Monday, March 03, 2008

2008: The year of....?

Holy Cow! Macro Man was away for a day and a half at the tail end of last week, and the world seems to have ended in his absence. It didn't come as a total shock, mind; risky assets can only ignore bad news for so long, and Macro Man did muse last Wednesday that equity risks were to the downside. Still....the reversal in market fortunes has been little short of stunning.

Where to begin? Thanks to all who responded to last Thursday's query on wheat. While Macro Man understands the long term dynamics behind the grain-intensive nature of protein-based diets, as well as the distortions caused by ethanol-related crop rotation into corn, neither of these adequately explain why the price has moved so much in 2008. The real reason would indeed appear to lie in increased speculative interest/participation....which itself brings a new set of MF Global can now attest. At least some of the hyper-volatility of last week would appear to be related to the unwinding of MF Global's positions.

Still....the wheat market fiasco is chump change compared to the stunning decline and fall of Peloton Partners. Peloton is a relatively new hedge fund, having been set up only a few years
ago by ex-Goldman guys, one of whom was most famous for not noticing when his secretary plundered £1 million from his bank account. However, Peloton was widely regarded as being full of smart guys...and small wonder, when one of their two funds returned 87% last year via short bets on subprime!

So it came as something of a shock to find that some of the guys who saw this mess coming have been carried away by the tidal wave of margin calls and restricted credit. While posting a picture like that to the left may be like shooting fish in a barrel, it probably tells you something about how difficult this environment is when even the guys who are short blow up. Perhaps Peloton's greatest weakness was that they didn't read enough poetry.

Macro Man, meanwhile, has received a first-hand reminder of just how difficult this game can be sometimes. Regular readers will know that he has maintained a short exposure to USD/JPY for most of the past six months, courtesy of some options that were finally exercised in December. The position has done very well indeed for him, but appeared to be stalling a month or so ago, prompting him to put on a low-risk hedging strategy that expired last Wednesday.

Well, the hedge finished in-the-money (barely)...which, combined with an additional USD/JPY cash sale, left Macro Man flat USD/JPY. Given that he knew that he'd be away from the market on Thursday afternoon and all day on Friday, Macro Man decided not to re-sell USD/JPY until he got back. In the meantime, of course, USD/JPY has absolutely cratered, and is now sitting perched precariously above a long-term double bottom in the mid 101's. %*&^!!!! It could have been worse, however...had Macro Man not hedged his hedge, so to speak, he could have found himself long and very wrong , which would have been nothing short of a disaster.Ultimately, however, last week's late volatility was a boon to the portfolio, given that it has a long implied volatility/long fixed income/short equity bias. While the returns were nowhere near as good as if Macro Man had stayed short USD/JPY, he still managed to notch up gains of nearly a percent and close the month at his high water mark for the year.
Unsurprisingly, February provided another strong piece of evidence that 2008 will be the "year of alpha". Macro Man's alpha portfolio is already up $8.77 mio this year, with particularly strong returns in equities and fixed income. Naturally, the beta portfolio has suffered mightily, but still...the year-to date return through two months probably isn't far off what one might reasonably expect to get from cash in 2008.
And as Peloton (and perhaps others) have learned recently, even a short beta position can have dire consequences if applied with sufficient leverage. On second thought, perhaps 2008 won't be the year of alpha after all. Maybe it will be the year of the Spectacular Blow Up- after all, we've already had three (SocGen, MF Global, Peloton), and 2008's just getting cookin'.


Anonymous said...

without sounding too doom and gloom have you read much on the kondratiev cycles...a favourite of many gold junkies (who have been right since the dot com bust) that real returns till the end of 2010 will be from one position. ie, long gold/short us stocks..roughly till the dow/gold ratio gets to about 12 stocks will keep falling and gold will keep rallying. the macro dynamics support this trade even though it has come a long way it feels like we are about to get a thumping on stocks in the black hawn ben fires up the choppers and the mobile printing press.....have a look at this guy anyway
can you really see the fed cutting to 1.75 as indicated by FF futures...definately time for the Eurpoeans to get out the rate cut calendar..

vlade said...

I thought Peloton tanked because they switched their exposure from short subprime to long high-quality MBS early this year - but that tanked too.

Anonymous said...

sufficient leverage....u do have a way with words...

CV said...

Hi MM,

As always, some very apt observations. From my desk I have of course also been pretty amazed by the USD/YEN. 102 and counting. I wonder whether the MOF is itching to move in although I have to say that I have changed my mind a bit on the whole intervention issue after having a talk with a guy in the comment section over at the Japan Economy Watch. The argument is summarised
here .

Basically, this guy is saying that absent of ZIRP it is 'too' expensive (i.e. 160% debt to GDP ratio etc) for them to intervene since they have to issue debt to buy up USD or any other currency. I had not thought about this before. However, I really don't know whether the argument has merit in practice.

In any case, the pounding of the USD continues and the low yielders (Swiss and Yen) outperform just about anything out there. So, this is the risk aversion/sentiment play being taken to the max it seems. My only question here would be, how long before we see the 'Dollar smile', if at all?

Oh, and one last thing everybody, watch the HUF. Any long exposure to this one needs to be reviewed I think.*


*please note that I am trying to confirm my own predictions with this one in the sense that I think (and have argued) that Eastern Europe is pretty vulnerable. But I do think that all this market turmoil will end up in Eastern Europe some way or the other and Hungary (after lifting the trading band) now seems to be a sitting duck.

Anonymous said...

3,35% ytd… not bad, pal! Your pace is between 15% and 20% by year end, after last year’s 16.52% - you’re more than a diesel engine than a macro manager!

Joking aside, you definitely need to recoup a Zen-like state of mind, since it seems to me that you‘ve been a bit self-absorbed and abstracted in these last weeks. I mean, the way you managed the January silver trade, the little mess you did with the USD/JPY trades and a bit of impatience while opening the GBP/USD and EUR/GBP trades… Your views have proven correct most of the time, which is good, but timing and money management have not been up to prior standards (did you happen to take a look at SIH8 after you closed the trade?).

You know you could have done much better, pal! Come on, MM… you’ll never walk alone!

Read you later, AT

Macro Man said...

Anon # 1: I am a bigger believer in Milankovitch cycles than Kondratiev any event, concepts like Dow/Gold rations over long term horizons are pretty spurious in my view, for reasons articulated here. impression is they were still short the subprime crap..but had always been long the high quality MBS as a hedge. The problem is that the subprime stuff had fallen so far that asymptotic considerations came into play (i.e., price can only go to zero), while there was much more room for the high quality stuff to fall in price...which it duly did. Their greater error was thinkiing that the credit crunch somehow didn't apply to them...

CV, the BOJ intervened plenty before ZIRP, so I really don't think it's that big of a consideration. The political angle is much more important, IMHO.

AT, well spotted. Something has changed in the last few weeks, though at this point I can't really say anything about it. Suffice to say, though, that while I may have made more of this volatility last year, I am reasonably satisfied with the blog portfolio performance this year, and consider that it has done its job.

(And yes, I've seen silver...and I thought it was rather Zen not to beat myself up about completely pissing away a huge potential profit!)

Anonymous said...

Nothing serious, I hope…

Anyway, “reasonably satisfied” sounds kind of an euphemism to me - yearly returns consistently between 15% and 20% and limited drawdowns (as your blog portfolio always had from its inception) are something great. I really think you should begin considering the idea of becoming your own boss, pal!

A few months ago, when gold moved a few inches below $800, you happened to write (in the comments section) that you’d rather wait until gold go back up in the $850 area and then go long with $1000 as a target, but you never follow suit. Why? As a paper-trader, I toyed selling some puts on gold back then and on silver early in January and – as you once wrote of the dollar – they are now toast.

If you were Luke Skywalker, this comment should end with something like “leave your beta behind and follow your alpha”, but I’m not Obi Wan Kenobi…


Macro Man said...

No, nothing serious...quite the contrary, actually.

Yes, point taken on the gold issue...I would say that the greatest self-criticism that I would level this year is largely missing the boat on the dollar down move...and I'd count the gold rally as part of that family of trades.

I suppose as justification, I'd say that the dollar has not been the big story this year- it's remained equities and credit, with the dollar as a second- or third- order trade.

So in concentrating on stocks and bonds, I have indeed paid an opportunity cost in not selling the buck. Next time, make sure you remind me of this stuff a bit earlier! ;)

Anonymous said...

That's a deal - I'll be in the prompt-box reminding you your own posts and comments. You know, my grandpa spent his whole life working as a proof-reader in a small publishing house…

Have a nice trip back home, AT

Charles Longfellow said...

Speaking of cows...