My least favourite kind of market

This is Macro Man's least favourite kind of market. Volumes and interest are low, noise to signal ratios are high, and the last order is what drives the price. These are summery, trading markets....and for a "signal trader" like Macro Man, there is the inevitable frustration of losing money for no apparent reason. In this environment, most positions don't have a chance to grow into pink flamingos; they get taken out when they're still pink hummingbirds.

Sadly for Macro Man, there do appear to be a couple of flamingos out there...and at least one is lurking in his portfolio. The last couple of days have seen a pretty dramatic outperformance of small caps, as proxied by the Russell 2000, over large caps (measured any way you like.) This rally has come just after the Russell index appeared to be breaking through support last week. Macro Man's only consolation is that volume has been modest at best (indeed, yesterday's NYSE volume was the lowest for a non-holiday in more than a year), which is symptomatic of bear market rallies.
Another pink flamingo has been the short sterling strip, an accident that Macro Man has thankfully avoided. Today's CPI print in the UK, which (un)comfortably exceeded expectations, now means that Swervin' Mervyn will have to write a letter of apology to Alistair Darling...representative of the same government that recently said that the Bank could trim rates due to low inflation. D'oh! In any event, the selloff in the strip has been extraordinarily painful; at the timing of writing, neither short sterling nor SONIA is pricing in much chance of another rate cut this year. Such a development on a day when the RICS survey showed a record balance of surveyors expecting lower house prices is remarkable.
If anything, though, the UK's conundrum merely provides supporting evidence for the axioms of globalization. Yesterday's PPI data was extremely interesting; input prices reached their highest rate of inflation since 1980, and appear to finally be feeding through into output prices. This, in a nutshell, is why Macro Man feels that the ultimate impact of globalization is inflationary.
Further evidence comes from British Petroleum, which publishes annual estimates for energy consumption. To illustrate how the US has moved from a quasi-price setter for energy to a price taker, he plotted the annual change in energy consumption (as measured by millions of tons of oil equivalent) for the world, the US, and China. The result was instructive; US energy consumption is broadly unchanged since the end of 2000, whereas that of the world has surged higher, powered by China.
Small wonder that the oil price has managed to surge despite the US slowdown...and small wonder that most macroeconomic models have underestimated inflation over the past few years. Ultimately, the signals from these trends should remain very powerful indeed, and Macro Man looks forward to markets where the noise recedes enough to trade them.
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jdc
admin
May 13, 2008 at 10:53 AM ×

He should be writing a letter, but I am given to understand that the tolerance band is up to 3%, so he has until 3.051 before he actually has to write, sadly.

Hike next month please, Merv!

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d
admin
May 13, 2008 at 2:39 PM ×

Hi,

I noticed that you stopped posting your portfolio setup. Last time you did it on March 18th.

best regards,
d

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David Pearson
admin
May 13, 2008 at 5:14 PM ×

Macroman,

One thing I wonder about: will markets ever stop having a deflationary reaction to inflation news?

What I mean is, UK inflation is bubbling, and that should mean higher nominal rates, a weaker currency and higher gold. The same holds true for the U.S. (see import prices). Yet the reaction of the markets is generally to look past inflation and towards what the Fed/BOE might do about it: tighten. Okay I understood this in '05, when the Fed still had some credibility and inflation was not in headlines every day. But now? With negative real rates again? The more inflation rises, the more accommodative monetary policy becomes, without any CB action.

I ask because if the tone changes, if inflation news is greeted as a signal of higher inflation ahead, then bond yields will have a lot of explaining to do.

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Macro Man
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May 13, 2008 at 6:08 PM ×

David, I think the typical market reaction to inflation has been because in the post-Volcker era, CBs typically have responded credibly to inflation .

It seems to me that some of that credibility might be wavering- in the US, of course, but look also at the reaction of UK markets to today's CPI print. And price action in bonds today has been unpleasant for the longs, I can assure you.

Insofar as inflation in the West is being driven by the three axioms of globalization, one might credibly wonder what impact that tightening to meet an inflation target could have, when inflation is not being driven by domestic demand. Indeed, I am starting to wonder if we are about to see the end of inflation targeting as we know it....might CBs start to target something else...like nominal GDP growth, perhaps?

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D
admin
May 13, 2008 at 8:17 PM ×

Re: Central Bank Targeting

If there is one thing we should have learned in the past 30 years, it's that economists targeting anything will be wrong eventually. Furthermore, their targeting creates distortions in the economy that destabilize it.

Monetary Base Targeting
Inflation Targeting
Growth Targeting

Just get rid of the CB completely.

PS - The US FRB has started the shift to a growth target with its dual mandate...unlike the ECB.

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Mr. Prop
admin
May 13, 2008 at 8:33 PM ×

First, the inflation debate is between those with faith in the Phillips curve and the M-squared argument that globalization is at the end of the day inflatinary. What I would say is that buying 5y5y breakevens is a nearly free option on central banks losing inflation credibility, which in my mind was undeserved anyway. They were just lucky thanks to the 1990's secular forces of globalization and technology which are fading. At least G-spin was right about that even if he is responsible for this one fine mess we are in now - so much for serial bubble blowing as a cornerstone for setting monetary policy. Second, the theory that higher oil prices, higher stocks, and higher bond yields being an unsustainable correlation is so far unproven. This correlation can persist in an inflationary boom, but surely this is unlikely in the face of growing overcapaity in china, global credit crunch, energy prices, and a popping of the housing bubbles just about everywhere. As for oil, the greater fool theory dominates. Despite negative fundamentals of weakening global demand and a heck of a lot of supply coming on the market in 2009, it is just about money. Calpers wants to put 7.2bn in commodities by 2010. This is on top of the 250bn ish that is already in the asset class, a whopping 5-fold increase in 3yrs. When does the "Emperor has no clothes" moment appear. You know the one that wasted the Dow in 1929, Gold in 1980, Nikkei in 1989, the Naz in 2000, and Chinese stocks in 2007. I recognize that understanding the fat tail risk on the oil spike is impossible. I thought oil topped on Monday, but so far I look like an idiot, just another idiot which the momentum traders count on to short it and then buy it back higher. I ask when will it become obvious to the collective and deluded masses that buying crude oil at these levels is no differnt than buying Dutch Tulips...Mr. Prop is frustrated, sorry for venting....

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D
admin
May 13, 2008 at 11:06 PM ×

Mr. Prop -

The oil trade is definitely in strong hands right now... I have been on the wrong side of the table as well. I am targeting shorts on energy companies who are negatively impacted by the parabolic rise in spot crude. It's the same momo money that's following the strong hands in crude.

XOM's lack of participation is intriguing.

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Mr. Prop
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May 14, 2008 at 8:48 PM ×

d-

Any record of XOM leading crude. I am in hope mode and will take any carrot on offer

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D
admin
May 15, 2008 at 1:18 AM ×

Mr. Prop -

Nailing the top is:

10% Knowledge
25% Cojones/Lunacy/Chutzpah
65% Luck

How much leverage are you trying to use on the trade? You might look at DUG to avoid theta and margin risk. Eliminating time and house risk can do a lot for you.

PS - Did you hear that Calpers CIO is gone AND the CEO is leaving June 30? Rats jumping ship...

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Gábor
admin
May 15, 2008 at 8:55 AM ×

There is a massive supply accumulating of low quality crude accumulating in Iran's ports on rented vessels. About 2o million barels of suplly in just over a month. Isn't first the lowest quality supplier expected to have inventory problems?

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