Friday, August 31, 2007

An Open Letter to George W. Bush, Ben Bernanke, Christopher Dodd, Pope Benedict XVI, Kang, and Kodos

Dear Mr. President, Mr. Chairman, Mr. Senator, Your Eminence, and future rulers of the Earth:

Greetings! I hope this letter finds you well.

Gentlemen, I was very pleased indeed to read this morning that the US government will announce plans today to deliver us (and by "us", I refer to the entire universe) from the evils caused by subprime mortgage borrowing (which is, after all, the center of the universe these days) and the concomitant loss of money.

After all, the broadest, most accurate measure of house prices in the United States, the OFHEO price index, registered a mere 0.1% gain in the second quarter of the year. As this is below the 0.8% quarterly gain guaranteed by the Constitution, it is pleasing to see such a rapid response from key policymakers. Mr. Chairman, I look forward to your Jackson Hole speech today, and am especially pleased that you have decided to deliver it while taking a helicopter ride over the mountains.

Your courageous rescue of a national treasure like Bill Gross will not be forgotten, and I humbly submit that you will go down in history as a true American hero.

But life does not begin and end with flippers of condos, liars of income, or indeed holders of mortgage-backed securities. No, I now wish to draw your attention to another disenfranchised class, a sector of the population that has lost tens of billions of dollars around the globe for many, many years. This is a group that almost always loses money despite being promised the chance of untold riches.

I refer, of course, to the purchasers and holders of lottery tickets.

Now, I feel as if I am in a privileged position to draw this crisis to your attention. I suspect that I am the most successful lottery player in recorded history; every day, I receive e-mail notification that I've won at least a dozen lotteries that I never even entered! So believe me, no one is a bigger believer in the "lottery ticket model" than your humble correspondent.

But I beg you: think of the millions and millions of people who have a dream and purchase a ticket, only to see their hopes shattered by the unlucky bounce of a ping-pong ball or two. How many children have gone hungry because the Powerball was 19 rather than 6? How many Ferraris have been left to rust, unpurchased on dealer lots, because the numbers came up with the wrong offspring's birthday? And worst of all, how many $10 payouts have been left unclaimed because of the cruel, cruel hand of fate, which forced a hapless winner to leave his ticket in his trouser pocket before it went into the wash?

It is a fact, and I invite anyone in the known universe to dispute this, that purchasers of lottery tickets lose money on a consistent and systemic basis. As you well know, this is in violation of the second Kellogg-Briand Pact, signed under the auspices of the United Nations last year, which has outlawed the loss of money in financial transactions.

Gentlemen, it seems clear that you are doing your duty with respect to mortgages, but I beg you: Do not forget the disenfranchised holders of losing lottery tickets!

A grateful nation, world, and universe awaits your response.

Your pal,

Macro Man

Thursday, August 30, 2007

Yen carry: The aftermath

Now that markets have to some degree calmed down (though the continued squeeze higher in interbank cash rates suggests that the current churn may simply be the eye of the storm), Macro Man thought it might be useful to revisit one of his favourite subjects, the yen carry trade.

Back in February, Macro Man wrote a series of posts about the yen carry trade, wherein he posited that analogues to the 1998 USD/JPY meltdown were misplaced, given that the size and nature of the participants had changed.

These posts generated a good deal of response, and naturally some readers disagreed with Macro Man's thesis that there would be "time to get out" in the event of a 1998-style crisis. Macro Man held the view for two reasons: a) he didn't believe that positioning was sufficiently large and/or concentrated that the market would cease to clear without a substantial repricing, and b) that he expected that there would be sufficient warning signs that a prudent investor could exit the position before it all hit the fan.

The second of those two conditions was met earlier than Macro Man had anticipated, and in April he amended his view on the likely future risk-adjusted returns for yen carry. A substantial build-up in positioning after the risk aversion event of late February/early March fulfilled one of the criteria that, in his view, had previously been absent.

At this juncture, he intellectually switched from an "owner" of a short yen position (i.e., short yen was a structural, high-conviction trade) to a "renter" of the position (i.e., he was happy to be short yen, but would have no qualms about flipping and going long yen.) Further support for changing return expectations came from a shift in personnel at the MOF.

It was at this point, with USD/JPY trading just above 123, that Macro Man decided to go long USD/JPY implied volatility. And while his beta portfolio both bought and sold yen in July, he was out of the carry trade for good from a purely mechanistic strategy by July 23. He believes that he was justified, therefore, in his original belief that there would be time to get out in the event of a market cataclysm.

So where does the market stand today? Purely price driven traders, many of whom are CTAs that trade on the IMM, are out. And it's clearly been a quick and rather painful process.
Real-time evidence on the activities of hedge fund and real money investors are obviously harder to come by. Anecdotals suggest that many of these types of names have vacated much of their short yen risk, having been badly hurt this month. The latest Russell/Mellon survey from Deutsche Bank, meanwhile, suggests that as of the middle of the month there was still a cadre of funds running reasonable yen shorts. Presumably many of these positions were closed in the subsequent meltdown that ended with the discount rate cut.
Source: DB, Russell/Mellon survey

While the move in USD/JPY was, in the end, not too bad, the collapse of other crosses was more telling. NZD/JPY sustained a 24% peak-to-trough decline in the span of a few weeks, with much of that coming in a final, climactic 72-hour period.

In retrospect, therefore, Macro Man appears to have been wrong in his original assertion that the market for yen would not stop clearing. Or, to put it another way, he was wrong in his implicit assumption that the market for New Zealand dollars, for example, would continue to clear without discrete jump-steps lower in price.

So we were left in a position where you had plenty of warning to get out, but if you didn't do so before the storm hit, you got absolutely stuffed. The evidence now appears that, like some unfortunate equity quant funds, the FX carry models may have exited their positions on the lows. After all, P/L's don't lie, and the chart below suggests that currency traders participated in all of the downside in, say, NZD/JPY, but none of the subsequent bounce. Ouch!
So where to from here? Well, tell me where equities are going and I'll tell you where the yen is going. Of course, the equity guys are saying "tell me where the yen goes and I'll tell you where stocks are going", which is probably as good an indicator as anything that conviction is pretty low at the moment.

Now, readers will know that Macro Man favours the W scenario for risky assets, which ultimately means another look lower for USD/JPY and the yen crosses. Interestingly, many of the yen charts show that the bounce off the lows has not yet entered the territory of the initial downleg from the ultimate highs. The implication is that we cannot confirm that this is simply a correction; rather, it could be a five-wave reversal and the start of a new trend.

Despite the fact that positioning is pretty square at the moment, therefore, Macro Man would expect traders to build longs on another lurch lower. His reading of the chart suggests a target of 110 on USD/JPY
If and as we get there, however, he will look to close out of his long exposure and start looking to get short again- he has one idea that's so sexy, it'll be modeling for Victoria's Secret after he's done with it. After all, just because carry won't work as well in the future doesn't mean it won't work at all. And Mrs. Watanabe has evidently not lost her appetite for either investment trusts or punting foreign exchange online, so Macro Man would expect the structural headwind of retail outflows to persist.

The one threat to his worldview is the existence of large and potentially toxic barriers below 110, so per the current plan, Macro Man expects to trade small and retain the flexibility to change his mind.

Wednesday, August 29, 2007

The legend of Stan the Man

So is this the start of the W, or the lambda, or whatever other letter 85% of you expect to produce a dip in risk assets? Peut-etre. (Incidentally, thanks to everyone who voted.)

While the scope of yesterday's sell-off in US equities was surprising, in many ways it simply unwound last week's low-volume rally, so perhaps we are all square. While the Fed minutes failed to imply that they were on the verge of easing rates three weeks ago, Macro Man would humbly suggest that anyone who had expected that sort of outcome was being pretty unrealistic. They have been quite clear in tying future monetary easing to developments in the real economy, albeit while noting the potentially deleterious impact of a financial market implosion on "the real world." To date, however, evidence of such an impact has been pretty slim.

What is curious is that European markets are thus far pretty happy to shrug off yesterday's horrid late-session price action in the SPX and further news of distress in hedge fund-land. Sure, stocks have been marked lower, but they've trickled higher since the open. And risky currencies have actually performed quite well on the day, no doubt helped in part by strong yen selling from Mrs. Watanabe and co. One possible explanation is a rumoured Fed discount rate cut; such rumours now appear to be de rigeur following any day in which the S&P 500 falls more than 5 points. Now, it's an interesting question: should the Federal Reserve cut interest rates?

If money markets are freezing up, it's not hard to see that something should be done to help ensure that markets can clear. However, it could be argued that this should be done via the discount window, which banks (who are, ultimately, the private-sector facilitators of credit to markets and the real economy) can access, but other financial institutions cannot.

Why should other institutions get a bail-out? A mortgage company that couldn't be bothered to verify someone's income before cutting a loan check for several hundred thousand dollars probably doesn't deserve to remain in business. A hedge fund that used excessive leverage and poor risk management to purchase crappy assets at inflated prices also deserves to be an ex-hedge fund.

As Macro Man sees it, cutting the discount rate would help those institutions whose functioning is important to the health of the financial system. Cutting the Fed funds rate in the absence of broad-based signs of economic distress (which the Fed has suggested is currently the requirement) would help support the survival of institutions who, to put it bluntly, made stupid decisions with other people's money.

Now, Macro Man admittedly has an axe to grind here. Back in the mid 90's, when Macro Man was young and just starting to earn some decent wedge out of this game, some of his buddies in the market put him in contact with a "red hot" stockbroker who was making triple digit returns for them in the then-new internet and networking sectors. After speaking to this guy (let's call him "Stan the Man"), Macro Man sent him a check for what at the time was a fairly hefty sum.

The firm that Macro Man worked for at the time stipulated that this had to be a completely discretionary arrangement. In other words, MM gave Stan the money, and Stan had total discretion to place trades (at $200 a clip commission!) on his behalf. And over the next four years, despite a raging bull market in the sectors that were Stan's "specialty", he proceeded to lose it all. He bought crappy stocks on margin but never sold them out, and so lost 99% of Macro Man's money by the time the Nasdaq went to 5000.

Along the way, Macro Man called him periodically to inquire WTF was going on. Sadly, the more money that Stan lost, the more difficult it was to get ahold of him- Macro Man's account had dwindled to such a tiny value that he no longer registered on Stan's radar.

Let's be clear about two things here. First, it was Macro Man's fault that his account dwindled to zero. He should have pulled the plug on Stan while his account still had value, and when it was clear that Stan didn't have the same attitude towards preserving Macro Man's wealth that MM himself did.

Of course, the other conclusion to be reached is that Stan had no business running other people's money. He showed no desire to preserve some modicum of Macro Man's account value when his plan went awry and absolutely no remorse when he failed to do so.

So when Macro Man sees the strategies that some of these firms have pursued, sees the flash cars they drive, the big houses they live in, and the big drawdowns they have subsequently sustained, all through taking big risks with other people's money, he sees one thing and one thing only: the ghost of Stan the Man. And that's a ghost that he wouldn't mind seeing laid to rest for good.

Obviously, not all firms are run in such a cavalier style, and there are plenty of people in both the mortgage and hedge fund industries who've lost plenty of their own cash. But just as the third rate cut in 1998 set up the subsequent equity market explosion and exemplified the moral hazard engendered by the Greenspan Fed, a cut in the funds rate at this juncture would slow or even reverse the very normalization in risk premia that central bankers have been calling for over the past several years.

And that, in Macro Man's humble view, would be a mistake.

Tuesday, August 28, 2007

Financial Nursery Rhymes

Blame it on the sun. After a glorious long weekend of relatively warm, sunny weather, Macro Man has developed a creative itch that he just has to scratch. When yesterday's traditional bank holiday poem inspired fellow blogger Cassandra to drop some nursery rhymes in the comments section, Macro Man couldn't resist devising a few of his own.

Consider these financial nursery rhymes a public service to those erstwhile members of the investment community who will now be "spending more time with their families."

Old King Cole was a merry old soul
And a merry old soul was he
For late in June
As he whistled a tune
He shorted the S&P

There was an old woman who lived in a shoe
With a mortgage so big, she didn't know what to do
She used to live in a house on Mulholland Drive
She made $20k but paid three million point five

Little Miss Muffet
Sat on a tuffet
Long of a CDO
But her Triple-B tranche
Made Miss Muffet blanch
Now she earns two and twenty no mo'

Mrs. Watanabe, she sold 10 million yen
The kiwi went to the top of the chart, then she bought them back again
When the kiwi went down she bought,
And then she bought a lot,
Now she's lost all her husband's hard-earned cash so he's left her there to rot

Old Mother Hubbard went to the cupboard
To get her poor dog a loan
So she lied on the docs
(She was sly as a fox)
He ran off when the teaser was done

Ha ha, Black Swan, who's the greater fool?
The shorts, or the longs with their eyes covered in wool?
The month's a disaster, my P and L's quite lame
Would you like to buy my pad I've got on Park Lane?

Jack Cox was quite short stocks
His wife was quite long credit
But when she sold 10 billion yen
He said "She doesn't get it!"

Elsewhere, risk-asset holders everywhere received a reminder yesterday that everything still isn't peaches 'n' cream despite the 109 point rally in the S&P 500. Bank of China, State Street, and Barclays are just three of the institutions fingered in the press as being on the hook for substantial losses due to subprime. And news from the root cause, housing, remains less than favourable.

While yesterday's existing home sales figures were more or less in line with expectations and appeared to show some signs of stabilization, the benign headline masked an ugly underbelly- namely, the supply of homes on the market. The data suggested that there is now 9.6 months' of supply of existing homes on the market; all in, Macro Man calculates that there are now more than 5.8 million new and existing homes available for sale in the United States. It seems pretty clear that housing will weigh on economic activity for the foreseeable future.However, evidence that subprime concerns do not necessarily filter through into economic sentiment and activity came from Germany this morning, where the ifo survey printed a better-than-expected 105.8. Remarkably, the 'current conditions' component actually rose to 111.5 from July's 111.3. What makes the data remarkable is that Germany has been hit by a series of high-profile subprime losses from regional banks, which one might ordinarily expect to hit business sentiment on expectations of tighter credit, etc. That it hasn't happened is another small piece of evidence that Wall Street overemphasizes its impact on Main Street.

This having been said, Macro Man continues to expect a mixed newsflow and sustained period of subtrend but positive US growth. In the near term, he remains of the view that the former factor should lead to another dip in risky assets. His belief in the latter is what makes him want to buy that dip.

Evidence to date from his poll, however, suggest that he has plenty of company on both Wall and Main Street in expecting a relapse in risk asset markets. With more than 200 entries so far, just 15% of the respondents expect the current rally to continue and form a V-shaped recovery. The remaining 85% of the vote is pretty evenly split between the buyable dip (W) and the transition to a bear market, the lambda. Interestingly, the market professionals favour the buyable dip while retail investors favour the lambda.

Does this mean that conditions on Main Street are not quite as healthy as Macro Man believes? It's a possibility worth considering, and he intends to keep a keen eye on the data. In the meantime, he was filled on his sale of 500 ESU7 1500 calls at 17, so his long risk-asset expoure has been (temporarily, at least) reduced.

Monday, August 27, 2007

A Bank Holiday Poem

When Big Ben cut the discount rate,
The market said "that's really great!"
And bought stocks in a frenzied hurry,
No more, for them, the subprime worry

And better, still, was FX carry
The kiwi didn't seem so scary
And as for the Japanese yen,
It's now a funder once again

The sun has left the clouds behind,
It seems a year since it last shined
On England's green and rainy land
But for a while, we'll be sun-tanned

But as the month comes to an end
Will stocks and risk still be our friend?
Or will redemptions hit next week,
And cause markets again to freak?

Alack, alack, I wish I knew
And I'll bet you wish you did, too
Should I buy or sell or hold
Should I be meek or rather, bold?

What happens if I pay the sky?
My boss will say "Man, were you high?"
And what if I should sell the low?
He'll tell me that it's time to go

If I do nothing, and sit tight
I'll look like deer caught in headlights
'Cause if the market goes down plenty
Remember, hindsight's 20/20

A plan, a plan, that's what I need
To balance off my fear and greed
To help me forecast markets better,
I'll simplify things to a letter

A lambda, W, or V?
Which market path will we soon see?
If you think you know the truth
Then please vote in my poll, forsooth!

And now it's time for me to go
The sun don't always shine, you know!
I'll soon be back, and full of pluck
For now, good bye...and much good luck!

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.

Harry Potter: The final chapter....?

Regular readers of this space may have been surprised over the last month that Macro Man has made very little reference to the July publication of the last installment of the Harry Potter series. Surely someone who calls another market participant "Voldemort" should have something to say about the long-awaited conclusion to the series?

In point of fact, Macro Man was waiting to read the book before writing a comment. And while he did in fact read Harry Potter and the Deathly Hallows whilst on holiday, subsequent events obviously took precedence. But now that things have calmed down (and indeed, now that Voldemort and his counterparts are back running over the G4 foreign exchange market), now seems as good a time as any to jot down a few thoughts.

First, a bit of background: Back when Macro Man was but a lad, his career aspiration was to be a writer, not a financial market participant. He was an avid reader of fiction (though his tastes have subsequently morphed more towards non-fiction) , and loved the fantasy-type genre in which the Potter series resides. And while he did have a bit of his fiction published in his early teens, by the time he got to college his focus was much more on the kind of stuff that he does today.

Yet he can still appreciate the Harry Potter series, because it is a superbly-crafted example of its kind, the sort of thing that he would have loved as a kid and can still enjoy today. In a sense, though, reading the books is a bit depressing for him: they are considerably better than anything he could come up with in several lifetimes of trying. That J.K. Rowling has reaped incredibly large financial rewards makes him wonder "what if?" he had pursued his early dream of literature.

So in a sense, the allusions to Harry Potter and Voldemort are a tribute to an incredibly successful series of books and a hat tip to what Macro Man's career might have been in an alternative universe. Indeed, one of his reasons for starting this blog was to flex his writing 'muscles' that so rarely get used in the day-to-day grind of watching Bloomberg screens and doing trades.

However, the metaphor wouldn't be effective (insofar as it is so) if there wasn't an easy parallel to be drawn between some aspects of the Potter series and the real world. Just as Harry struggles against forces larger than himself, often with imperfect information, so too do humble private sector traders and portfolio managers in markets that have come to be dominated by public sector actors. For those of us educated in the Anglo-Saxon tradition of government non-intereference in private sector markets (and yes, that includes bailouts at the drop of a hat!), the brave new world where central banks are trading for profit is a bit difficult to swallow.

Similarly, in the books the forces of Voldemort seem to be everywhere, and acknowledged as such, though are (famously) rarely called by their proper name. The same holds true for CBs, who have come to dominate markets while cloaked in a shroud of secrecy.

Of course, there are important differences between the books and the real world as well. In the books, Harry, while appearing smaller and less powerful than Voldemort, nevertheless has a hold on his rival that forces Voldemort to seek him out. America's own HP, Hank Paulson, is the one that goes hat in hand to the Chinese to demand greater currency flexibility and strength. And while Macro Man does not like the role that "his" Voldemort plays in real life, his use of the epithet is not an attempt to call SAFE, CBR, et al. morally evil like the one in the books.

And of course, Rowling's Harry is guided by the benign and virtually omniscient hand of Dumbledore. In real life, Hank is working for and with a leader that many people in the world would characterize as just plain Dumb.

Finally, in the books, the whole story plays out over seven years and reaches a definite conclusion. Things in the real world are rarely so tidy. Macro Man's children are a little too young to understand and enjoy the Potter series, though they are beginning to show an interest in it. Over the next few years he looks forward to reading the early books to them and then watching them read and enjoy the books for themselves. He can only hope that by the time they find out what happens to the "real" Voldemort in the stories, his own adventures with Voldemort will have reached a satisfactory conclusion as well. Somehow, though, he has his doubts....

Elsehwere, perhaps Macro Man was a tad premature in concluding that current market turbulence would not impact the real economy. The ad below appeared in yesterday's London Evening Standard:

Elsewhere, Macro Man decided against the FFU7 options play, as a poster pointed out some particulars of the contract that make the risk/reward less compelling than at first glance. However, a similar bet can probably be constructed with equity index options. The Sep futues roll off three days after the FOMC meeting. Macro Man is willing to bet that a stock market at 1500 would mean no rate cut, and thus come under some pressure. By the same token , the very thing that would inspire a monetary tonic-financial panic- also suggests lower stock prices.

It therefore looks to him that a good "not rate cut" bet is to sell Sep calls on the S&P 500. He will initially try to sell 500 ESU7 1500 calls at 17 (they closed at 15 yesterday). If done, he'll then think about offering some more of a slightly higher strike.

Thursday, August 23, 2007

A few thoughts on economics

Enjoying this? Macro Man is not, particularly, and wishes he were back on holiday. And from what he's hearing, he has plenty of company. One broker he spoke to this morning said that everyone she has spoken to, across asset classes and strategy, lost money yesterday.

That, boys and girls, is called a short squeeze, and looks set to get worse before it gets better. Macro Man was frankly surprised to hear it, as it suggests that many risk takers were quicker than he had assumed in cutting longs and going short whilst he was sunning himself. The 40 day moving average in the SPX (currently at 1492) is as good a target as any for a likely faltering point; in the meantime, get ready for a barrage of commentary today about a break back above the downtrend line and that the worst has passed, etc. Keep your stack of red tickets handy to lighten up and reposition into this low-volume rally.

Macro Man has used the relatively quiet conditions this week to update all of his macroeconomic data spreadsheets and engage in a good old-fhasioned bit of data digging. After all, there was a fair amount of data released in the two weeks he was gone. One thing he saw inspired him to create a little game for his readers. See if you can match the economy below with its non-annualized real economic growth in the first half of 2007:

1) Eurozone a) 0.92%

2) Japan b) 0.99%

3) United States c) 1.04%

Those growth rates look awfully similar, don't they? Maybe global de-coupling (amongst the G3, at least) really is a fairytale! The answers, for what it's worth, are as follows: 1) c 2) a 3) b

Of course, many people will tell you that the US faces substantially greater headwinds moving forwards. While it's true that the mortgage issue isn't going away, which should keep the US at a subtrend growth rate for some time, it's also the case that the future doesn't look quite as bright for the other two, either. Europe can no longer rely on easy monetary policy to help fuel growth, and Japan seems unlikely to enjoy the sort of marginal boost from a weak currency in the future that it's had for the past couple of years.

A number of very smart people with whom Macro Man has spoken this week maintain vigorously that "all of this is bound to impact the real economy." While Macro Man won't dispute that- lending standards seem certain to be tighter moving forwards- it's also the case that Wall Street tends to have an exaggerated view of its place in the world, and thus its impact on Main Street.

The 1987 crash did not cause a recession.
The Asian crisis did not cause a recession.
Russia's default did not cause a recession.
The LTCM crisis did not cause a recession.
The corporate scandals and credit massacre of 2002 did not cause a recession- they occured as the US was coming out of recession!

The chart below shows the 6month change in the SPX, US industrial production, and US real personal consumption growth. While this is admittedly a quick-and-dirty representation of Macro Man's view, he believes it is instructive nonetheless. Observe that over the past fifteen years, the six month change in the S&P 500 has had thirteen seperate episodes where it's been negative.

Industrial production has had eight episodes where it's been negative.

Personal consumption has had one epsisode where it's been negative.
Now it's true that Wall Street has flagged each of the last two recessions; but it's also flagged plenty of recessions that did not occur. And that preponderance of false positives makes Macro Man very leery indeed of extrapolating market prices into real activity.

Of course, there is distress in the housing market, and household wealth is set to take a bit of a hit. And naturally, there remains a coming hit to personal income from the reset of adjustable-rate mortgages over the next couple of years. But income growth is the primary driver of consumption, and in Macro Man's view many market participants grossly overestimate the macroeconomic impact of ARM resets.

The reason is perhaps because it is easy to focus on the gross amount of ARMs resetting rather than the marginal impact. Throwing around numbers like $500 billion or $1 trillion or even $2 trillion makes it sound like a problem that MUST have a huge impact. But remember, those figures represent the nominal size of the debt and not the change in servicing costs, which is what really matters.

And even if we use the aggressive assumption that there is $2 trillion of ARM debt that will all reset 3% higher over the next year, that only represents $60 billion. While that is certainly more than Macro Man has under the sofa cushions, it still only represents 0.5% of US personal income. Personal income growth can and has exceeded that total in a single month, as recently as March of this year. Under less aggressive assumptions, the annual change in debt servicing costs could be in the $15 billion- $35 billion range. To put those numbers in perspective, there have only been two months in the last year when that latter figure has not been exceeded.
Now, Macro Man is not saying this will have no impact- he is happy to concede that consumer spending and thus growth will be below trend for some time. And that should, in and of itself, beget market volatility. But in his view, when markets feel the worst, Wall Street is most likely to overestimate its own impact.

And that is why he wants to clear the decks now so he can buy at lower levels.

EWZ gapped through the offer level yesterday, and Macro Man was filled at 55.55. Premature, in retrospect, but Macro Man would rather be too early than too late. Another trade that Macro Man is looking at, from a pure risk-reward perspective, is to fade the consensus that a Fed easing by next month is a done deal. He will look to buy either the 94.8125 or 94.875 Sep Fed Funds futures puts this morning, spending $200k or so of premium. The potential payoff should be something like 4-1

Wednesday, August 22, 2007


Well, Macro Man knew it was going to happen. His vacation saw more market fireworks than the 4th of July, Chinese New Year, and the Millennium put together. His return has seen those pyrotechnics extinguished by a steady stream of volatility-dampening drizzle (and alas, he is speaking literally.)

For those who endured the first half of August, the current respite must be welcome. Indeed, this morning's recovery in erstwhile favourites such as the Turkish lira suggests that risk appetite has not been completely eradicated. Anecdotals suggest that volumes are fairly low, however, which is hardly a firm foundation for a sustainable recovery.

Yesterday's meeting between Senate Banking Chairman (and would-be US president) Chris Dodd, Ben Bernanke, and Hank Paulson has helped to calm things as well. Markets appear to have interpreted Dodd's press conference as indicating that the Fed could cut rates should conditions deteriorate further. How this is near-term bullish (rates cuts should things get worse) is a bit of a puzzle to Macro Man, but then again so was the risk asset rally after the last Fed meeting. And we know how that turned out!

While Dodd stopped short of promising rate action (or publicly requesting it), the implication was pretty clear that he'd like some relief. He did his part as well, of course, providing viewers of the press conference with a phone number (1-800-999-HOPE) to ring if their teaser rates are about to reset. Now, Macro Man would guess that the sort of people who watch or read about press conferences from the Senate Banking Committee chairman are generally not the sort of people that need to dial a financial literacy hotline. Nevertheless, it is probably a good thing that SOMEONE is doing something to increase the financial nous of Mr. and Mrs. Joseph Sixpack.

Imagine, though, what the world would be like if our buddy Jim Cramer held political office. Macro Man can just imagine Cramer on CNBC, in full Crazy Eddie-style rant mode:

Mr. Bernanke! The market is broken! My guys are puking stocks at prices so low, they're practically GIVING them away!

Hedge funds! Struggling to shift unwanted inventory? Do you HAVE NO IDEA how you're gonna trim risk and meet redemptions? Prime broker playing hardball and asking for more margin?

Shop around, see what terms they're offering, then call me up and I'll beat 'em!

That's right, dial 1-800-BAIL-OUT and Crazy Cramer will sort you out, pronto! That's 1-800-BAIL-OUT for the finest prices on government prop-ups! 1-800-BAIL-OUT! Call today!

That, we can all be thankful, resides in alternative universe that none of us currently inhabit.

In any event, Macro Man retains the view that the medium-term prognosis for risky assets remains broadly constructive, even if neither economic growth nor market Sharpe ratios can match the pace of the past four years. A key caveat to the view is that the US avoids recession, even if consumers spend at a below trend pace. The rationale for this view is that corporations have not exhibited the type of excesses (in terms of hiring, capital investment, or inventory accumulation) that has almost always foreshadowed periods of negative growth in the United States. Those conditions may be met in the fullness of time, but for now Macro Man believes that 'muddle through' economic growth remains the most likely outcome.

The rationale for the generally upbeat view of risk assets, meanwhile, rests on one word: liquidity. While asset markets have clearly seen a sharp reduction in the amount of micreconomic liquidity available (in other words, the amount of trading that can be done in asset markets without producing catastrophically expensive transaction costs), on a macroeconomic basis, liquidity remains ample.

Now, to demonstrate this fully would require more time and space than Macro Man has at his disposal. So his explanation will be necessarily brief. Suffice to say, however, that a primary tenant of his view is that most market participants and commentators underestimate the impact of the developing world in providing liquidty.

Take, for example, the global monetary policy setting indicator that Macro Man posted yesterday. It showed that global (actually, Macro Man uses the ten largest economies in the world as a proxy for the globe) monetary policy is still slightly accommodative, albeit much less so than it was a few years ago. If we break that down by source (developed markets versus emerging markets), however, we see an interesting disparity. Developed markets (which comprise 82% of the GDP weight in the world's ten largest economies) appear to have a monetary policy setting which is broadly neutral, a conclusion that does not seem unreasonable. The 5 EM countries in the world's top ten largest economies (China, Brazil, Russia, South Korea, and India), while comprising only 18% of the GDP weight, nonetheless contribute 80 bps of policy accommodation to the global economy. (Note that this measure is GDP-weighted.)

Focusing primarily or exclusively on developed market central banks, as many in the market tend to, would lead one to underestimate the degree of policy accommodation left in the global economy, and perhaps by extension the potential for growth and asset returns.

Looking at money supply produces a similar picture. Macro Man has constructed a measure for dollar-terms global money growth, measuring the growth in dollar-term M2 in each of the world's ten largest economies. The picture there also looks constructive for risk assets, and for similar reasons. Dollar money growth, while not at the levels seen in 2003, neverthless remains extremely firm at 12%. And again, the 5 EM countries punch above their weight in contributing; by Macro Man's calculation, the five aforementioned countries have contributed 40% of the dollar-term money growth recently.
Now to some extent, the growth in this measure is symptomatic of dollar weakness. But if we look at local-currency term money growth and GDP weight it, we still get a y/y increase of more than 9%, the highest reading in four years. And again, the EM countries contribute something like 38% of that growth.
Now, Augustin Mackinlay at the Global Liquidity Blog will tell you that broad money growth doesn't tell the whole story, and he is of course correct. You often see episodes of large money growth during periods of economic duress, during which the investment prospects of risky assets may be very bleak indeed. Moreover, one also sees a spurt in broad money growth during periods of market distress, as funds exit securities markets and enter money market funds (and thus, the broader monetary aggregates.)
However, the past few years have hardly been characterized by global economic duress. And the EM countries who have contributed most to money growth, China and Russia, don't exactly have the sort of financial systems characterized by rapid switches between securities and money market funds/cash deposits. So Macro Man is willing to conclude (and, at the right price, to bet) that this liqudity is in fact real and waiting on the sidelines to be invested. Who needs FIG when you have VIG, RIG, and BIG waiting in the wings?
In any event, the utility of the $ money growth measure as a proxy for risk asset market conditions can perhaps be demonstrated by the chart below. Even Macro Man was surprised by the very high degree of correlation between y/y global $ money growth and y/y changes in outstanding financial derivatives (data via the BIS). To be sure, there is probably a small currency translation effect here dependent on moves in the dollar. But that effect should be linear and relatively small, and certainly does not explain the dramatic shift in derivatives trading as dollar money growth ebbs and flows.

Needless to say, the current macroeconomic liquidity environment would appear to remain relatively sanguine for financial risk-taking. A final piece of the puzzle, at least when it comes to the United States, is the level of cash sitting on the sidelines. According to ICI (via Bloomberg), US money market fund assets have risen more than $300 billion so far this year. If you're scoring at home, that's more than twice the amount taken out of conumers' pockets in a year if $500 billion of ARMS reset 3% higher.

That money market fund assets have grown more than $100 billion since the last week in July underscores Mr. Mackinlay's point that broad money aggregates can jump during times of distress. But you have to wonder how long that money will be content to sit on the sidelines in the event of a non-recession outcome for the US economy, particularly if and as some quality assets start to look cheap. A few months, perhaps, but Macro Man is willing to bet that it's not much longer than that.
All of this, therefore, suggests that the dip should, in fact, be bought. However, from a tactical perspective, it's also important to remember that another noisy dip is very likely indeed. And one will hardly be in the mood or position to go shopping for bargains if too much money has been lost on the way down. In these markets, it's important to position yourself so that you can trade because you want to, not because you have to.
Macro Man will therefore lower his EWZ offer to 55 and perhaps lower as circumstances warrant. That, he hopes, will prove sufficient to avoid the need to dial Cramer's hotline in this or any other universe.

Tuesday, August 21, 2007

The title of this post has already been taken

The obvious title of this post, to continue a theme, has already been taken. But the message is still valid. So far this week, signs of distress and, yes, panic, remain evident in financial markets despite the unchanged close in US equities yesterday.

The newsflow has not been particularly encouraging:
* Capital One closes its mortgage business
* Thornburg Mortgage has puked some of its portfolio and taken a charge
* Solent Capital, a UK hedge fund/SIV manager, considers changing its name to 'Insolvent Capital'
* Rumours abound of a UK insurer going bust
* Queues are beginning to form at CB discount windows

Remarkably, the yield on 1 month US Treasury bills traded below 1.3% yesterday. That is pretty amazing, given that Fed funds remain at 5.25% and that 1 month LIBOR fixed at 5.50% yesterday. Whoever was buying bills at those levels was presumably not doing so as part of any kind of investment strategy. If ever you needed proof that focus has shifted to return of capital rather than return on capital, that is it.

Everyone's new favourite indicator, of course, is the TED spread, which was last relevant to global markets at roughly the time that Liar's Poker was published. This indicator measures the difference between the yield on three month Treasury bills and 3 month LIBOR, the interbank borrowing rate. Like swap spreads, it is used to measure the level of distress/panic/praying in the financial system. The current reading is not particularly pretty.
The current reading is the highest since 1987- or is it? While the three month TED spread was wider than 2.5% in 1987 (and substantially wider than that in the 70's and early 80's), those reading came with interest rates at or close to double digits. Expressed as a ratio (i.e., the current 3 month LIBOR rate is 1.71 times the 3m T-bill yield), the spread is the widest that Macro Man can find in his data set. So quite clearly, there is indeed panic on the streets of London....and Frankfurt...and New York...and Tokyo.

Another sign of distress has been the complete implosion of the Russian basket trade, where rouble weakness has more than wiped out the last two revaluations by the CBR. While not fail-safe, this trade was widely thought to have the best risk/reward characteristics in EM-land. Indeed, until a couple of weeks ago Macro Man was involved in his real job. The dislocation this morning suggests, like the TED spread, that positions are being liquidated out of necessity rather than desire.
For the brave, this environment can ultimately set up some real bargains. However, it is important to wait until the period of maximum pain and panic. Something tells Macro Man that we're not there yet. Thus, while the CBR is, to their credit, offering the basket just above current levels, this is no gurantee that it cannot widen further. After all, the ecu basket trade, for those that remember, widened much more substantially in September/October 1998, only a couple of months before it was guaranteed to go out at par. The message here is that nothing is guaranteed and that everything can move more than you'd think.
If Macro Man has maintained one purely financial market theme this year, it is that volatility is likely to be higher in the future than it has been in the past. One rationale for that view is that monetary conditions, while not restrictive, are no longer ludicrously easy. The chart below illustrates a proxy for global monetary conditions (where 0 is neutral, below there is easy, above there is restrictive) overlaid with a moving average of VIX. There is a reasonable correlation over long periods of time, and the policy indicator has been hinting at higher volatility for some time- one reason for Macro Man's conviction that vol has been set to rise, and his preference for hedging risk positions when the opportunity arises.

Tomorrow, Macro Man will look at global liquidity conditions and why he remains, in the medium term, constructive on risky assets.

Monday, August 20, 2007

Tanned, rested, and ready

So, did I miss anything?

Unbelievable as it may seem to those who have sat through the carnage of the past couple of weeks, two of the bellwether asset prices in global finance would suggest 'not really.'

The S&P 500 closed last Friday at 1445.94, a smidge higher than the 1433 closing price on August 3, Macro Man's last day in the office.

Likewise, the current yield on the benchmark 10 year US Treasury bond is 4.69%, identical to the closing yield on August 3.

So nothing's really changed, right?

Clearly, that's not the case. There has been an enormous amount of financial, reputational, and psychological damage wrought over the past couple of weeks. Those suffering know who they are, and in many cases, so do the rest of us. Yet the lack of net change amongst the two most important financial asset prices in the US, the epicenter of the recent market earthquake, is telling. Macro Man is now tanned, rested and ready to step back into the fray, happily in considerably better financial and emotional shape than many other market participants.

Here are his first impressions of the recent carnage and where we stand today:

1) While more equity volatility is to be expected, there's a good chance we've seen the low in the S&P 500.

This conclusion, it must be said, has nothing to do with sifting through the trade blotters and performance details of suffering hedge funds, a projection of consumer spending over the next six months, or a firmly held belief that the Fed will cut rates 0.50% in September. Rather, it is based on his reading of the chart, which is his only tool for objectively assessing the price action while he was gone.

The S&P 500 has sketched out a pretty textbook A-B-C correction, albeit a deeper one than originally anticipated. The A wave, from the highs down to 1427, represented an 8.2% decline. The B wave, back to 1503, retracement almost exactly 61.8% of the A wave. And Wave C, that most painful of waves, has had a peak to trough decline of 8.9%.

That Wave A and Wave C are roughly equal in magnitude is a good sign that the correction has fulfilled its objective. Moreover, the bottom was marked by a bullish candlestick, with a long downward wick and a small positive daily return. That is generally a reversal signal. That the bounce from Wave C has eclipsed the Wave A low also suggests that the pattern will not morph into a more bearish type structure.

From here, Macro Man would expect a bit more upside, culminating in failure, and then a noisy downmove that fails somewhere around 1400, give or take. That will likely be the dip to buy.
2) The Fed has changed its tune, but that doesn't guarantee a rate cut

Jim Cramer's rants remain misplaced, in Macro Man's view. Natural selection mandates that a normalization of volatility conditions will weed out some traders and portfolio managers who are ill-equipped to deal with the new reality, just as natural selection has dictated that US autoworkers have seen job losses because of Detroit's inability to manufacture high-quality automobiles at a competitive price. Cutting rates because some hedge funds are closing would be a grave, grave error, and merely propagate the next financial asset bubble.

However, it is also the case that a permanent increase in borrowing costs, lower household equity wealth (on top of continued reductions in household housing wealth) , and the recent inability of the money markets to clear does represent new information. The move in the discount rate looked largely symbolic to Macro Man, and it is possible and perhaps even likely that it will eventually be seen as such.

More important was the change in bias, reflecting the potentially pernicious impact of higher borrowing costs (which seems likely to be a feature of the landscape for some time) and lower household equity wealth (which, if equities remain weak, would no longer offset housing) on economic growth and employment.

However, it doesn't seem quite right to assume that a September cut is a done deal, as some investors mistakenly did immediately after the August meeting. In a sense, the surest way to a rate cut is to experience more pain; the more pleasure that markets feel over the next four weeks, the less likely a rate cut (which is presumably the whole rationale for the risk asset rebound) is to pan out.

All the more reason, then, to expect more volatility over the next few weeks.

3) As noted previously, a lower Sharpe ratio for risk trades does not necessarily mean a negative return for risk trades

Macro Man has debated internally this morning whether we have seen the 'death of the carry trade' and/or the 'death of the equity dip buyers.' His answer to both of those questions was 'no.'

Liquidity has, in his view, been the primary explanatory variable in the superb performance of most risk asset markets over the past several years. And while it seems quite clear that liquidity conditions are less easy now than they have been in some time, it does not necessarily follow that they are restrictive.

Yes, cash markets have seized up, but Macro Man would suggest that that was down extreme risk aversion in the wake of the credit crunch, not necessarily because of insufficient liquidity. To put it another way, just because liquidity was the solution does not necessarily mean that it was the problem.

Global liquidity conditions remain moderately easy, in Macro Man's assessment, because of the EM central banks- i.e. the BRICS. That China was rumoured to be the buyer of last resort for Bear Stears tells you much of what you need to now. VIG has plenty of cash and no internal risk manager that shrieks every 20 minutes or 2% (whichever comes first.) As such, they and other SWFs are sitting in the catbird seat; private sector investors have been selling assets almost regardless of price, which naturally sets up some nice bargains.

Should equity and other risk asset weakness continue, Macro Man would expect these guys (and others, such as Warren Buffett) to step in and starting buying up quality assets on the cheap. And, that, ulimately, should help drive decent if not spectacular risk asset returns moving forwards.

So what if the Bernanke put is struck lower than the Greenspan put; Gentle Ben is also long the Voldemort put.

There was some portfolio activity during Macro Man's absence, per the post from August 3:

* He bought 120,000 shares of XHB at 25.50

* He sold 70,000 shares of SPY at 150 (whew!)

* He bought $15 million USD/JPY at 117 spot basis

* The DAX puts expired

* The XHB puts expired

Also note that the comments section now requires word verification due to the sad recent emergence of spam posts from online purveyors of pharmaceuticals.

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.

A Holiday Limerick

As Macro Man sat by the sea,
The destruction was quite plain to see
The waves caused consternation,
With a big dislocation,
And the worst of the lot was Wave C!

Saturday, August 04, 2007

Greatest Hits

Friday's late session swoon was surprising, to say the least. While Macro Man has been confident that the worst for risky assets was not over, he reckoned that the bounce had a bit further to go. Of course, the really ugly interpretation is that the entire sell-off from the highs is still part of Wave A, in which case the ultimate low is that much further away (both in terms of time and of price.) Regardless, a re-think of the original gameplan is in order.

Unfortunately, this period of market volatility has coincided with Macro Man's annual summer holiday. And while he will be managing his real-world portfolio from afar, he will not be in a position to update this space while away. Readers should feel free to use the comments section of this post to exchange views; there is a small chance that Macro Man may occasionally comment himself. For what it's worth, his view is that the hysterics and histrionics of Cramer and the hyperbole of Bear Stearns is unwarranted.

Is there some distress amongst certain mortgage borrowers? Yes.

Is there distress amongst people who thought that buying high-yielding "AAA" paper was free money, and so stuffed their portfolios with turds? Yes.

Is there distress amongst people like Cramer who evidently think that the Fed should target positive equity returns instead of inflation and employment? Yes.

Will there be more losses? Yes.

Will there be more hedge funds closing? Yes.

Will the market go down more? Almost certainly yes.

Is this the end of the world? No.

This is a painful repricing of credit risk, and a timely reminder to people that if anything seems too good to be true, then it probably is.

To give readers, particularly those who have come across this space relatively recently, something to peruse over the next couple of weeks, Macro Man hereby presents his list of 'Greatest Hits'- some of his favourite posts of the last eleven months:

* What is the bond market smoking, and where can I get some? Macro Man's very first post

* Is the yield curve forecasting a recession? On the (in)utility of the yield curve as an economic forecasting tool

* Harry Potter and the FX Reserve Managers The original of the term 'Voldemort' for China's FX reserve manager

* Beta release The study behind the equity beta-plus strategy

* Carry Me Home And the study behind the FX carry beta plus portfolio

* Nouriel Roubini is a Big Fat Idiot The post that instigated Macro Man's correspondence with Brad Setser, Macro Man debunks the myth that the yen carry trade is similar to 1998

* Eight points, Yen again, and Return of Serve Follow-ups to the above

* When the Facts Change Macro Man revises his view

* Cornflakes Without the Milk On the importance of accounting for dividends

* A remedial lesson in statistics On the nature of distributions- particularly apposite in the current fat-tailed credit environment

* FX Carry: A SAFE Haven Calculating Voldemort's investment performance

* A Ratings Agency Toolkit A recent attempt at humour

Good luck.

Macro Man will return on August 20

Friday, August 03, 2007

A snoozer

Imagine Macro Man's surprise when, ten minutes after the data release, two differnt brokers noted that "clients don't really know how to react to the number." The prior view that the figure was largely irrelevant appears to have been vindicated.

On balance, the number was weak- but not diastrously so. Headline and household employment was low, and the unemployment rate was a couple of high school burger-flippers away from jumping to 4.7%. That monthly payroll growth has slowed sharply is clear- that the Fed will care is not.
The uptick in the U-rate, while surprising, is hardly disastrous and looks very similar to what was observed late last year. Moreover, it should also be viewed through the lens of the recent downward revisions to GDP. Those should lead to upward revisions to unit labour costs, as output per worker has evidently been lower than previously though. This in turn might imply that NAIRU is a bit higher than previously believed as well. And lest we forget, both the three and six month averages for payroll growth are in the 125-130 range- levels that the Fed appears to believe are consistent with trend.

As such, the preferred setup remains in play- market strength until 2.15 EDT on Tuesday, no real loosening of Fed language, and the onset of Wave C at 2.16 EDT on Tuesday.

As such, it's probably wise to leave a few orders to play the anticipated set-up:

* Macro Man will sell his residual long SPY position in the alpha portfolio at 150;
* He will sell his EWZ position at 67;
* He will bid 25.50 for 120,000 XHB to offset his long put position;
* He will bid 117 for $15 milion USD/JPY to hedge his straddles

Best to use the current quiet period to adjust portfolios; if Macro Man is right, it should all kick off in the second half of next week.

UPDATE: Doh! Super-weak services ISM and Bear Stearns on negative outlook by S&P may have wrecked the game plan, though would make any non-throwing of an easing bone by the Fed that much more powerful....

A Day in the Life

I read the news today, oh boy

-The Beatles, A Day in the Life

It's US payroll day today, but Macro Man can honestly not remember an NFP release that holds less interest for markets. Given that just about all asset correlations are at 1, markets are (correctly) trying to focus on the ultimate driver, which is the condition of the credit market.

The only way that Macro Man can see NFP being relevant is if the number is negative or near-negative, which could perhaps encourage the Fed to relax its language next Tuesday. Failing that, Macro Man would expect the FOMC statement to retain its relatively tough stance, which could prove to be an ideal catalyst for the start of the next downleg in risky asset prices. Certainly anything close to the consensus 125-130 forecast will represent a continuation of the recent trend.
In the "you heard it here first" department, the WSJ is now reporting that AXA is funding redemptions in its US Libor Plus fund (now down more than 20% from its peak) out of its own pocket. While Macro Man has neither the time nor the desire to morph into a financial gossip-monger a la Dealbreaker and the like, he did highlight the AXA redemption story more than a week ago.

Elsewhere, an anonymous poster pointed out an IHT story describing the internal backlash within China to VIG's to-date money-losing investment in Blackstone. While the premise is somewhat preposterous, given the sums involved (the $500 million loss is less than eight hours' worth of reserve accrual), a couple of things were quite striking to Macro Man. First, it seems that he is not the only victim of state censorship of blogs; secondly, the xenophobic comments from Chinese punters (no doubt cherry-picked to fit the story) sound remarkably similar in tone to what one might expect from unemployed Rust Bowl factory workers. Perhaps the world isn't so flat after all!

The again, maybe it is. The Times has a rather amusing feature on Japanese housewives' currency trading in its supplement today. That such a piece appeared in the style section, rather than the business pages, was somewhat remarkable; that the article concludes with a thinly-veiled invitation for UK punters to have a go was more than a little worrisome. The highlight of the piece, however, is a blow-by-blow account of a day in the life of one housewife:

7am: Ritsuko decides on two currency bets. She has 100,000 yen (£417) in her online trading account and the brokerage will lend her ten times that.

8am: She studies the Nikkei and Bloomberg and reckons the euro will rise

8.15am: She borrows 500,000 yen. (cheaply: the overnight interest rate is just 0.5 per cent), goes on to the spot foreign exchange market and buys euros at one euro per 160 yen.

8.30am: A medium-term bet: she borrows another 500,000 yen and buys New Zealand dollars, which will earn 8.25 per cent interest.

12 noon: Lunch and shopping (there are sales at Furla and Max Mara).

5.31pm: She was right: the euro is up 1 per cent. She buys back her yen, this time getting 176 yen per euro. After brokerage fees, her profit is around 5,000 yen – which about pays for her lunch. (Editor's note: shurely shome mishtake? No wonder she's making so much cash if she can sell EUR/JPY 7 figures above the all-time high?!?!?!?)

2 months later: Ritsuko believes the Icelandic krone will be more lucrative than her New Zealand dollars. She exits her position with one sixth (two months out of 12) of the 8.25 per cent annual interest on the NZ dollars, pocketing around 6,100 yen – which she immediately churns into her next trade.

Not a bad life, is it? Compare it with one of Macro Man's days:

6 am: Wake up

6:05 am: Check overnight action on home Bloomberg terminal

6.30 am: Board commuter train

6.31 am: Receive elbow in ribs from fellow passenger

7 am: Purchase coffee

7.10 am: Spill coffee over desk

7.12 am: Receive barrage of prices for ITRAXX Euro crossover opening

7:30 am: Watch GBPJPY scream higher as Russian agent banks purchase it

8.15 am: Check DAX option prices and consider directional strategy

8.30 am: Read research

9.15 am: Meet with investment bank China economist

10.30 am: Watch GBPJPY collapse as Russian agent banks sell it

11.15 am: Publish blog post

12.45 pm: Lunch at desk

12.46 pm: Spill lunch on desk

1.25 pm: Receive torrent of emails, Bloombergs, and chat posts previewing US data release

1.35 pm: Receive torrent of emails, Bloombergs, and chat posts analyzing US data release

2.13 pm: See US 10 year yields move 6 bps in 3 minutes. Inquire with broker as to cause. Broker says “We’re not seeing it.”

2.30 pm: US stock market opens

2.31 pm: Total system failure requires reboot

3 pm: Engage in modeling research

3.29 pm: Sell a bit of EUR/USD

3.30 pm: Hear from 5 different brokers that China is buying EUR/USD

4.15 pm: Receive multi-asset structured product trade idea from broker

4.16 pm: Deconstruct multi-asset structured product trade idea, find that it is drastically overpriced

4.32 pm: Receive barrage of prices for ITRAXX Euro crossover closing

4.47 pm: Run daily P/L

5.02 pm: Discuss forthcoming sporting event with broker

6 pm: Board commuter train

6.01 pm: Receive elbow in ribs from fellow passenger

6.50 pm: Enter home

6.51 pm: Get tackled by children

8 pm: Check prices on Bloomberg, see positions are doing well

8.10 pm: Play Scrabble with Mrs. Macro: win.

9 pm: Play Gin with Mrs. Macro: lose.

9.45 pm: Check prices on Bloomberg, see that late session stock price move has had adverse impact on positions

10 pm: Go to bed and dream of career as goatherd

Thursday, August 02, 2007

July post-mortem

July was really quite a fascinating month for a number of reasons. Aside from the obvious market-based factors (credit market implosion and concomitant risky-asset fallout), last month provided an interesting insight into different portfolio management techniques and highlighted the utility of a multivariate approach. After a number of months where beta was king, July demonstrated markedly different return profiles for static beta, active beta-plus, and alpha-generating strategies.

First, the bad news. After a promising start and generally solid performance throughout the month, July ended up as Macro Man's first losing month of the year, courtesy of the Tuesday's late-session swoon in the S&P 500. The return, -1.15%, dropped less than half of what Macro Man had made in each of the prior two months, and the blog portfolio still closed July up 7.5% on the year.
The primary culprit, unsurprisingly, was the equity beta portfolio, which shed 1.71% on the month. While the SPY position actually does represent a market-timing beta plus strategy, the threshold for exiting the position is so far away that it is tantamount to a passive equity long. And with the S&P 500 down 3.2% on the month, that spelled trouble for Macro Man and anyone else running beta-heavy strategies (more on that later.)

Much more satisfying was the performance of the FX carry beta plus portfolio, which notched a tiny gain despite catastrophic declines in most carry crosses in the latter portion of the month. While Macro Man took a costly round trip in FX carry early in July, his exodus from the basket a few days later proved fortuitous in the end. While a 0.07% monthly return on a carry strategy doesn't set the world on fire, it nevertheless beats the hell out the performance of a passive carry strategy, which dropped 0.87% on the month (see below.) Lopping off left-handed fat tails is one of the primary attractions of a "beta-plus", as opposed to pure beta, strategy.
All in, the beta strategies dropped 1.65% on the month- not great, but it could definitely have been worse. The alpha portfolio, meanwhile, made money in each of the three market segments (equity, fixed income, and FX) in which Macro Man had a position last month.
Macro Man was slightly unlucky insofar as his alpha portfolio index hedge (long the puts in a July 1520/1555 ESU7 risk reversal) expired more or less immediately before the stock market rolled over meaningfully. He dithered before purchasing more downside protection, allowing precious performance to slip away. The hedges that he did end up buying (DAX and FTSE puts) only made 0.12% for him in the last few days of the month.
Considerably more profitable, of course, was the short XHB position, which all in (cash short, long puts, long SPY hedge) made Macro Man around 0.96%. While he has subsequently closed the cash short, Macro Man can look back fondly on this trade as an obvious sectoral macro play that came good. The long equity portion of the Brazilian RV trade added 0.44%- a good return, albeit substantially less than the profitability at the stock market peak. All in, equity alpha bets added 0.21% to portfolio performance last month.
Macro Man notched a comparable return from fixed income bets. He essentially has a long inflation breakeven trade on, though with the nominal leg expressed in JGBs rather than Treasuries. This proved fortuitous, as the combined position more or less broke even during a month in which 10 year US breakevens declined five basis points. The SGD payer position, meanwhile, made 0.18%, which was the ultimate performance of the fixed income alpha portfolio during the month. If only Macro Man had gone short credit....
In currencies, Macro Man's only real bets were long volatility, albeit with modest short EUR/USD and USD/JPY betas. The short EUR/USD delta of his powerball portfolio more than offset the continued uptick in long-term volatility. However, the powerball loss was compensated by the vol and delta gains from the USD/JPY straddles. The overall return of 0.11% was modest but nevertheless positive, and took the all-told performance of the alpha portfolio to 0.50% for the month.

So there you have it. The buy-and-hold equity position took it on the chin, the active FX carry basket emerged unscathed from the yen-cross carnage, and the active alpha overlay generated modest positive returns across sectors. All-in, it's disappointing to lose money in any month, but the size of the losses, particularly in relation to prior gains, validates the underlying investment strategy of the blog portfolio.
And while hedge fund performance indices in many cases do not capture the best and brightest of the industry (who don't need to be included to sell their services), the recent fortunes of the HFR Macro hedge fund index (the white line in the chart below) does suggest that its constituents may need to adopt a more diversified investment strategy, lest their clients tire of paying two and twenty for what appears to be an underperforming equity beta strategy.

Focus today is on European central banks, as the BOE and ECB announce their rate decisions this afternoon. Neither is expected to move, but markets will parse the ECB press conference for signs of 'strong vigilance', which would foreshadow a rate hike next month.
Otherwise, it's as you were, with the SPX putting in a 'hammer' on the candlestick chart yesterday, which suggests to Macro Man that Wave B is here. That the mysterious late-session rally may have been caused by a miskeyed futures trade is neither here nor there; Macro Man now looks for the rally to extend over the next few days. Perhaps the Fed not throwing the market a dovish bone next Tuesday will be the catalyst for Wave C to commence. Hard hats on....

Wednesday, August 01, 2007

It's time

With talk of Beazer going bust this afternoon, the death of housing has well and truly gone tabloid. Macro Man reckons it's time to bank some profits on what's been a stonking trade, so he has covered his XHB cash short at 25. He may look to sell out the SPY portion of the spread trade during Wave B.

He also bought SPY at 145.60 with the proceeds from yesterday's dividend payment.