Non-predictions for 2008: Marking to market

Having been a sell-side researcher in the latter years of the last millennium, Macro Man knows better than most the folly of trying to make predictions and point forecasts. Amongst both analysts and risk takers, the temptation is that, having made a forecast, one selects one's facts on the basis of the forecast, rather than changing the forecast on the basis of the facts. As such, one finds as much myth as science in modern-day markets.

For this reason, Macro Man doesn't do predictions or forecasts. He does, however, do non-predictions, and at the last year wrote down a list of stuff that he thought would not happen this year. Given that he is in an introspective mood, now seems as good a time as any to mark his views to market as he tries to determine how he's gonna make money for the rest of the year.


1) Oil will NOT rise 60% in calendar year 2008, or 100% peak-to-trough during the year. Oh dear. In retrospect, Macro Man underestimated the degree to which the three axioms and the dollar down bubble would drive commodity prices, and overestimated the degree to which US consumer demand destruction would cap energy prices. While oil has not yet rallied 60% this year, it is on pace to do so. By any possible criterion, this has to be called a MISS.
2) VIX will NOT hit single digits again. The first month of the year, this looked like a dead cert to be right. However, since March equities have ground higher, sending VIX deep into value territory for those who believe that the world financial system and economy are not out of the woods yet. All Macro Man knows is that every single option/option strategy that he has purchased since Easter has finished out of the money. Ugh. For now, the JURY IS STILL OUT on this call, though a grind to 1500 would likely render it a miss.

3) Inflation will NOT die as a macroeconomic issue. Food riots. A hawkish ECB. 15 year high CPIs across Asia. Some US inflation measures at their highest point in more than a quarter century (the chart below shows the average 1 year Michigan inflation reading alluded to in the weekend special.) This can only be called a HIT.
4) China will NOT step-reval the RMB. The first three months of the year, it looked as if they wouldn't need to, as USD/RMB tumbled at a nearly 20% annualized pace. Since then, downside progress has ground to a halt, although curiously it has begun to fix lower again after the recent spec goolie-squeeze. Regardless, it appears as if policy-makers remain content to operate within the current regime, so for now Macro Man calls this a tentative HIT.

5) The BOJ will NOT hike rates in 2008. The irony of this prediction is that underlying Japanese CPI inflation is at its highest in nearly 15 years, and the nwe BOJ governor was the first to vote for rate hikes. Yet the deterioration in Japan's domestic economy, along with ongoing strains in financial markets, make it unlikely in Macro Man's mind that the BOJ will pull the trigger. Still, markets are pricing greater than 50% chance of a rate hike by year-end, so the JURY IS STILL OUT on this call.

6) GBP/USD will NOT make a new high in 2008. EUR/USD zoomed through its old highs with ease this year, peaking at a level 7% higher than its previous high. GBP/USD hasn't come within 3.5% of its old high, meanwhile, as Macro Man's bearish UK view has been realized and priced by the market. A HIT.

7) We will NOT see an honourably fought US presidential election with the outcome determined by the issues. The Democratic primary season has already rendered this one a HIT.

8) We will NOT see a US recession in 2008, as defined by the NBER. D'oh! The miss in number one forced Macro Man to change his view on this one fairly early on in 2008, as running the numbers forced him to conclude that the US consumer is finally stuffed. While the official figures and the stimulus package may forestall an NBER announcement this year (but then again, looking at the labour market, maybe they won't), the very fact that he had to change his view early in the year renders this one a glaring MISS.

9) Japan's MOF will NOT intervene in currency markets in 2008. USD/JPY dropped 11.5% in three weeks, going below 100 for the first time since 1995...and the MOF still didn't intervene. While the year isn't over, Macro Man will still chalk this one up as a HIT.

10) The Shanghai Composite will NOT rise another 100% in 2008. Wow. Macro man isn't sure what is more remarkable; the degree to which his relatively bearish view on Chinese stocks has materialized (the Shanghai Comp's down 31.5% YTD!), or how little it's mattered. Suffice to say that the market has had bigger fish to fry...Macro Man cannot remember the last time anyone mentioned Chinese equity indices to him, despite the currency shenanigans and the tragic earthquake. A HIT, but something of a hollow one. So there you have it. Six hits, two misses, and two "jury still outs." It would be a pretty good scorecard for a set of predictions; for a set of non-predictions, it's less impressive. That's particularly the case given the two that have missed; getting oil and the US economy wrong has meant some missed opportunities so far. Ironically, however, even getting everything right wouldn't necessarily have been much help over the last couple of months; being bearish on the UK hasn't exactly been the path to riches in short sterling, for example.

Markets are, after all, all about Keynes' beauty contest; it's more important to figure out which way the market will change prices than it is to get the economics right. Over time, of course, one should expect a good correlation between economics and prices. There are times like the present, however, when the Keynesian beauty pageant is chock full of nothing but mingers.
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15 comments

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Anonymous
admin
May 19, 2008 at 12:56 PM ×

mm, how would you recommend someone playing the vix to use that thesis that you said volatility is back for good, this looks like one of those dips that should be bought.

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Macro Man
admin
May 19, 2008 at 1:07 PM ×

The simple answer is "buy index puts"....the slighty fancier answer is "buy index puts, delta hedged."

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t
admin
May 19, 2008 at 1:11 PM ×

Any thoughts on maturity on that downside vol?

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Macro Man
admin
May 19, 2008 at 1:23 PM ×

Not a strong view at the moment- my large/cap small position has a payout profile similar to long vol, with the added benefit that it doesn't decay (thereby requiring further purchases as time passes.)

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Anonymous
admin
May 19, 2008 at 5:49 PM ×

At this time of year, with la liga closing its doors for the year, there take place some curious celebrations. On Sunday, Osasuna fans feted their failure to be relegated to segunda - the loyal gladly forgetting for a moment that last year they qualified for the Champions League eliminations and, failing in first round there, made it to the UEFA Cup semi's.

Think about explaining any of that to the citizens of Pamplona last night.

CB

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D
admin
May 19, 2008 at 5:57 PM ×

The best options guy in the business is riskarb at fattail.org.

FT is not a site for trolls, it's a serious options forum and not for beginners. Great source if you are unfamiliar with trading exotics also.

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Macro Man
admin
May 19, 2008 at 6:19 PM ×

Thanks, D. I made my professional bones trading FX options, but am still a tourist in equity vol markets.

CB, I watched Zaragoza go gentle into that good night last night with the Macro Boys, who are suddenly football mad and jonesing for a fix with the Premiership and FA Cup finito.

As none of the three passports in our house are represented in Euro 2008, we've opted to support Sweden, land of 1/4 of my antecedents...

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D
admin
May 19, 2008 at 7:23 PM ×

Riskarb started his career at CRT if you are familiar with the former (sold) Chicago options powerhouse. He eats, sleeps and breathes greeks.

He keeps a trading journal (equity and fx trades) and relishes critiquing other people's trades...the upside is you gain a much better understanding what the hell you are doing.

OTOH - RA is very independent and doesn't make a very good employee Right now short equity vol. via short flies.

LOL

:)

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Macro Man
admin
May 19, 2008 at 7:45 PM ×

I'll check him out. I am familiar with CRT, having started out in Chicago for a rival firm.

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D
admin
May 19, 2008 at 7:51 PM ×

No kidding, which one?

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Macro Man
admin
May 19, 2008 at 7:57 PM ×

O'Connor. I started as they were joining up with Swiss Bank; half of us worked for SBC, and the other half (the parts of the biz that needed section 20 approval) still worked for O'Connor.

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D
admin
May 19, 2008 at 8:20 PM ×

Nice, I have a few friends that came out of CRT. There has been a lot of consolidation in the market-making business. O'connor via Fortis, Susq, Wolverine, Citadel, Timber Hill are still going at it though. IBKR (Timber Hill owner) is the closest thing to a pure play on market-making these days, I keep it now for a personal holding...bought the August/March dips.

Globalization and technology are creating some big opportunities in the market-making space.

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Macro Man
admin
May 19, 2008 at 8:42 PM ×

I remember 15 years ago, Timber Hill guys making option prices off of multicoloured patters on TV monitors. We thought they were tools, but I guess they've stood the test of time...

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D
admin
May 19, 2008 at 9:49 PM ×

You mean like this:

http://img255.imageshack.us/my.php?image=2wkprofilexq7.png

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spagetti
admin
May 20, 2008 at 10:23 AM ×

have the feeling that the next pink flamingo will be EMERGING EQUITY MARKETS..

after watching Chinese stocks last night and the European EM indices this morning, I have the feeling its all aabout to fall off a cliff..

what do you guys think ?

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