Thursday, July 10, 2008
One of the refreshing things about this business when you run risk is that you have a very clear criterion of right and wrong: your P/L. Now, for a (M)acro (M)an, it is the medium-term evolution of his P/L that is the statistically significant criterion in determining the accuracy of his views. As he has explored in the past, short-term swings for even the most astute of traders are largely random.
That said, on a short term horizon Macro Man's decision to cover some more of his equity short was clearly wrong, given the meltdown in the US last night. In many ways, of course, being wrong is not unexpected. Macro Man's style is to scale into positions as conditions become more favourable to his views, and scale out as conditions become less favourable (more on this below.) Whilst employing such a strategy, it is highly likely that some profit-takes will go offside.
Still, Macro Man cannot help but laugh at what passes for analysis these days. Yesterday, he received a Bloomberg message from a large bank before the US open, trumpeting that one of their analysts was looking for a 10-15% bounce off the lows in banks stocks.
Mind you you, this came the day after a $4.19 rally in the BKX. Hmmmmmm. When Macro Man did a bit more digging, this call became even less insightful. Measured off of Monday's low, the BKX had already rallied 10.1% from its lows. Gee, thanks for the heads up there. Of course, yesterday the BKX rallied another half a buck and then collapsed. So while this chap may have technically been right in analyst world, under the more exacting microscope of a P/L one cannot help but think that his call would have been proven disastrously wrong.
In any event, Macro Man stands by his view that conditions are making equity shorts less comfortable to hold. Intraday volatility has risen dramatically, particularly in comparison to close/close volatility. Frankly, Macro Man isn't whether this heralds a bounce or collapse. To get a flavour for how this choppiness relates to historical precedent, he constructed a "choppiness index" for Eurostoxx, which compares the average daily range with relatively recent price history.
He calculated this index back to the beginning of 2001. When he ran the numbers, he found that the recent price action has been in the 99.5th percentile of choppiness over the past seven and a half years. Yowsah! No wonder it's been so confusing!
Although Macro Man hasn't performed an exhaustive study of how prior episodes of chop have resolved themselves, intuitively it makes sense that they would produce either countertrend moves (as directional positions are covered) or high-volatility continuations (as trend faders/Maginot Liners give up the ghost.)
How the present period of chop ends will likely depend on earnings season. Given that modern corporate earnings announcements are little more than a public exercise in creative accounting, Macro Man has little wish to go in with heavy positioning in one direction or another. Far better to flatten exposure and remain nimble, adjusting the view as fresh data emerges. And with that game plan in mind, even though yesterday's profit-take was the wrong thing to do in the micro term, from a more strategic perspective it was right.