Story time

It's one of those days again, with markets jumpy and spreading more stories than the Brothers Grimm and Hans Christian Andersen combined. Whether market gossip proves to be accurate or merely the latest financial fairy tale remains to be seen in the fullness of time. In any case, among the talking points this morning include the following:

1) Dude, where's my deed? Another downside of structured credit rears its ugly head as an Ohio court denies Deutsche Bank the right to repossess 14 homes because they cannot prove that they own the mortgages to the specific properties in question. So much for subprime borrowers getting chucked out of their homes!

2) Fannie Mae slides 10%. LIBOR spreads continue to widen (the 3m TED is up 60 bps this month) as the credit crunch, Mk. II continues to escalate

3) IKB has even bigger losses, perhaps requiring even more refinancing? That's the word on the strasse.

4) A Chinese daytime talk show says "Sell, Mortimer, sell!" when it comes to household dollar holdings. One would presume that the dollar really is in trouble when the Chinese Oprah Winfrey starts dispensing currency trading advice.

5) Is a bank other than Northern Rock getting emergency liqudity from the Bank of England? So speculates The Times today.

6) The GCC de-pegging story gets even more press. Friday is the weekend in the Middle East, so bids for dollars are few and far between. Markets are now pricing in a 2% reval in the AED over the next six months.

And of course, today sees the release of September's TIC data as well as equity option expiration. The TIC data could be quite telling, coming as it does after August's epically bad figure. That number helped stoke an accelerated bout of dollar selling, which in turn has got us where we are today. Moreover, the G20 meets this weekend in Cape Town, where it seems likely that China is going to be on the receiving end of a concerted call to quit screwing around with the RMB.

And while CBs continue to sell dollars for euros in the open market, the trend has, for the moment at least, run out of steam. Macro Man suggested earlier in the week that he is getting close to profit-taking mode, and a glance at the gold chart is pushing him even closer to taking something off the table, as it's coming awfully close to crashing through the uptrend line off the August lows. Macro Man will probably look to lighten up his long euro position close to 1.47.

The equity option expiry also leaves him with a conundrum. Having previously expressed a broadly constructive view on risk assets and equities, does he now maintain a "naked" long exposure via the beta portfolio? Such a course of action appears risky given current credit market ruptures, at least until the Fed shows signs of capitulation (at which point the dollar probably gets smoked again, per yesterday's post.)

What to do? On the one hand, recent price action looks to be just enough to confirm that the sell-off from the highs is corrective, rather than the start of a new trend. Wednesday's price action briefly exceeded the October low, which by definition means that the bounce was not Wave 4 of a new 5-wave bear move. Rather, it appears that current weakness is the same sort of A-B-C pattern that Macro Man has written of before.
So a technical framework provides some comfort, and suggests that Macro Man should now be shifting towards a more bullish positioning in equities. On the other hand, the fundamental backdrop is deteriorating: gas prices are rising, housing remains a mess, and money-market conditions are queasy, to say the least. Moreover, for the time being at least, the Fed has withdrawn the near-term prospect for another go at the milk-teat of liqudity (via a lower Fed Funds rate) that the market craves.
Another factor which has been around for awhile but warrants the occasional re-visit is the apparent collapse in corporate profit margins. There is clearly something a touch odd going on: while corporates had, until recently, posted an unprecedented run of strong earnings growth, the macro data has suggested corporate recession for much of the past three years. To wit, looking at the CPI minus the PPI gives us a broad-brush picture of what's going on with margins. Observe how the collapse into negative territory accompanied the last three recessions, circled in the chart below.
However, since 2004 this margin proxy has spent most of its time in deeply negative terrritory, and has made a new low in the October data. What's going on here? Are producer costs overstated? Consumer costs understated? Or does this measure miss out on the whole offshoring phenomenon, and indeed explain the outsourcing of production wherever possible (due to negative domestic production margins.)
Macro Man doesn't know the answer, but it's clearly a cause for concern. He has yet to make his mind up about whether to re-layer equity index hedges; perhaps today's price action will spur some ideas. What is clear, however, is that November has not been a month for beta models: both the equity and FX carry model, which stopped out of its carry positions again this morning, have been butchered.

He will probably decide to layer some type of hedge, if only a partial one. An environment of elevated financial market volatility and poorly performing quant models is not a time to have large nominal risk; this may not be August, but it ain't the second half of September, either.




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Anonymous
admin
November 16, 2007 at 10:24 AM ×

Have you seen the cover of the latest Economist? Any thoughts on fading that :)?

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Macro Man
admin
November 16, 2007 at 10:48 AM ×

It is tempting, I must say.

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"Cassandra"
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November 16, 2007 at 12:20 PM ×

MM - you forgot to mention the increasing labour strife (be it France, Chile, US or Hollywood). When looking at equities, on must wonder: Is this as good as it gets?

One other question (being in NY & watching the visitors pull everything in sight off the shelves particularly things AAPL) why haven't European retail prices been falling MORE given the strength vs. USD and things there tethered? This of course relates to the first question, because IF its padding MNC margins, this will ultiamtely be arbitraged away...

Really nice post yesterday. I've been losing a lot of sleep over it - literally - and would love to talk it over with somone, but there is no such thing as "Financial Shrink". Given this, I'd be grateful if as a special favour to me, you'd make a little time travel sojourn to 2010, and have a look at the world, relative and abolute asset prices (and a leek at the 2009 NCAA tourney results) and report back . This will help me work out what disintegration of BWII actually means to prices, and life as we know it.

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Macro Man
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November 16, 2007 at 1:24 PM ×

To be honest, I'm not that bothered by the labour market strife. I feel quite safe in thinking that Hollywood writers do not inhabit the "real world" (well, unless their houses have burned down), while striking Frenchmen isn't exactly a new development for the world economy. When I was working in France early in my career, I recall a French acquaintance telling me the he wanted to travel to Australia, but could only afford to go if he wasn't working...

As for the homework assignment, I'll give it some thought!

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Anonymous
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November 16, 2007 at 1:42 PM ×

MM, what a surprise, you finnaly starting to throwing the bull towel, perharps taking a look at the overwhealming evidence will do the trick instead of just trying to a rebel and go against investment gurus.

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Sally
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November 16, 2007 at 3:46 PM ×

Seconding Cassandra's request!

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OldVet
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November 16, 2007 at 5:24 PM ×

Great discussion yesterday, inspired my opinion of this morning: http://angrybear.blogspot.com/

I would have thought PPI would have already included offshore labor costs. Stops took me out of GLD (thanks) but I'm back in, and ill gotten gains plowed into Puts on S&P and short on Xinhua. But I'm still thinking about BWII and what to do about it, as a small investor.

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cmacculloch
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November 16, 2007 at 9:31 PM × This comment has been removed by the author.
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cmacculloch
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November 16, 2007 at 9:33 PM ×

I think the Fed has been backed into a corner via their recent rate cuts, and they know that they can only cut maybe one more time before the gauntlet is thrown down on the dollar vis a vis the Chinesse and other Middle Eastern country reserves.

They have one more get out of jail free card, and they had better use it wisely!

Of course I don't necessarily think that a weak dollar is such a bad thing for the U.S. now, as it will continue to help shrink the trade deficit and will perhaps discourage overconsumption and overlevarging, but I doubt it will be a vote getter next year.

We'll see what comes out of South Africa this weekend.

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Anonymous
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November 19, 2007 at 1:08 AM ×

1. The BoE have said it would have liked to loan to NR without disclosing this fact.
2. The BoE now effectively owns a sizable amount of NR.

Is it crazy to think the BoE could use NR as a conduit for anonymous loans? Could this explain the discrepancy in loan amounts?

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Macro Man
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November 19, 2007 at 9:27 AM ×

My understanding is that the discrepancy is BOE lending to non-NRK institutions. If that's the case, I am not sure how using NRK as a slush-fund/conduit type vehicle would explain this.

Equally murky is the exit strategy for the authorities from their NRK entanglement. Does Gordon go "old skool" and just nationalize them?

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