Tuesday, June 03, 2008

A bad hair day

This morning in London is one of those gray, damp affairs where the relative humidity feels like it's 101%. On such a morning, it's a bit unpleasant to be stuck on an unventilated, un-air conditioned train that's slower than usual, as was Macro Man's lot today. Back when he sported a more luxurious barnet than the current "number three all over", today is what would have been called a bad hair day. An early 90's Jaromir Jagr, pictured left, illustrates just how gruesome this can be.

After yesterday's S&P downgrade of the banks and the latest Lehman rumours, Macro Man wonders if risk assets aren't in for a bad hair day as well (if not a bad hair week and/or month.) Now some, including regular reader Mr. Prop, are putting some faith in "turnaround Tuesday." To be sure, yesterday's late session SPX rally took away some of Macro Man's bearish glee, and the relative resilience of European equities in early trading (spurred by TCI/RBS rumours, perhaps?) hardly suggests a further dump in stocks. But still, consider the following items of interest:

* Bonds making a comeback? Just like James Bond always escapes the villain's clutches (except in the book You Only Live Twice), bonds have launched an impressive rally over the past couple of days. Overnight, 5 year JGBs literally put in the rally of the century, registering their biggest trough-to-peak gain since 1999. That's not exactly what you'd expect to see when markets are defensively positioned and/or willing to overlook bad news. Macro Man himself managed to scoop up some JGB futures overnight, as recent data has been poor and 10yr US-Japan yield spreads are near their lowest levels since 1994.

* A double top in key equity indices? The NDX failed on a retest at last month's highs, yet is close enough to those highs to offer a good risk/reward short. The obvious near term target is 1944, a break of which would target a move to 1850 or so, closing the April 17 gap. Equally ominously, the SPX is putting in a very rare and very dangerous formation.....
* Inflation: here, there, and everywhere. Regular readers will know that inflation has been one of Macro Man's key macro themes virtually since the foundation of this space. Inflation is making long-term highs in just about every country that either a) has no 90's record of hyperinflation, and b) doesn't fiddle with its index calculation to systematically reduce the level of inflation. The latest shoe to drop is in Switzerland, where May CPI rose 0.8% m/m and registered its highest yearly increase since 1994. And both history and Macro Man's own research suggest that inflation is not a positive for equities and, by extension, other risk assets.


* Remember when? Remember the carnage of spring 2006, the last time that there was a legitimate inflation threat priced by markets? There was an initial leg lower in May, then a recovery. But in early June, Turkey reported an awful inflation figure, which helped kick off an absolute rout in emerging markets, which in turn helped feed back into lower developed market prices. Well, guess what comes out at 3 pm today? That's right, Turkish inflation figures. EUR/TRY has come quite a bit lower in line with the recent equity rally, and last Thursday/Friday probably squeezed out any remaining longs. Macro Man has been running a short delta position through options, but has hedged it out to be long volatility.
If it really is going to be a bad hair day for risk assets, long vol in an uber-risk asset doesn't seem like a bad position at all.

22 comments:

spagetti said...

i been looking at the turkish stock market and TRYJPY charts
both seem to be about to tip over into bear territory.
TRYJPY is i suppose still a favourite domain of carry/option traders

Macro Trading Ideas said...

Inflation dictates direction in most asset classes, and it seems to me that is better to remain in cash or at least to carry the highest rate as 3M Euribor.
But now I'm wondering why spread SPX-Russel2000 is moving in favour of small cap?? In a risk-adverse environment as in these days and with the background that small-caps have far less pricing power than large-cap, how can they outperform?
The worst thing is that a lot of previous correlations don't work anymore (for example 2yr yield vs equities vs oil).

Macro Man said...

MTI But now I'm wondering why spread SPX-Russel2000 is moving in favour of small cap??

Another way to ask this is |"why is there a big hole in Macro Man's portfolio where a percent of P/L used to be?"

Sadly, I don't really know the answer to either question, as small caps seem to be outperforming regardless of underlying market direction. Given the travails of fixed income RV strategies recently, however, is it a huge shock that equity RV has come unstuck as well?

Macro Trading Ideas said...

ahah...No, it's not a shock, but I'm not happy to lose money too.
And about financial cds narrowing today after downgrade?? and about big reversal today on Euro FI??
The only trade for me now, also if with a few risk, is 10yr EU/USA,at new wides..

AB said...

The recent outperformance of the R2000 has been very frustrating. A lot of it is coming from energy and financials. R2000 energy stocks were up 15% in May compared to 3% for SPX energy. R2000 financials were close to flat versus -6% for SPX. I guess I can see a fundamental case for both of these but it seems overdone. Small-cap energy stocks seem to outperform large-caps even on days that oil falls.

Anonymous said...

@MacroMan:

The black swan thing you were referring to as an ominous pattern was a joke from a post on EliteTrader so referring to it as "yet another signal of bad things happening" in your post might not be such a great idea.

Just a heads up.

Macro Man said...

Anon @ 2:38 Yes, I know it was a joke. It's been all over the market this morning. For those somewhat bemused by the recent deification of Mr. Taleb (or at least me), it was pretty damned amusing....

Anonymous said...

Turkish inflation prints 1.5% and into a double digits for the year. However the price action does not seem to indicate a big effect on the EUR/TRY.
Is market so optimistic about the hikes - a 50bp hike in May did not help much.

Macro Man said...

I had 10.7% y/y in the office pool...bang on! I would rather have been badly wrong on the CPI and gotten the bloody currency right, rather than spot on with inflation and 3 big figures out of court on my EUR/TRY hedge.

sargon TM said...

One difference between small and large cap that I haven't heard mentioned is cash (or cash equivalents) on the balance sheet.

Small caps and unhealthy big caps don't have it: "healthy" big caps do have it. In the reports of sell-side analysts cash on the balance sheet means "safe" and "able to take advantage of opportunistic situations". We're supposed to think it's something good.

But does it really mean that in 2008? I don't think so: I think it means, WTF is "cash equivalent" hiding? People who think that way probably see being cash poor as a benefit, and are more willing to bet on small cap in 2008 than they were in 2006.

sargon TM

Macro Trading Ideas said...

@ab and sargon:
i've tried to analyze better Russel2000 and as cap-weighted index i see that running components are integrated oil and other energy sector, that are driving this index. The only thing that i can't find on BBG are sector weights, but it seems that the sum is higher than in spx..
so if it seems similar to FTSE100, we need a deeper analysis before to bet on a index to get a view on the economy behind.
About cash, small caps needs cash to finance their growth, more than large-cap that usually are FCF generator, but it works in textbooks, on reality, in term of asset prices, i don't know...

D said...

When in doubt, go to the source:

http://www.russell.com/Indexes/characteristics_fact_sheets/US/Russell_2000_Index.asp

Oddly enough, R2K's top sector weighting is financials. What an upside down world we are living in right now.

Macro Man said...

Trust me, I went to that site before I put the trade on, and it's one of the reasons I loved it so much (and added when it started working.) So you can imagine my frustration (and the number of four letter words uttered) as I have seen the banks go to new low and my R2K short (replete with 'small enough to fail' fin services companies) makes new highs!

AB said...

The R2000 has a lower weight to energy than SPX (4% versus 9%), but relative performance has easily overcome the lower weight. Financials are 17% of the R2000, and about a third of that is in REITS. REITS didn't help the R2000 much in May, but have contributed about 20 bps of SPX outperformance ytd.

Banker said...

A change in subject here but I am came across this...Buy one get one free Housing....Is this the beginning of the end ?

http://www.usnews.com/blogs/the-home-front/2008/6/3/buy-a-home-get-one-free.html

Macro Trading Ideas said...

I'd prefer to remain into my ignorance, now i'm also really angry!!
Just to note, yesterday has been another nice outperforming day... wow!!!

spagetti said...

have the feeling we could be in for a bad day in EM today

spagetti said...

another parallel with USDTRY in 2006 and Turkish inflation..etc

hearing from sales that israeli banks buying USDTRY in option related flows..

for those who remember the 2006 EM selloff will surely have a deja vu feeling

(although this time the israeli option positions in usdtry maybe a lot smaller than they were, given how badly one gentleman got burnt back then)

Macro Man said...

Spagetti, speaking as someone who's sitting long vol (via a rather expensive to carry spot hedge) in TRY, one man's "bad day" is another man's "thank f*** it's moving"!

Anonymous said...

So whats the verdict, is this SPX-Russel2000 thing The Worst Idea In the World or is it going to turn around with a vengeance? Or neither?

Maybe like the Economist and the US dollar, BCA Research ruined it by publishing this on their website:

The bounce in small cap vs large cap is over.

Timing doesn't get much worse than that.

Macro Man said...

No, I think long short sterling is (or has been) the worst trade in the world. However, for a supposedly non-directional, slow burn RV trade, this can't be far off, for the last month at least.

My strategy is to keep a tiny position so I always know where it is and how it trades; eventually, think it will be OK, but picking this bottom will definitely foul one's fingers. I won;t add again til the bloody thing starts working again.

Anonymous said...

"number three all over"

that's what i do! self-administered :P