Monday, September 08, 2008
Having recently re-read Arturo Perez-Reverte's excellent Flanders Panel, last night Macro Man played chess with Mrs. Macro for the first time in at least five years. He discovered to his chagrin that it is very difficult to play chess with one eye on a Blackberry; the missus dusted him twice with surprising swoops that caught him badly off guard.
This morning's parallel with financial markets is obvious, of course. The announcement of the Agency bailout/rescue package/whatever it is has wrong-footed risk asset shorts, and the early anecdotal reports suggest that a few punters may be facing checkmate. Macro Man will leave the in-depth breakdown of the mechanics of the rescue to others, and instead focus his thoughts on what it actually means for markets and his portfolio.
After Friday's appalling payroll data, it looked like we were all systems go for an equity and FX carry meltdown. It certainly seems like the market deployed a lot of risk shorting stocks, EM, and yen crosses, at least during European trading. In retrospect it certainly looks like someone had the heads-up about the GSE bailout, given the sharp bounce in equities into the close. With Paulson's close ties to Goldman Sachs and Morgan Stanley having advised the government on what to do with the Agencies, Macro Man is left to wonder if the Chinese walls are actually of the Japanese paper variety.
Regardless, now that Bill Gross and foreign CBs have been made good by the US taxpayer...err....Treasury, we need to figure out what happens from here. It seems almost axiomatic that financials (ex FNM and FRE common, naturally) and broader equity markets will continue to rally for a few days. However, in Macro Man's view today's action doesn't necessarily alter the medium term dynamic.
The greatest impact of the weekend announcement will be psychological; it will do relatively little in the near term to clear the inventory of unwanted houses in the US, it could put pressure on regional banks via a hit to their holdings of preferred Agency stock, and does nothing to assuage the weak US labour market. Further afield, of course, Europe is still in a world of hurt, particularly with the financial Calvinists running the policy show.
Next week sees GS, LEH, and MS release Q3 earnings, and none of them will be helped by yesterday's announcement. Perhaps there is room for good news if Lehman can find a buyer, and of course GS will beat estimates like they always do. But overall, Macro Man would expect a fairly dismal set of figures.
Moreover, there is plenty of precedent not to expect too much support over a three month time frame from the bailout. Consider some of the "substantial" policy actions taken last year: point A on the chart shows the first discount rate cut in August (also leaked to the market a day in advance), whereas point B shows the introduction of the TAF (which was supposed to fix all the funding problems.) While each of these prompted a knee-jerk rally in equities, ultimately the fundamentals and drove stocks lower.
Perhaps more relevant is the precedent of the Resolution Trust Corporation, formed in 1989 to be the buyer of last resort of assets held by the S&L industry. The RTC's formation occurred into a decelerating economy...but the SPX didn't bottom until October 1990. It wouldn't at all surprise Macro Man if the SPX didn't bottom until next year.
While Macro Man is still organizing his views, here is a simple summary list of his thoughts on the market implications of the GSE takeover:
1) The short European equity trade should be changed to a short Europe/long US equity trade, reflecting the different policy settings.
2) US Treasuries should sell off and spreads should tighten; the Treasury is selling government bonds to buy MBS.
3) FX carry should do pretty well. We've already had a gap higher in NZDJPY, and no doubt CTAs/carry models/Mrs. Watanabe have more demand in the pipeline.
4) Macro Man isn't really sure what it means for the dollar. While he can accept that a policy response can be construed as dollar-positive, he can't help but observe that the dollar did pretty well when everything looked horrible. A "heads I win/tails you lose" scenario always makes him uncomfortable, and he's frankly happy to be largely out of currencies at the moment.
5) It wouldn't surprise to see more pain in commodity equities, if there are any more stale long energy/short financial trades out there. Macro Man doesn't have a good feel for this one.
In any event, views are likely to evolve in real time, and for equity shorts like Macro Man today is all about damage limitation. His decision to put on some short long bond deltas on Friday hasn't saved his bacon entirely, but it has at least mitigated today's pain. Once again, his policy of "hedge when it looks like you least need it" has come in handy.
Having a back-up plan and protecting key assets are of vital importance in both markets and chess. And frankly, Macro Man will take a checkmate from Mrs. Macro every time if it means that he's mounted an appropriate defense of his portfolio and lives to fight again another day.