Friday, September 05, 2008

No Market for Young Men

Anton Chigurh: What's the most you ever lost on a coin toss?
Gas Station Proprietor: Sir?
Anton Chigurh: The most. You ever lost. On a coin toss.
Gas Station Proprietor: I don't know. I couldn't say.

- No Country for Old Men

Hunting season continues apace, with an apparently ever-increasing number of punters discovering just how much it's possible to lose on the coin toss of financial markets in 2008. Another morning has spawned yet another story about a hedge fund in trouble, and yesterday saw a significant volatility spike across a number of financial markets. With the coin toss that is the US non-farm payroll report looming in a few hours' time, it doesn't look set to get any easier.

Yesterday's rate decisions passed as expected, with no change, but the ECB press conference was momentous nonetheless. As forewarned in this space yesterday, the ECB changed its collateral rules, ostensibly for risk management purposes but in reality to stop banks from drinking too generously from the ECB liquidity milk-teat.

The Bank has increased the haircut on certain types of illiquid ABS (you know, the kind that banks are most eager to jettison) from 2% to 17%; as financial haircuts go, that's dramatic as going from this to this. While the changes don't take effect until February and there is some debate as to what the literal impact of the changes will be, the psychological message is clear: European banks are in for a rough ride, and they don't have a friend in the ECB. Indeed, Trichet hit the wires this morning proclaiming that "financial stability cannot substitute for price stability."

Presumably the Central Bank of Carthage was equally pleased with the price stability that ensued after the Romans sacked the city and sowed the soil with salt.

In any event, the impact on equities was immediate; the FTSE, for example, which had been up half a percent on the day, collapsed to close down 2.5%. Price action in continental Europe was just as bad; Macro Man sold a little bit of Ibex and was up 2% on the trade within 20 minutes.
What is interesting is that with global banks likely to come under renewed pressure (year-end funding globally, investment bank earnings coming up in the US, rollover pressures for European banks), the BKX is still a lot closer to the top than the bottom of its range since the panic lows of early July. While the past six weeks have been about the destruction of relative value plays in equity (the cops have busted the equity crack addicts), we may well start morphing into a phase where the price of everything goes down.
Certainly Macro Man is structuring his book away from a primarily FX focus back towards a heavier equity concentration. While there may still be good money to be made in FX from taking the other side of Mrs. Watanabe's trades, they've come a long way and the volatility has increased dramatically- at one point yesterday Macro Man saw NZD/JPY down 5% on the day.

For those punters who have only known a relatively low volatility, flush liquidity, bull-market world, some of the price action must come as a nasty shock. Yesterday's post inquired as to remaining pink flamingos out there and generated two broadly consensus responses: long BRL and long US fixed income.

The BRL has clearly suffered over the past couple of weeks, and on the chart below looks fairly dramatic. For those of us around in the 1990's, however, the recent rally (of less than 10%) doesn't even register compared to volatility in Asia, Russia, or Latin America.

What's interesting is that the despite being an evidently consensus trade (disclaimer: Macro Man had no sense that this was the case before asking the question), US 30 year yields are rapidly approaching their lows of the century. With a large looming bill for financial system cleanup (whether in 2009 or 2010, who knows) facing the US, you'd have to think the long bond will be worth a stab from the short side at some point.
In any event, out of the money calls (correction: puts) could be quite a nice hedge against an aggressive equity short.

Ultimately, what we are seeing is the separation of the investment wheat from the bull-market chaff. As many have noted elsewhere, a lot of so-called "alpha generators" are getting found out as nothing more than beta-loving bull-market babies. In a very real sense, this is no market for young men; most people younger than 30 haven't been in any sort of responsible position when it all hits the fan.

While his recent misadventures in NZD have given Macro Man a few more gray hairs, it's his entire collection of gray that's proving useful in this crazy market.

Finally, there's at least one story of distress that should put a smile on most punters' faces: Voldemort is apparently running out of money.


Anonymous said...

"With a large looming bill for financial system cleanup (whether in 2009 or 2010, who knows) facing the US, you'd have to think the long bond will be worth a stab from the short side at some point."

Higher rates are coming, but I think we see lower rates first.

Seasonal factors tend to favor long bond positions now (not to mention money flowing there if the equity downturn accelerates dramatically).

Anonymous said...

Are US treasuries going to be the last bubble? The final frontier so to speak? They have blown a bubble in everything eles so if not why not.

Macro Man said...

Anon @ 12:00 ....a large part of the seasonality in bonds is due to the abysmal performance of equities in early autumn...which is why I suggested OTM puts (erroneously posted as calls) as an overlay to the core equity position.

Anonymous said...

"In any event, out of the money calls could be quite a nice hedge against an aggressive equity short."

I assume you mean to hedge lower long bond prices against an equity short?

Macro Man said...

See above

Anonymous said...

Another thought-provoking post, MM. I had been wondering about the real trigger point of the ECB actions and your comment about haircuts helps explain. Your comment about the due bill for bailouts is too often overlooked. See also Greenspan's piece re the "magical piggy bank." Too many in Congress appear to believe that the Fed's actions have no cost-- buy now/ pay never. Despite the above, I have been intrigued by the US long bond possibilities. Don't know whether to approach this as a macro issue (trouble ahead) or a shorter term trading opportunity. What are your thoughts on these sorts of timing issues?

Macro Man said...

Well, my ideal long term set up is to find two macro trades I like but which are un- or negatively-correlated in the near term....such as short stocks and short long bonds. Take bigger risk in the side with more short-term conviction, then overlay a cheap-ish hedge on the other one.

Run the book as a package...and when the bigger position has run its course, close it and try to make money off your hedge...which you can then build into a new core position.

All of this is easier said than done of course, particularly with respect to timing. But I wonder if equities and US long bonds might not be developing into such a set up.

Anonymous said...

Re previous post and comments:
Why has nobody mentioned long £ and € govvies? When you see what UK and European economies are headed into, there is simply no way rates will stay where they are now. CBs are insisting on seeing fall 1st, but by then we will all be in full blown recession. Now, I know what I am going to say is going to cause an uproar but here it is: this entire inflation chinwag is more a result of misplaced perception than reality. There is a medium term growth problem rather than a m-term inflation problem. The most important thing, wage inflation, is generally absent. What i find the most surprising is that core inflation did not go above 2% in EU-zone and the UK.
While BoE doesn’t have such history, Bundesbank has and it follows this scenario:
Month 1: Nope, inflation is high
Month 2: No way, not yet….
Month 4: inflation is finally down, growth –ve and then BANG! Bundesbank cut rates by 100bps. I fully expect ECB to have adopted similar rules

Macro Man said...

Anon, I would agree with that. Yesterday's post was more about what are the widely held, stale positions out there that are likely to get punished.

I personally think Schatz offers some value at 25bps below the refi rate.

Danny said...

The dollar is crushing foreign currencies, and it looks likely to continue on that path. Meanwhile, market rates on treasuries are collapsing, and it would not be surprising if the Fed CUTS rates, sooner, rather than later.

Welcome to Japan 1990, when rates hit 0 and it didn't even matter. Dollar deflation is going to continue to cause havoc in currency markets, the Euro and the Pound are going to continue to get drubbed.

Anonymous said...

I thought traders as a group would love CBs. I remember that I read somewhere that one very good rule of thumb for professional investors is to do the opposite of what the central banks around the world are doing. they are dumb, backwards-looking, herd-like investors who consistently destroy value for their “shareholders".

Anonymous said...

the buying in global, particularly US fixed income, is levered hot money getting stopped out of risky assets and parking the proceeds in short end of the curve. im fading this pretty aggressively by selling call spreads on EDH9 and buying z8z9 around 40. unfortunately i've bearish option positions on last couple weeks before this week's hot-money rally. price action post-payrolls is somewhat encouraging as well

Medium term, negative real rates got us into this mess by US government basically pushing people to dissave and lever up to buy assets. Greenspan keeping and even cutting one 25 in summer 2003 when there were clear signs things heating up and keeping rates there another year was biggest monetary policy of decade in my view, NOT cutting aggressively in 2001. Also, if you accept the premises that Fed has a growth mandate over last year during the crunch, then oil going down is growth positive and should put an offer into bonds.

Anonymous said...

Reading posts and comments gives me many ideas to research this weekend, esp in USD and Euro govvies. Thanks MM and all. US equity market here seems unable to find a bottom even though the bad news coming out has been long anticipated. In the tattered financials, LEH is under $15 and MER is close to $25, down 50% in 6 months. I wonder if MER will join LEH in sinking below the waves?

Anonymous said...

Article on Chinese CB was fascinating. I otherwise had missed it, so thanks for including the reference and the link. Any opinions about whether the Chinese will stop/reduce buys of US bonds? Are they in too deep to do so?

Anonymous said...

Appreciate you commenting on Mrs. Watanabe & Co.

Thinking it might happen eventually, I was fortunate enough to catch much of the aggressive move down on EUR/JPY yesterday. I'm beginning to wonder if the carry unwinding is pretty much played out now. All is not lost for Mrs. Watanable & Co. though as it appears the Japanese stock market is going to allow her to speculate in 25 additional currencies starting October 1st(including the Turkish Lira, Brazilian Real & Mexican Peso)

Although outside my seems a bit early to get long equities. Maybe certain cyclicals but as a whole I expect equities to take another lurch down before investors capitulate and throw in the towel. Vulture funds certainly seem to be circling carcass like beaten down assets but I haven't seen a lot of conviction yet. It's striking that anyone can be sanguine about equities in the face of what will probably be an atrocious 3rd qtr. earnings season.

When I see the extreme blood-letting in credit markets begin to abate and the massive over-hang of existing & new homes begin to dwindle...I'll become more convinced that the worst, if not behind us, is certainly more quantifiable for American equities.


Macro Man said...

Anon @ 3.12, we loved them when they had a finite amount of money and did stupid things. They still do stupid things, but with an infinite (or close enough)amount of money at their disposal, fading them is a lot trickier.

Anon @ 4.41, in a rational world they wouldn't buy so many bonds going forward....but then again, in a rational world they wouldn't have bought so many in the first place. I do think the events of the past year may encourage PBOC to move down the risk spectrum, in which case their bond purchases may be centered primarily at the short end.

Anons @ 3.26 and 4.16: agreed.

Coelocanth, per today's post I have drastically reduced currency risk and re-focused on equities, where the fundamentals remain dreadful and, in my view, unpriced.

Anonymous said...

MacroMan, isn't it logical to believe that, if the PBOC is running out of money, that Bradsher's prediction that the Ministry of Finance is going to start investing in stocks is flawed?

It seems more likely to me, reading the facts as he lays them out, that we are about to experience a financial shock as PBOC starts dumping Treasuries to raise the necessary capital.

Or do you think they can issue some IOUs to the Gulf States and cover their capital requirements?

--Charles of MercuryRising

Anonymous said...

modest skin in the game compared to you heavyweights ... but i think we are in for similar market action to the events following bear... if unnamed sources to the WSJ and NYT are to be believed, it appears that fre and fnm shareholders are toast, but pref, sub and sen creditors are safe... i think short financials will crack for the immediate future.. US equity action in financials post close suggest as much... credit spreads also seem ripe to tighten... sell the long bond and fade USD?

as an aside, post at 1:22 was much appreciated MM for a guy just getting into the business

Anton said...

run, run run. That´s one thing to be sure of. Its gonna be another bank run. 2008 or 2209 who knows. Think the one with Baltic expo. are in danger. Sweden's Swedbank looks like the most obvious target.

Anonymous said...

Market chatter this weekend seems desperate. FanFred increasing default rates on loans with "credit worthy"customers is the cause. Also, bottom fishers who bought FanFred equity (some BIG names) are in pain. Finally, Calpers is flexing its muscle vs the Black Rock guys. How this all pays out in the currency markets will be most interesting. Will stay tuned for MM views.

Anonymous said...

Hi, regular reader and poster - love the blog...thought I'd give it a go myself.
Going to be fixed income/currency thoughts and trading ideas. Appreciate any contributions/advice etc. Thanks