Tuesday, February 24, 2009


Another day, another dump in equities. Hard as it is to believe, the sense that the (financial) world is coming to an end is becoming almost commonplace. While such resignation is perhaps the stuff of which bottoms may eventually be born, Macro Man isn't willing to countenance much more than a small short-covering bounce at this juncture.

As February comes to an end, more interesting to him is the comfortable fabric of the investment landscape may be fraying somewhat. It's that time of year; Macro Man literally cannot remember the last March that did not bring (at least temporary) reversals and breakdowns of usual relationships. In his experience, January and February are for making money, and March is for playing defense. (Not that it should work that way, per se...it just seems to happen every year.)

In that vein, it's perhaps worth touching on a couple of points that suggest some fractures in the thematic monolith that is Financial Armageddon. Macro Man has already highlighted one issue in recent days, but it's worth touching on again. Given that equities are near or at new lows, and that the economic newsflow remains execrable (Taiwan's exports and IP both dropped more than 41% y/y in January!), one would normally expect USD/JPY to be on its knees. Yet here it is, up nearly 10% from last month's lows, showing a clear correlation break with its supposed anchor, the SPX.
Similarly, one might rationally expect that an equity meltdown would prompt a safe haven bid for government bonds. Yet Treasuries have barely budged with the last 10% in the SPX, and have yet to put much, if any, dent in the step-jump rise in yields at the beginning of the year. While it's true that German govvys have performed quite well, this probably has more to do with intra-European spreads than it does with outright longs.

Now, Macro Man isn't sure what all of this means, other than that he has to be very, very wary of other correlation breakdowns, which could potentially submarine a previously smoothly-running portfolio mix. Correlation breakdowns are among the most difficult and frustrating things to trade from an established book of positions, so Macro Man is trying to keep an especially close eye on his assumptions...which will hopefully save him another frustrating March.

One notable development last night was JP Morgan slashing its dividend from 38c to 5c. Now, this would appear to be common sense, particularly for a bank, but it nevertheless highlights the frailty of one of the major arguments in favour of equities- namely, attractive dividend yields. A quick survey of his Bloomberg shows the SPX with a divvy yield of 3.8%; the FTSE has a yield of 6.4%; the Nikkei has a yield of 3.0%, and the Eurostoxx has a yield of 8.2%. Yowsah! Who needs bonds when you can buy equities and, if not wear diamonds, clip divvys?

JP Morgan highlights your answer. Dividends represent a claim on an earnings stream that a)
may be lower, or at least more uncertain, in the future, and b) need not be paid out to rhe same degree at all times. While it is true that earnings recessions generally see payout ratios rise, it is also a case that there is a limit to everything. Macro Man would humbly submit that an S&P 500 paying out 113% of earnings in dividends is ripe for the type of divvy cut that JPM delivered last night.

More broadly, there is no gurantee that dividends yields will fall. It could be the case that stock get "cheap" and stay "cheap" for a long, long time. Indeed, time was that divvy payments represented a substantial portion of an equity's total return, and Macro Man has maintained for some time that there is a risk that we return to that regime. It is perhaps worth re-posting a chart that Macro Man showed last autumn; there is a long and glorious history in the US (which ended in roughly 1957) of dividend yields trading above government bond yields. This party could just be getting started.
This little wander down memory lane stoked Macro Man's imagination. The first month of the Obama administration has come and gone, and the results from both a policy and market perpective have been underwhelming. (This is an observation, and is not intended to spur unrewarding political debate.) This got Macro Man thinking.....how does the equity market's performance in the first month of this administration compare with that of previous Presidents? With the aid of Bob Shiller's excellent online database, he took a look.

The chart below sets out the equity market price change during the first month of a President's tenure. Grover Cleveland, with two separate terms, is counted twice. The short answer is that while equities have performed poorly during Obama's first month, he has plenty of company; indeed, during Macro Man's lifetime, only Bush I and Clinton have seen the stock market go up during their first month of office.
More broadly, since Rutherford B. Hayes, the first month of a president's tenure has seen stocks go down. Some of this may reflect a "shock value" deriving from presidents who die in office, but that doesn't appear to be the case; Truman and Johnson saw sparkling returns during their first months in the White House. A more cynical theory might be that when new presidents fail to walk on water, markets express their disappointment...and then recover as expectations are set to a more realstic level (and, one might add, a new president's policy platform has time to gain traction.)

Macro Man leaves it to the reader to judge for himself which of these has been in play for the past forty years or so......


spagetti said...


on correlation breakdowns..
i think the bond (10yr and longer) <-> equity one might keep breaking down.

perhaps bonds might even take the lead in a simultaneous selloff of both equities and bonds ?

FX said...

YEN correlation is dead. The idea of risk aversion is temporarily dead; the entire flock is "risk aversed" to the max. How can the media or the market participants get any more scared?

Yen is now all about the steaming pile, island nation we all call Japan. Old, tired, broken, with a leader who isn't cracking 15% approval. Who in their right mind would want to own YEN.

I guess I also need to mention the obvious fact that this currency also yields zero. Nice.

Anonymous said...

analyst dividend forecasts are possibly more dubious than their earnings forecasts IMHO. analyst spend their time on earnings , not payout ratios and dividends. in terms of where people are placing bets...if you use the dividend future for 2009 for eurostoxx 50. it is pointing to 100 euros of cash dividends this year. that is 5.5% yield. if you look at 2010. it falls to 2.7% yield i.e dividend future @ 54 euro. You can take the time to dig into this in a lot more detail. You only have to analyse the current 50 company earning/dividends/pay out ratios and take a view on composition of SX5E in 2010. easy right?!? not eays. one bull point...the decline that is priced into the futures market is greater than the decline observed in the 1930s. the bear points remain however that dividend yield got to 12% in the 1930s for the US stock market. and in a world where pensioners need dividends and regular income the ongoing reduction in dividend payments (coupled with peak earning margins) does not get you in anyway excited about equities from a dividend discount model perspective. Actually what fair value do you get to for SX5E if you put the futures into a DDM? One article i read the other day said S&P would have to be at 550 to get interesting from a dividend yield perspective. Ouch.

Manc Trader said...

I've always thought that March/April behavior at least in equities is affected by the looming tax bills.
It's hard to see market participants owing much this year.
Maybe, March won't be as turbulent as you expect MM.

Macro Man said...

Anon @ 12.17, the SX5E divvy futures were first brought to my attention by a commenter here (you perhaps? I forget whom) a few months ago. I have seen the research, and indeed replicated it myself, on paralleling the 1930's with what's currently priced in. While the analogue isn't perfect (SX5e divvy payouts have shown much more volatility over the past 10 years than US ones), I do think it highlights the extreme discounting (and lack of recovery) in future dividend streams. My understanding is that this sell-off has been largely technical in nature. Anyhow, my view is that the divvys look cheap, and the divvys can rally from here without the stock index going up (if an as actual payments exceed what is priced), but stocks will have a hard time going up without taking dividends higher. So divvys look like a much better trade to me, and indeed I have a few odd lots stuffed in the bottom of a drawer somewhere.

Manc, you see the same thing in fixed income, viz. euribor and short sterling last March, which had nothing to do with tax season. I kinds think it's just human nature.

Leonardo said...

My 2 cents;
1) "...the (financial) world is coming to an end is becoming almost commonplace.....perhaps the stuff of which bottoms may eventually be born" If anything it's the complete opposite. There has never been a bottom where 'apathy' was the common sentiment

2) With regards to correlation, wasn't it this kind of thinking that got us into this mess? Correlation does not imply causation, so why trade them at all? There is no reason why the eurYen should trade inline with the S&P even though a multitude of reasons can be concocted.

A wise old man once told me, (market) participants are generally right for the wrong reasons and wrong for the right reasons. Either way, you will still be right or wrong....

Anonymous said...

SPX hit -17% year to date, lets see if they can rally the wagons in the face of boom boom's testimony...banks do like the dividend cut by JPM in the pre market trading, seems logical they all would do it

mcclellan fairly historical, reading before these two was -256

VIX only in 50's rather than 80's last year

somebody said the us dollar went up against every currency last week, it sure has looked liked the G7 meeting came up with the idea that america would strengthen it's currency so the world could heal by having their currencies weak

Anonymous said...

oops forgot my name on previous post

margin call selling into 10am et would be the norm and then let's see if they hate boom boom or he tries to say something to produce a squeeze

i couldn't believe that a barrons cover would kill the us treasuries and posted same and was wrong, we need the long bond strong for the mortgages, but the risk is huge supply or america defaults or devalues, witnessed by leap in treasury insurance rates
cheers! -deacon

Anonymous said...

my only question is

will you be upgrading to 'pro' as you've exceeded your bandwidth limit? :-)

Seriously though, it is rather irksome they spam your blog with 'upgrade now' graphics.

Anonymous said...

Another excellent post raising some really disturbing questions.
On correlation breakdowns, particularly ones that have been reliable trades for some time, YES. Though the correlation not causation is valid one should then ask what are the links. For example this has been a liquidity driven market and the EUR/JPY a measure of the carry trade's funding of the rise in SPX perhaps ? But that correlation among many others is broken by fundamental changes. FWIW here's my little survey of some of those:
On that note the dividend indicator is fascinating. There looks to be an old finance world, pre-WW2 and a new finance world, post.
Are you implicitly arguing for a return to where dividends are more of the returns as PEs return back to earth and valuations stay low for decades ? That strikes me as reasonable and consistent with a lot of other analysis (e.g. Shiller).

dblwyo said...

Oops - fat thumbs. My comment on breakdowns and dividends vs valuations.

spagetti said...

hearing all day that citi is a big buyer of usdjpy ..

maybe its the inflow from the sale of that brokerage they sold .. ?

maybe the whole usdjpy / equity correlation break is just the result of a big flow.. ?

Anonymous said...

MM, i have some sympathy with the 'bottoming' call....actually call is too strong, let's say muse.... I'm not much one for charts, but a guy who has had a great track record in last year or so who i have been following sent me a chart of SP monthly going back to 1930 ish.....The key thing is that RSI now 18.54 which is second lowest reading over this time-span......He states that an oversold RSI is never a buy signal in isolation, but he is starting to think we could see a serious bounce of a decent proportion soon. The market as you note is miserable enough to not be calling for it, ergo positions reflect that. He is watching Vix closely....If that can stay sub 57, then we could see a stock rally for a couple of months even......A close below 730 in the S&P and a rise above 57 in Vix would negate this view.....
Good luck out there, and if you see the March Hare, shoot it, goes nice with the tins of baked beans in the bunker ;-)

Macro Man said...

Anon @ 2.26..thanks for pointing that out. I have no idea WTF that is or where it came from...will try and get rid ASAP.

dbl, I think there is a chance we move back to the ancien regime, if you will....surely that appears likely until the financial system is back up and running (by itself) again.

deac, I too have been bemused by the enduring "power" of the Barron's cover. Fortunately, I have spent most of my time in fixed income in the short end and doing calendars, which has been a bit more successful.

Anonymous said...

MM - do you think the reason that treasuries aren't managing to rally is that traders are expecting huge issuance from the US Treasury? (apparently, $94 billion over the next three days - thanks to Across the Curve for that figure).
- Chris

Macro Man said...

That might be the specific reason, but doesn't explain the more generic underperformance of Treasuries over the last month. Maybe it really is as simple as the wall of supply..I dunno. It is interesting though.

On another note, apparently there is nothing I can do about this stupid error message...I might need to switch templates ASAP. This is what you get when you use a free template, I guess...

Macro Man said...


Anonymous said...

makes sense as the world moves to equity vs debt funding that dividends must rise....

Anonymous said...

I like your new layout, looks professional! But perhaps you should make the text field a little "wider"..

Macro Man said...

Thanks...I assume you are referring to the width to the width of the main post body? Sadly, I am useless at HTML, and while I can download and install a new template, and even add in a couple of widgets, I am singularly unable to alter anything fundamental with the look.

Indeed, the reason for the change was that my old look, another free downloaded template, somehow ran out of bandwidth. A cursory google search suggested that somehow the look of template was hosted on the designer's server, which ran out of bandwidth... Dunno, seems spurious to me; all I know is that I couldn't fix it, so it was time for a new look.

Glad you like it.

Family Man said...

try this on JPY

BlueMonday said...

A couple of ideas on why treasuries fail to rally.

Last december parabolic move was caused mainly by 1) the perception that the Fed would buy Treasuries which forced pension funds and bank exotics desk to buy the long end as well.

On 1) we are still waiting on 2) Bank exotics desks are slowly dying and do less and less; and real money is migrating slowly towards corporate bond buying, which makes sense as the yield pick up over Treasuries is mostly caused by the discount to par offered on issues that banks/HFs have been selling for month in deleveraging phase ... but if yield on BBB corp in now often 10%, coupon is often 6 or 7% -> corporate issuers will be able to service that debt.

A true "real life" test on the power of QE on Treasuries is about to start. Some firms think that the UK is about to buy up to $ 100 bio in Gilts .... ie about 100% of this year net supply ... we should soon discover if it's possible to force yields down ..........

Anonymous said...

MM, what do you make of Bernanke's performance in the senate? To me, he displayed a fairly good understanding (more so than before, I think) of what is going on, even though the whole "our plan contains all the elements of a successful rescue of the financial system"-thing is not entirely foolproof. But I guess he couldn't really say anything else without getting his head chopped off by team O'Drama.. And, his argument that tightening policy when growth picks up can protect us against inflation is not really foolproof either.. But at least, I think he's way ahead of the others (in the administration, other central bankers etc..) in his understanding of what's going on.. What do you make of it?

Anonymous said...

what about this?