On the hunt

At last. September (and with it, the third quarter) is over, and we can now all hopefully move on with our lives. For some, of course, September's volatility proved fatal; while the fate of listed companies has been on the front page of the newspaper in recent weeks, there may well be bad news in the pipeline as September's hedge fund returns begin to trickle in.

So the likelihood of further apparently puzzling, flow-driven price action in financial markets appears to be very high indeed. Macro Man has asked for a couple of prices this morning, and let's just say that liquidity will have to improve quite a bit before we can label it "execrable."

Still, with September in the bag, it's time to go on the hunt for tradable themes for the rest of the year. First and foremost, of course, is stayin' alive. It's not just a Bee Gees song, it's also become a way of life for financial market punters. Focusing on risk management and market liquidity has become of paramount importance; while trading defensively can carry its own pitfalls, recognizing the downside risks before putting on a trade has never been more important.

In terms of macroeconomic themes, Macro Man is focusing on the death of the US consumer. "Never bet against the US consumer" has been a useful maxim for the past twenty-five years, but in Macro Man's view it has finally run out of rope. Current data suggests that the decline in US household net worth has not yet reached historic proportions; however, current data doesn't capture the declines in house and equity prices in Q3, which were considerable. Moreover, there is no other bubble for the authorities to inflate, as they inflated a housing bubble in the early part of the decade to offset the equity bear market.
What Macro Man has yet to figure out is how to profitably play the death of the consumer in terms of financial asset prices, given that he doesn't do single name stocks or sector ETFs.

This year, betting against the ECB has been as profitable as the historical return from betting against the US consumer. However, the confluence of financial crisis, economic slowdown, and inflation base effects have made Macro Man increasingly interested in betting on ECB/BOE capitulation. Whether this pays dividends in October or November will likely be determined tomorrow, when the CBs announce policy rates (and Trichet holds a news conference.)

While OIS markets are already pricing in easing from the BOE and ECB, Macro Man still sees value in some short end instruments. Schatz (German 2 years), for example, currently yield 75 bps under the ECB policy rate. In the US, that spread traded to -1.9% soon after the Fed started easing rates. While Macro Man doesn't expect that sort of spread in Europe, it does suggest quite a bit of downside for front end govvy yields in Europe; Macro Man wouldn't be surprised to see Schatz yields 100 bps lower at some point in the next six months.
Emerging markets going for growth is another theme that seems likely to intensify in the coming months. Again, however, the immediate asset market implications are not obvious. If EM fixed income traded purely as bonds, it would simply be a case of receiving rates in the usual high-yielding suspects. However, EM fixed trades primarily as emerging market risk, and thus is subject to global risk aversion concerns. And those can turn on the unpredictable, such as the failure of the TARP vote, etc. If, however, equities but in a sustained, multi-week bounce, EM fixed income should trade well.

As always, an open mind is important. In this market, Macro Man is trying his damnedest to remain the hunter (of investment ideas) rather than the hunted.