Monday, December 03, 2007

Happy New Year!

Macro Man would like to wish all readers a happy and prosperous New Year. What's that, you say? It's only the beginning of December? The Christmas tree isn't even up, and it was only this weekend that the holiday music made an appearance on the radio?

Never fear. Macro Man has not lost his mind. He is all too aware that it is not a new calendar year, given that he has not done the least bit of Christmas shopping yet. But for some major players in financial markets, 2008 starts today. A number of major investment banks and some hedge funds end their fiscal year in November, so the beginning of December represents a new slate. Subprime is last year's story, and with year-to-date P/L's reverting to zero, it's now time to layer fresh risk for 2008.

So goes the theory, at least. It is indisputable that for firms like Goldman, Lehman, and Morgan Stanley, 2008 starts today. Whether that will represent an incentive to swing it around remains to be seen, of course. Friday's payroll data and next week's FOMC announcement represent significant event risks, and it would be a brave speculator indeed who bets the ranch today and risks starting the new year in the hole.

Macro Man's inquiries on the matter suggest that while there may be some increased risk-taking, the magnitude will be smaller than normal given the current environment and the event risks noted above.

Even if we did know that more risk was going to be deployed, it's tough to say what the implication may be. Last month was challenging for many market particpants, and it's hard to know exactly what the "risk trade" is at the moment. For most of the year, for example, there was a strong positive correlation between macro returns (at least as proxied by the HFR index) and the S&P 500. That correlation seems to have broken down recently, however, which may explain the "VIX divergence" that Macro Man observed a couple of weeks ago.
November, meanwhile, was clearly a month when alpha triumphed over beta. The financial press was replete with horror stories of quant fund underperformance, and Macro Man's own quant strategies had an absolute shocker. Any environment where 1 month dollar LIBOR can jump 0.40% in day (as it did on Thursday) is unlikely to be a successful one for strategies predicated on normal market conditions, and so it proved for Macro Man and the market at large.

The beta plus portfolio shed 5.9% last month, more than half of its year-to-date gains through the end of October. The equity portfolio clawed back gains late in the month to lose "just" 2.56%, while the FX carry positions chopped in and out before giving up the ghost for good
in the middle of the month. Still, the 3.34% hit could have been worse, at least judging by the performance of some of the carry-driven FX funds out there, most of whom bled performance throughout November.
While Macro Man's alpha strategies performed very strongly indeed, for much of the month they only managed to staunch the bleeding from the beta portfolio. It was only gaining long equity deltas via the expiry of option hedges, and the month-end rally in the SPX, that propelled the overall portfolio smartly into the black.
All in, alpha strategies generated a return of 7.5% last month, far and away the best of the year for that portfolio. Unsurprisingly, all components of the alpha portfolio generated strong positive returns, as broadly correct market views (long gold, long duration, short equity, short dollars) were accompnaied by some fortuitous market timing.
That the absolute value of all the return numbers was so large testifies to the accuracy of one of Macro Man's most strongly-held views, i.e. the return of financial market volatility. With event risk galore in the next 8 days, it seems unlikely that we'll get a cessation of P/L gyrations any time soon.
The alpha + beta portfolio strategy has served Macro Man very well this year, both in the blog portfolio and, more importantly, in his real job. At this point the near-term direction of markets may well depend on things impossible to game (payrolls, the Fed), so running a lower overall risk profile appears warranted, new year or no year. Good luck.


Anonymous said...

any thoughts on shorting UK homebuilders macro?they came down quite a bit this year(thats why I will put a not big stop) but it seems that the UK housing problem is only begining and while credit might not have been so easly expanded there they did their fair share of arms and the like.

Anonymous said...

btw, im thinking of using the BOE as a guide and short on the week they cut rates with all the frenzy of the 'they came to rescue us'

Macro Man said...

To be honest I don't really know much about the individual homebuilding names in the UK, so am not qualified to suggest a strategy one way or another.

What I do know, however, is that the UK does NOT have the supply problems of the US- quite the contrary, as lack of supply is one of the major reasons why UK housing is so unaffordable.

So while UK homies might have some downside in the event of a further cylcical downturn, I don't think you'll see anything like the returns that were had from the short side of the US equivalent.

Anonymous said...

hmm, interesting, do you know where I can get figures on their supplies and investories?If thats the case the can then you must be right, I probably missed the party in terms of r/r

Peter said...

*S&P back to prev. support, now likely to turn into resistance..

*carry trade / yen strength ditto..

it just all seems too easy..

Anonymous said...

I remember reading you thought that the stimations of mortgage equity withdraw effects on the economy were overstimated. Can you tell why?It seems to have that the data is credible since it comes from alan greenspan himself

Macro Man said...

Peter, I dunno....which is why it seems prudent to trim risk, in my opinion.

Anonymous, my research into this subject suggests that incomes, rather than wealth via housing, remains the primary driver of consumption. Moreover, during much of the 'housing equity withdrawal' period, net household equity in their homes was continuing to rise. It IS now falling, though to date overall net wealth is not.

FWIW, I have spoken with another former Fed governor who now runs a macroeconomic advisory service...and who has a view similar to mine, e.g. that Greenspan's analysis is wrong and that MEW was not a lynchpin of spending.

That doesn't mean I am right, of course...but it at least suggests that the matter is up for debate. In any case, it does seem amusing how many people decry Greenspan's mponetary policy track record on the one hand, then take his MEW views as gospel. Not accusing you of that, mind, but it is somewhat odd.

OldVet said...

Added more PUTs on SPY this morning. Bleeding of bear portfolio staunched for now, but rearranging to reduce risk in medium term. Hard to believe blah-blah out of WashDC. Plans to solve crisis? How about the plans that got us into this? Dec may be lost, back to writing aphorisms for me.

Anonymous said...


Macro man...I'm a relatively recent convert to your blog, but its one I check faithfully, both for content, and style. I appreciate your insight in this comment section regarding the UK homebuilding market. Am holding a smallish stake in LYG, and had been holding off adding...thinking that the UK was in the early stages of what's going on in the US...perhaps I need to rethink things....

Keep up the good work.


Macro Man said...

Jan, thanks for your comments. As I noted yesterday, I am utterly qualified to comment on the specifics of individual companies, and it could well be that some merit shorting on the basis of microeconomic issues.

From a macroeconoic perspective, the UK faces a housing shortage, rather than the surfeit of supply in the US. Stricit planning regulations and finite space in the South East have meant that supply is unable to keep up with demand, hence the consistent rise in prices over the past fifteen years.

To put it in context: the UK has 1/5 of the population of the US, but has not exceed 300,000 housing starts since (I believe) 1979. The US exceeded that building rate (e.g., 1.5 mio homes) every year but one from 1993 through 2006.

Anonymous said...

> To put it in context: the UK has 1/5
> of the population of the US, but has
> not exceed 300,000 housing starts
> since (I believe) 1979. The US
> exceeded that building rate (e.g.,
> 1.5 mio homes) every year but one
> from 1993 through 2006.

I can't say you are wrong about the relative supply of housing in the US versus the UK, but the US has a much faster growing population than the UK, so simply comparing the level of construction versus the level of population in the two countries doesn't seem like the best analysis to me.


Macro Man said...

By the same token, the housing stock in the UK is much older than in the US, and one might presume it would, all things being equal, require greater replacement at a greater rate.

All things are not equal, however, as the UK has very strict zoning, particularly in the South East, which is the root of the problem. Googling 'UK housing shortage' generates 3 times as many responses as 'US housing shortage', by way of a very simple comparison.

Anonymous said...

Well, I really can't claim enough expertise in residential real estate to estimate demand (either replacement or new construction), but I still don't like the comparason simply based on population.

Certainly the US has a short term surplus, as one-third of the homes purchased at the end of the boom fall into either the second home or "investment" categories.

I also agree (although you didn't say this directly) that land use policies represent the single biggest factor affecting home prices.

The US does generally avoid supply problems - except in areas where the left controls things.