer. That will force a depreciation of risky assets worldwide. I don't know what letter this makes me.


salvatorem said...

Wow, I'm in the minority with retail V. I hope this is a contrarian indicator!

Anonymous said...

There is every reason to be bearish on fundamentals right now, therefore I am bullish.

I favor a W scenario because:

1. It sets a bear trap.
2. Shakes out the remaining weak longs.
3. Allow me to add to a leveraged position on the long side ;p.

wcw said...

I can't really vote, since I'm neither fish nor fowl (not currently paid to trade, but a longtime CFA).

I did sell my ZN calls and started adding some single-stock futures last week, which sounds like a V play. However, I've had limit buy orders in for more longs that haven't been hit, which looks like a W play.

Honestly, though, I'm no good at predicting market paths ahead of time. I had no idea subprime was going to blow up and Treasuries were going to rally. I had those ZN calls because Treasuries seemed too cheap given how the economy and housing markets were doing. If they'd expired worthless, if nothing in the data had changed and if implied vols had remained as cheap, I'd have bought more.

Put me down for a W, I guess, but with very, very low conviction.

Anonymous said...

I'm guessing "w" with low around 1450-1460 -- (wishful thinking by a retail investor looking for a long entry)

normal being said...

I'm not sure, what you mean by risk assets.
Do I believe better times for many banking stocks are ahead and many credit spreads will tighten? Yes.

The banks, that are proven survivors can make quite some bull runs from here (at least if they're globally oriented). But first Fannie and Freddie have to go down.

Is this the time to by good credit (or sell CDS)? Well, this time should be pretty close at least. Another bout of bad news and here you are, I think.

But- there has been a massive capital outflow from the US (see BIS data), that's going to continue, I think. So credit contraction and consumer weakness has merely begun. And even exports from the US will suffer now, because Europe alone can't hold up demand for the whole world.

I don't see no recovery for the S&P. Not even close.