Monday, November 03, 2008

Comedy or Tragedy?

So......while markets expected Friday's fixing/rebalancing to be the tempest of a lifetime, at the end of the day it was much ado about nothing. Still, it brought closure to a month that was bloodier than Macbeth for many punters, and ultimately may consign more than a few to a grisly fate a la Romeo and Juliet.

In any event, everyone's MTD column has rolled back to zero, and markets are now entering the stretch run into the end of the year. The backdrop remains one of turmoil, and the midsummer night's dream of a resolution to the crisis has been rolled forward into a bull's winter's tale of how the SPX (and other markets) now offer attractive value. Colour Macro Man skeptical; the arguments in favour of attractive equity valuation are not as black and white as the pieces on an Othello board. Indeed, comparing the current market measure for measure with the past does not offer a lot of encouragement.

The ECRI US leading indicator has crashed back below the lows seen during the last recession; an equivalent out-turn for SPX earnings would taken them down 60% from current levels (and 75% from the consensus expectation for 2009.) So while Macro Man can see the argument for renting an equity long as a trade, he's not sure if he'd want to hold it past the twelfth night.
This week also sees the latest episode in the comedy of errors that has been economic policymaking in Europe. The ECB will almost certainly cut rates, probably by half a percent; unfortunately for M. Trichet and co., it probably comes too late for the merchant of Venice or two gentlemen of Verona.

Similarly, the Bank of England will cut rates, with expectations ranging from 50 bps to a full percent. Macro Man had a chat with his mortgage broker over the weekend, as his current deal expires early next year. The deals on offer made grim reading; despite having very little leverage in his mortgage, Macro Man is looking at an effective rise in his borrowing rate of 1.5% over his current deal. Borrowers with less equity and a greater loan-to-income ratio are no doubt getting squeezed even harder. So while the merry wives of Windsor (the Queen, Camilla, et al.) may not be in any trouble, your average UK mortgage holder (as well as Europeans like Timon of Athens) is facing a very significant squeeze.

And something still appears to be rotten in Denmark; witness Danske Bank's special access to the Fed's liquidity milk-teat, announced last week. Someone needs to get Hamlet on the phone and figure out what the hell is going on there. EUR/DKK has fallen back towards the bottom of its range, which to Macro Man looks like a cheap way of playing a relapse into crisis.

Because from his perch, the situation with the global economy just looks worse and worse. Over the weekend China's PMI sank to a level well below 50, indicating a manufacturing recession. There isn't much history to the survey, so at this juncture it's difficult to judge how significant the reading is. Still, the fact that the authorities have relaxed restrictions on bank lending, essentially telling them to "lend as you like it," is telling. How effective this is remains to be seen.
And of course, Tuesday sees the US elections, where we'll finally know the identity of the replacement to the current US administration, whose terminus is as widely anticipated as the government of Julius Caesar. There appears to be some sort of belief, particularly on this side of the Atlantic, that the election of St. Barack will effect some sort of immediate improvement in the state of the US economy and the market.

Such a belief is probably misplaced; even if the calibre of leader goes from King Lear to Henry V (and that remains to be seen), it will be a long, hard slog out of the current mess. Looking at prior revolutionary leaders of the past from both sides of the political spectrum (FDR, Reagan/Thatcher), there have been several years of pain and generally poor market performance before things meaningfully and lastingly improve. (Of course, this assumes that McCain and Palin are dispatched like Antony and Cleopatra, but at this juncture that seems like a safe bet.)

Of more immediate interest is the summit in mid-November, where the G7 will discuss changes to the global financial architecture. France has been particularly vocal in agitating for change, with both President Sarkozy and Finance Minister Christine Lagarde regularly appearing on the wires in recent months. For those countries who seek an evolution, rather than a revolution, of the world's financial system, the taming of the shrew (and her boss) will be an imperative for the summit.

Ultimately, the decisions taken at this summit could be crucial in determining the future of the global financial system and, by extension, the world economy. Dirigiste or market-based? Inclusive (giving China, the GCC, et al a seat at the table in exchange for an end to piss-taking) or exclusive? These issues are pretty critical to the future of those of us in global finance, and it wouldn't surprise if the negotiations are as bloody as Titus Andronicus.

When the history of our times is written, these decisions may well determine whether the next decade or two end in comedy....or tragedy.


Anonymous said...

even the bloomin' lex column thinks stocks are rich...

Anonymous said...

I actually live in US and have never heard the 'St. Barack' comment. Maybe you have some bias to discuss...........
Anyway, give whoever gets elected a chance, before you decide they suck.....

Macro Man said...

You probably haven't heard it because I made it up. I am more than willing to give the new president a chance; I am, however, bemused by the unquestioning adulation that he has received in Europe. (BTW, where exactly did I say he sucked?)

luther said...

another brilliant post MM.
love the shakespearean allusions.

to attempt an answer to your title question: perhaps it's not a choice between the two but like the other strange bedfellows, it's rather an unique combo of both?

black & white
left & right
up & down
short & long
capitalism & socialism
comedy & tragedy

if so, then perhaps a reading of the kalachakra tantra may serve to develop a successful trading strategy?

remember in the times of shakespeare, the men also played the women characters and in many of his plays, some women characters (played by male actors) protrayed men.

Anonymous said...

MM it will be worth your while to do some digging in the Kingdom of Denmark.

There is a huge ARMS reset coming up in December. The mortgage bond market in Denmark is in a terribly bind.

John said...

Felt like I was back in high school literature. Absolutely great post. By the way the St. Barack comment is once again perfect.

gramps said...

Its hard not to argue that tragedy will prevail when you read pundits on both the buy and sell side arguing for more rate cuts. This is a classic example of fighting the last war.

All over the U.S. and Europe, "investors" are massively over-leveraged (over-geared in British phrasing). Consumers are even more over-levered. There is legitimate doubt whether borrowers can service their existing debt, never mind take on new debt.

Anyone who was awake in economics class will tell you that increased risk requires INCREASED interest rates, not lower.

But somehow we still have pundits arguing for the Fed / ECB / BoE to lower interest rates....

If I didn't think you were solvent enough for me to risk lending you money at 4% interest -- what would possibly make you think I would want to lend to a risky borrower at even lower rates?

In a period where everyone needs to de-lever (reduced borrowing) and credit risk has increased -- we still have "analysts" supporting Keynesian / Greenspan policies of lowering interest rates.

Bad banks must be allowed to fail. Bad managers must be thrown out. Bad fiscal policies must be abandoned. And the "baby boomer" generation needs to grow up and start living within its means. Stop trying to stick the next generation with your bills.

BTW -- if you read the op-eds and political blogs in the U.S., the majority of voters do not favor Obama... rather they are anti-Bush. Its hard to argue that Bush was anything other than bad -- but he isn't in this election.

It was mind boggling that thousands of Europeans gathered in Germany to "cheer" Obama -- given that almost no one in the U.S. (never mind Europe) knew he existed a year ago. He doesnt represent any change in political philosophy the way FDR or Reagan/Thatcher did. He is simply the Anti-Bush.

I don't like McCain either -- but its worrying that people are pinning so much hope on Obama based primarily (if not solely) on his being from a different political party than Bush.

Anonymous said...

of course equity is rich...just give a look to yields of corporate bonds, why should I buy equity with those yields around?
but as for a bear rally, no problem at all...

Anonymous said...

In a recent FT article on the possibility of deflation, a board member of the ECB, Erkki Liikanen (or Likkanen as his name was consistently misspelled), seemed somewhat worried about it. So, major rate cuts coming up soon and continuing through 2009?

Mike said...

There once was a Man named Macro

Who wrote a Shakespearean column that was crap-o

With allusions galore

It read like a bore

But in the end it was really just so-so.

Macro Man said...

Mike, if you're going to come on this site and insult me, could you at least do a bit better than that?

Anonymous said...

Obama is not a saint. However, he is probably smart enough to figure how to unravel this mess. This is not something one can say about his opponent, and especially about his opponent's understudy.

The prospect of an end to the reign of Little Caesar only makes one feel sunny inside if the successor is a noticeable improvement.

I feel the warming tendrils of optimism for the first time 2000. AND scored a 34% daytrade (AFTER taxes and fees) this morning, an event which cannot help but warm the heart.

--Charles of MercuryRising

Adrem said...

We know of your brilliance on the markets but competing with Harold Bloom on Shakespeare is quite a surprise. And I like the riposte.

Reader says raise rates rather than cut them?.....Rate cuts are not for you and me but the banks to help them patch up their balance sheets which they ripped to shreds with their egregious credit strategies. That's why they know they're in a win-win. Moral hazard? That's for people from Venus. Bankers are from Mars.

Anonymous said...

... the election of St. Barack will effect some sort of immediate improvement in the state of the US economy and the market.

In Fact the opposite will happen: Once congress is elected they are immune until the next election. They don't even have to appear to care for a long while and since the economy is already screwed there is opportunity in screwing it some more.

fajensen said...

The mortgage bond market in Denmark is in a terribly bind.

Mostly thanks to the idiotic Danish government who felt the urge to create a 'bank stabilisation plan' - complete with side effects - to feel included in the good company.

I can get 6.75% on a year deposit in the bank, loosing only the excess interest on early withdrawal, guaranteed in full by the gubmint.

Why indeed should I buy the crappy F1 mortgage bonds at less than say 8% yield then considering the trouble with tax and all?

Or - why should I not also take out the biggest fixed interest 7%, 30 years mortgage I can possibly get and stash the proceeds in the bank?

If long rates move higher my mortgage will drop exponentially in value so I can buy it back in the market. Long rates WILL move higher because of these trades.

Now the government is changing pension funds allocation rules to get them to buy more mortgage bonds to press rates down for the F1 reset at 01/01/2009.

The government is even spending government money on buying mortgage bonds for the same purpose.

The response must of course be to move one's pension saving into cash just to piss on their barbecue!

Link (Danish):

Anonymous said...

Maybe Mike had a point though, I think the quality of the posts is directly correlated to the VaR you are running. Nothing like a position to focus the mind and all that. Not saying there is anything wrong with not having a position right now. Markets are unpredictable, vol is therefore expensive and, with uncertainty in the workplace, why would you want to run elaborate risk positions and risk getting caught with your pants round your ankles?

Anonymous said...

I am really glad I don't live in a world ruled by gramps. I am not sure what economics class he went to.

gramps said...

Anon 10:14

Sorry to have to explain this to you, but in the real world bigger credit risk means higher lending rates.

Corporate debt yields higher than government debt. Lower rated bonds yield more than lower rated bonds. It was that way for decades.

Libor spreads have been uncharacteristically high because no economically motivated player is going to lend to an insolvent bank at politically dictated rates.

Again, that isn't new. Lots of other banana republics learned that the hard way.

You cannot force intelligent people to lend to insolvent banks-- not even by political edict. Sell side traders on the other hand are happy to do it -- which might explain why their employers are writing off hundreds of billions in losses

Anonymous said...

There are a lot of traders on the buy side who don't understand that greater credit risk means paying higher rates.

A big reason why so many people lost so much money on mortgage and asset backed debt is because they failed to even take into account credit risk.

walter said...

Its pretty embarrassing that Anon 10:14 probably represents a widely held view in the investment community.

It explains how credit got so wildly mispriced the past few years

walter said...

This guy does a quick job of explaining why AIG failed (as an example case) -- basically the risk models AIG was using were just plain wrong. And its a fair bet AIG wasn't that different from the rest of the street

Supreme Magus of the Rosy Cross said...

However, will Mme. Lagarde play the good part of Catherine of Valois to our Henry V, or will the dauphin Sarkozy selfishly spoil the quest for unity. I have been inattentive to your efforts for a several days, unfortunately. Any updates of our Shropshire Lad's verses?