Thursday, August 16, 2007

Top 6 things spotted on the beaches of Europe this summer

Macro Man's holiday is drawing to a close, and with it his absence from the market tumult of the past couple of weeks. While there's clearly been some "signal" in the spate of recent developments and the concomitant market volatility, there's undoubtedly been some noise as well. Contrary to what one might suspect, it has actually been a fine time to be away, as Macro Man has been able to consider market developments from the comfort of a sun lounger, which naturally lends itself to a more thoughtful and deliberate approach. It has hopefully benefited his real world investment performance, if not the blog portfolio.

All that having been said, not having one's face buried in front of a Bloomberg terminal all day permits one to draw investment conclusions from, ahem, untraditional sources. Herewith, then, are six sources of investment wisdom gleaned from the beaches of Europe this summer:

1) Augustus Gloop. The porky German glutton from Charlie and the Chocolate Factory
is represented on European beaches with distressing frequency, thereby illustrating that American children do not possess a monopoly on obesity. Similarly, the past few weeks have demonstrated that American institutions have not been the sole (or indeed primary) consumers of subprime financial junk food, as the recent travails of a number of European banks, many of them German, have indicated. The primary difference is that while Augustus was sucked up a tube, these banks' share prices are going down the tubes.

2) Waves. The Mediterranean is normally the most placid of seas, with many of its bays, coves, and inlets only registering the slightest of waves. Similarly, the subprime credit crunch was popularly believed to be Made in USA for domestic consumption only. However, holders of UK, Spanish, French, and even selected German shares have recently found that waves created on the western shores of the Atlantic (south Florida, if you will) can reach even the most secluded Mediterranean cove- Wave C in particular is rocking a number of portfolios (as well as a few boats.)

3) Sunburn. Morrissey wasn't noted for his savage tan, so it's perhaps not surprising that the Dipbuyers of the World aren't used to the sun's rays. Just as prolonged exposure to sunlight can cause sunburn for the unprepared, so too can prolonged buying of risk asset dips result in a scorching of one's P/L. The hole in the financial ozone layer makes purchasing assets flying too close to the sun a very dangerous proposition indeed, and it may take more than generous lashings of aloe vera to soothe the burning sensation in many portfolios. The latest intelligence suggests that even the Japanese housewives, clad in their broad-brimmed hats and bearing parasols, have decided to venture indoors and buy back some of their yen shorts. Like sunburn, the DOTW's pain will eventually fade, but only with the passage of time.


(Note: The fellow in the picture is NOT Macro Man.)

4) Icthyosaurs. OK, these marine dinosaurs haven't really been seen on beaches in Europe, or anywhere else, for that matter. They're still extinct. But imagine the furore that would ensue if these fearsome creatures were found, like the coelacanth, to have defied the odds and survived what had been thought to be certain extinction. It would presumably be similar to the commotion that has attended the Lazarus-like resurrection of two other creatures commonly thought to have died out, the 10% equity market correction and generalized financial market volatility.

5) Retired supermodels. OK, Macro Man didn't literally see a retired supermodel. But European beaches do tend to feature lissome women in their 30's and 40's that could certainly pass for retired supermodels. Speaking of retired models, it seems clear that a number of erstwhile "super" models in the credit, equity, and multi-asset space will soon be retired, either by choice or via natural selection.

The implosion of equity quant strategies has been covered admirably and amusingly by fellow-blogger Cassandra, and Macro Man has little to add to what Cassandra has already said. Suffice to say, however, that when a supermodel starts going pear-shaped, she swiftly loses her portfolio of business and is forced into retirement (a few, of course, leave the business on their own terms.) Now that the quant "super" models have also gone pear-shaped, it will be very interesting indeed to see who is left standing and, perhaps more importantly, what the end investor appetite will be for models whose blemishes have now been revealed for the world to see.


6) Sunsets. There's nothing quite like seeing the sun disappear over an ocean horizon, leaving a kaleidoscope of colours amongst the sky, the clouds, the water, and the sand. It conjures enormous feelings of well-being and is an immensely satisfying way to close a day of productive relaxation. A somewhat less satisfying feeling, of course, will be the sun going down on a number of funds and/or portfolio managers. Whether it's an equity quant or a chronic dipbuyer or a subprime credit long, there are plenty of folks for whom the sun is about to set, never to rise again. Many of these managers have been extremely well paid in recent years, so they'll be able to afford an extended holiday where they can take in the sort of sunsets that Macro Man has enjoyed the last couple of weeks.

Conspicuous in its absence: Harry Potter and the Deathly Hallows. While Macro Man saw a few English readers of the final volume in the Potter series (including, it must be admitted, himself) by the pool, he has seen nary a copy on the beach during his entire two-week holiday. The reason may well be perfectly rational, such as there hasn't been time to translate the book into foreign languages yet.

But the parallel with the Voldemort that inhabits Macro Man's world is striking. As best as he can make out, central bank activity in G10 currency and bond markets has been conspicuous by its absence recently. And it seems unlikely that PBOC, CBR, Bacen, and the like have been adding a whole lot to reserves recently, given that all of their currencies have sold off against the dollar. (Why they don't sell a few bucks to 'smooth market conditions' and take a little profit is another question.) Anyhow, crisis-like conditions have meant that, at least temporarily, currency markets have been truly free-floating, and Macro Man has not been terribly surprised to see the USD rally against Europe, the dollar, bloc, and EM as a result.

7 comments:

Ape Man said...

Thoughts from your holidays are all well and good, but what inquiring minds really want to know is if the carry trade is really over. Since you were not on the job, Emmanuel had to go look at the charts himself. But we are all still interested in your thoughts.

Quarrel said...

Ah MM - have missed your wit. Hope you've enjoyed the holiday.

You were (at least for me) very prescient in your picking of the big Wave C ahead when you left. Let us know when it's over :)

You made the point of noting the first sunburnt guy wasn't you - but were surprisingly quiet on who might be accompanying the retired supermodel...


--Q

CDN Trader said...

Macro Man;

Recently read your post on the equity market "beta" study. Was intrigued by the differences in results pre- and post-1980. Do you think it is possible that the current economic environment is more similar to the 1970s than to the 1980s or 1990s? If you are interested in an in-depth study on the topic, I recommend John Hussman's recent comment, which can be found here: http://hussmanfunds.com/wmc/wmc070820.htm

"Cassandra" said...

MM - While we've been singing in harmony since you changed your tune on the Yen, and while I share your view that charts can be revealing, I have a nagging suspicion that US PCE is really errr, cooked. With no further refi gains to draw upon, and the ripples of housing start doldrums being felt earnestly in earnings, and employment, and ARM resets that will continue to to take their toll, not to mention the feeling of impoverishment (and negative equity) that many other existing homeowners will feel as housing collateral continues to be liquidated , bitch-slapping prices in surrounding neighborhoods for all to see, and bemoan. This will likely lead to a HIGHER savings rate, even though for many there is already precious little to save, something that has always a point of contention between Financials Calvinists (like yours truly) and the Laffers & Mankiws of the world extolling the virtues of fiscal laxity coupled with negative real rates.

This wealth effect will be particularly dramatic since as conservative AEI economists and apologists for America's persistently low (yes even negative) savings rate always pointed to real estate as the prescient hyper-constructive (no pun intended) alternative means-of-savings that never failed to turn (what to some was) a blood-curdling time series into a Panglossian Valhalla.

Alas, Roubini's right, a USA recession is nigh, and the resulting angst has political-economic turmoil written all over it, from protectionism and anti-china fears, escalating anti-immigrant-ism, to an emerging soak-the-rich (or at least tax them appropriately) policy platform that will yield no counter-cyclical benefit to say the least.

(oh, and while the outside reversal that underpins a weak wave "c" POV, note that all the Demark, mt & lt DMIs all appear to suggest this is but a bear bounce.

On this one, I'll gladly wait til credit spreads begin to converge, commerical real estate breaks its downtrend, and other liquidity correlated sub-classes begin to say this was a mere epileptic fit, and not a chronic condition.

Macro Man said...

I am not quite so quick to assume that the consumer's goose is cooked; the two worst macro bets during my career infinancial markets have been betting on the BOJ to tighten policy and betting against the US consumer.

I agree that wealth looks set to be a drag on spending, but it is important to remember that disposable income is about six times more significant an explanatory variable on spending growth than wealth is.

I suspect we are set for a period of tepid, below-trend spending growth, possibly for a couple of years. But that is, after all, what financial and global imbalance Calvinists have been calling for, and is not necessarily a bad thing.

But as I said in the post, I think liquidity remains, like Reggie Jackson in the Bronx 30 years ago, the "straw that stirs the drink." And my assessment is that those consitions are, on a macro perspective, still favourable, even if a) not as favourable as over the past few years, and b) micro-liquidity in various markets is causing distress.

Macro Man said...

CDN trader, I think the failure of the model to perform in the 70's is down to the impact of high, persistent, double digit inflation during that decade.

Ex post, interest rates didn't go as high as they needed to be until Volcker dropped the hammer, and as such bonsd traded rich throughout the decade. While sound similar to today's environment, the magnitude of overvaluation was much higher 30 years ago.

I suspect if the terms of the study were altered to evaluate RELATIVE performance of equities (versus bonds) rather than ABSOLUTE performance, the results would be more consistent.

"Cassandra" said...

The US consumer has indeed been the White Whale to many macro-men (note lower "m's").

Be that as it may, in the case of PCE, each spin of the wheel is rather than independant, likely to be path-dependent (the greater the past glory & extraction, the larger the future encumbrence). And while the US consumer may yet make a great save like Brooks Robinson in the 70 World Series, or pull a ummm (rabbit?)from a hat, I am NOT heroically betting FOR it until I see more indications that the Feast of The Miraculous Consumption continues (and continues to be financed). Call me a sheep.