Tuesday, August 25, 2009


Well, it may (or may not) be the case that bonds are trading rich, but regardless, the valuation gap (insofar as it exists) remained wide open yesterday. Had Macro Man not unsuccessfully tried to call the top in equities more than once throughout the year, he'd be tempted to label yesterday's price action as a classic blow-off high.

Low volume and a bearish candlestick on the index are ample reasons for caution. However, digging beneath the surface, it certainly appears as if the quality of the equity rally has deteriorated significantly. Among the top performers in US equity land, on on heavy volume to boot, were well-known turds Freddie and Fannie.

Now it's true that another turd, AIG, has been enjoying a renaissance for a number of months now, much to Macro Man's dsbelief. But this month the Agencies are tracing out what appears to known in the trade as a "Lazarus" pattern, e.g. coming back from the dead.

Macro Man asked one of his banks, a US institution that is generally assumed to be extremely well-placed, WTF was going on with FNM and FRE. And the answer that he got virtually defied belief. To paraphrase, he was told that interest in these stocks is primarily driven by retail, who believe that the low share prices mean there is less downside and that the stocks have the furthest to rally.

Now, Macro Man doesn't know if this explanaton is true or not (any readers with more insight are encouraged to chime in!) But if it is, it must represent the apotheosis of stupidity as an equity investment strategy. And that is usually the sign of a market headed for a fall.

Beyond that, Macro Man cannot help but have concerns over the divergences that he's observing. Yesterday, he highlighted the divergence between a relatively bid fixed income market and equity strength. He was somewhat surprised to see bonds and front ends rally after the Bank of Israel hiked rates yesterday.

As far as he can recall, this is the first tightening by and central bank coming out the other end of the easing cycle. What made it particularly interesting is that a) the BOI adopted QE in February, b) BOI governor Stanley Fischer was at the Jackson Hole conference that seemed to adopt a "lower for longer" consensus, and c) Fischer himself punches above the BOi's weight, having held senior positions at the World bank and IMF.

Might this be a roadmap for a surprisingly early exodus from QE by more important central banks? Perhaps, but markets appeared to dismiss the possibility yesterday with a wave of the hand.

Closer to home (or at least, Macro Man's book) has been the interesting and frustrating divergence between equities and other pro-risk assets such as emerging market foreign exchange rates. Ordinarily, one expects a strong negative correlation between Spoos and EMFX, and indeed that's what's been observed for most of the year, including this month. So what's the problem?

Well, the issue is that return correlations caputre the direction of daily moves without saying too much about their magnitude. And what's been happening recently is that on the days when stocks do well, EMFX goes up a little, but when stocks go down, EMFX gets butchered.

So while the 3 week daily return correlation between the SPX and USD/TRY and USD/BRL is somewhere around -0.8, the aggregate return to the friendly macro punter has been less impressive. Indeed, over the past three weeks USD/BRL and especially USD/TRY have both risen (i.e., the emerging currencies have gone down versus the dollar) even as the SPX has tacked on a 2% plus gain.
So in a sense, EMFX has given you none of the upside and all of the downside of a "risk-on" position. Great! At the same time, bonds have traded persistently bid, the Baltic freight index has been pummelled, and Chinese stocks have gone from rock star to reality-show reject.

Oh, and a strange bid has emerged for the worst of the worst of the US equity market.

Interesting divergences, to stay the least, particularly as we approach a period of seasonally poor performance for stocks. Perhaps this time, equities are "right" and everything else is "wrong."

Then again, perhaps not......


Nemo Incognito said...

Like I said, thin end of the wedge. Even I'm selling upside vol here. There is NO marginal bid for HK/Sing/Australia equities much above where we are. Either the taps get turned on in China or we are at best moving sideways.

CDN Trader said...

This at blog Slope of Hope last Friday:

"I had breakfast with my boss, Tom Sosnoff, on Saturday, and we were talking about the markets. I always enjoy discussing the market with Tom, because even though our methods couldn't be more different, our conclusions are almost always the same.

He has taken on a big FAZ position, and he was looking at a graph of it on his laptop during his flight out here. The stewardess was coming up on the aisle, glanced at his screen, and said to him, "No, no. That's not the one you want. You want FAS!""

Donlast said...

Lovely. Like the lift boy syndrome in 1929.

Nic said...

I'm not sure its enough of a spike on the indices to mark a blow off or exhaustion top, much as I would like it to be ;)
Anyone think we might have a Bernanke re-appointment rally today?

Crisis Management said...

Seems that the Fed was making clear that it rather enjoys QE: "The markets must perceive that there's some effect there" - Vice Chairman Kohn

Trichet seemed to be bond positive as well: "I am a little a bit uneasy when I see that because we have some green shoots here and there, we are already saying, 'well, after all, we are close to back to normal,'"

He warned the euro appreciation was "brutal" in Nov. 2007 before it fell in the recent crisis. He was also warning about "one way bets" around USDJPY 120:

"One-way bets in the present circumstances would not be, it seems to us, appropriate," he said. "We want the markets to be aware of the risks that they contain."

Wonder if that would include a one way bet to SPX 1200?

Anonymous said...

Shanghai is down only %2.6 after down as much as %5 during the day (what say ye, Nemo Incognito?), Nikkei down %0.8, and EU indexes are down marginally, probably waiting further 'green shoots' by reappointed Fed Chairman when the markets are open at NYSE.

Macro Man, market stopped making sense a loong time ago for many inquiring investors almost across the globe. So, some joined the party, many on the sides. Some still have some short positions waiting for the upcoming October!

Then again,, everything is manipulated by Big Boyz, ergo no one can ever predict at best.



Skippy said...

For those who have not looked, there is also a nice divergence bewteen the AUD and Baltic Freight Index. The BDI should be important for the AUD as iron ore is the key export commodity for Australia and has a large influence on the BDI.

It is also interesting that Sterling has been weaker than many of the other default anti-dollar currencies recently.

Nemo Incognito said...

Shanghai rally appeared to be due to Wen coming out and indicating that taps would stay on. That may be true, and that's why HSI held 20k and continued to stay in its range. The problem is that even with it being made quite clear that the punch bowl wasn't going to be taken away all at once and fund flows still being quite good onshore (new funds, etc) it isn't pushing higher. Any seriously bad news to the downside could take use through support all too easily, and momentum money must be getting bored or getting out with all the moving averages etc catching up here.

Oh, and the SOEs still can't make a buck.

Anonymous said...

MM, had this forwarded on - comments from one UST head trader on the street

One of the key reasons for the rally in both stocks and bonds in August is the lack of supply of financial assets

- For example debt issuance from both the corporate and European government sectors have ground to halt, while equity issuance has also reduced

- Meanwhile consumption is down and saving is up, coupled with high cash balances there has been a lot of money put to work

- The supply dynamic noted above should end in early September when these sectors crank up issuance again - and the Treasury comes to market with high duration supply

- Meanwhile large real money accounts continue to "sell vol" by carving out a well defined range for UST: buying circa 3.70-3.80, selling circa 3.25-3.40 - pressuring realized vol.

IMO this is simply limited discretionary players whilst CTAs continue unabashed means curious moves can occur in August.

As for Fre etc - John Hempton on his Bronte Capital blog laid out the case for owning their prefs - after he picked them up at 2c on the $. Maybe the blogosphere works in mysterious ways... More likely is people were punting Citi, Boa etc. - made good money there and then looked for the next financial turds to rotate into. Sad but true.

Macro Man said...

Anon @ 11.26, while I agree with some of that, a couple of points by way of rejoinder:

* i'd take small issue with the notion that there's been a dearth of supply of finanxcial assets. Surely the regular Tteasury auctions which seem o domicate price action every few weeks are the elephant in the room? (And incidentally, one place where there clearly is supply is China, which saw another couple of big ipos again ovenight, I believe.

* Moreover, it is by no means axiomatic to me that cash gets deployed towards the purchase of financial assets. Surely debt reduction by consumers, which has only been modest thus far (judging by consumer credit outstanding) is just as if not more likely to attract some of that dough? Meanwhile, on an individual manager level, cash levels are evidently quite low, at least judging by the ML survey.

Ultimately, though, I think you're right...a lot of what we see, particularly in non-equity space, can be ascribed to CTAs as more discretionary guys stay out of the way. Will be very curious indeed to see what happens after Labor Day when every man and his dog is back at his desk, ready to trade 'em up into the end of the year...

Anonymous said...

Add in corporate insiders hitting bids everywhere and it does suggest it's gonna get a little bit fruity shortly.

Personally think we squeeze until 1 week post Labor day to allow some more of the pension community panics in before the wheels start to come off.

Macro Trading Ideas said...

And finally, after "green shoots", we have its evolution (and also a welcomed comeback!!!): "Goldilocks 2.0.
There's only a problem, aren't valuations anymore meaningful?
Fisher is actually the best CB governor.

Anonymous said...

yes retial folks (and most everyone else) can be that stupid-irrational---just take a look at stock splits if you want confirmation---or even cerburs buying into us car co because its the patriotic thing to do---there is a reason why there is money to be made as an active manager and its cause others purusue non alpha strategies (cya, or buying gm under a dollar cause it can only go down a buck)

Anonymous said...

Case shiller higher than expected! Terrible news for equities!!!!

Anonymous said...

Anyone see the seasonally adjusted case shiller number?

Macro Man said...

Yeah, up 0.75...first rise in more than 3 years. Even Case himself is on the tape saying "the boat has turned." And yet despite this, a rumoured 54 CC figure and shocking OMB projections, bonds are still pretty bid. It just gets curiouser and curioser.

Nemo Incognito said...

NFI. Thank god I get paid on the next 1000 pts of HSI before I reach the strike of the options I sold. Long end sold off a bit though. And honestly, for all this good data the minis should be up past 1040 by now. Its the non-responsiveness to news that is really weird.

leftback said...

The housing market always tends to be stronger in the summer, and this year's emergency exit door is about to close on many unwilling homeowners who now have to settle in for another winter of uncomfortably large mortgage payments on an asset of y/y declining value. The foreclosure machine is going to grind on and put a lot more supply into the market next spring. The people who sold into this "green shoots" rally were very smart. Next Spring, unless there is further intervention, we will either be looking at lower house prices or higher interest rates.

wcw said...

Anon 11:26, I was long FNM-Q for a good long while this calendar year (in my comments here I used to refer to it as a cynical trash long or similar). Made great, great money; sold recently and left the last 30% the table. Them's the breaks and I feel no regret: FNM/FRE equity is garbage, and their preferreds will only pay out again at a politician's whim. That is not a bet I like long-term. Betting on greater fools during a bottoming housing market, though, I liked.

Bonds are chapping my hide, though. I am short Treasury futures as of yesterday, and while my entry print was fortuitous enough I am up slightly, I expected to be up big on today's news. Case-Shiller is not just up month-over-month, it is up SA MoM, adjusted for seasonality. Grr.

Also, a mea culpa: so far I am precisely wrong about the form of the US house-price bottom. My bet was that low-price tier housing hit bottom last month and was headed up, high-tier still had room to fall. It's only one month, but a simple average of the tiered SA C-S indexes had low tiers as the only area not rising on balance. Drat.

Anonymous said...

MM, on FNM & FRE you might want to read the analysis done by Bronte Capital.

zanon said...

Anon is right -- Bronte capital had a good post on Fannie and Freddie.

I'm long Fannie preferreds. Do you honestly think Obama is going to let those guys go down? They are *more* politically connected than GS, and have a more plausible story for the good that they do.

Preferreds get you more leverage.

Also, MM, sooner or later you have to admit that you, and most instit investors, have totally missed this rally. Clearly there is stuff going on that you aren't understanding.

Macro Man said...

Re: FNM and FRE, I've read one thing on Bronte. Unless I badly misinterpreted it, the conclusion of the piece was basically that a) FRE is unlikely to lose $91 billion, and b) that the author has conducted a study that yields surprising (presumably bullish) conclusions.

I am not competent to render particularly insightful comment on either issue. I'd submit, however, that what FRE/FNM "earn" or lose with the umbrella of government support measures is unlikely to bear much resemblance to their income statement in the absence of such supports.

At the same time, FNM/FRE common stock, which is what I referred to, has no claim on Agency "earnings" until the preferred/government holdings are satisfied. In other words, they're lower in the capital structure seniority scale than whale shit is in the ocean.

I would submit that far from Obama not allowing the Agencies to go under, I think it would be political dynamite to allow them to show a profit. While they may well have more allies on the Hill than GS, they also face substantially more formidable opposition than Maxine Waters. And as Peter Eavis points out in the comments section of the Bronte post, the Agencies' role in housing can (and should) be taken on by a government agency.

So while I have no view on the investment merits of more senior paper like prefs, I would naturally concur with wcw's rather apt description of the common as trash.

Oh, and anyone who thinks that I understand what's going on with equities hasn't been reading closely enough. There's lots of stuff I don't understand...and that's what I typically write about.

Fortunately, there's a bit of stuff I do understand, but frankly that's a less interesting subject matter.

Professional Gringo said...

Take a look at 1 day chart on SPY.

Anonymous said...

when i started working in equities many years ago, i was told a valuable piece of advice. "macro based investors are almost always bearish, they don't understand individual companies, and assume that the whole world correlates". this has been shown repeatedly in conversations i've had with macro investors which i'm afraid are sometimes echoed in blogs. it seems "average macro" seems to be willing to express all of its bearish analysis in one instrument "the S&P" which it trades ad nauseum through technical analysis (see comments many months back). and then throws toys when an equity rises on technicals. PS: if a company goes from having a weight of "nothing" to becoming "something" in an index. if you don't understand that stock you go to neutral as a benchmarked manager. so that is why you see irrational moves in stocks coming off an extremely low base.

leftback said...

Anon: With respect, sir/madam (and not much of that, because apparently you are as blind as a bat), you are overlooking the fact that this is the ultimate market for macro traders, because there is only ONE TRADE, which is long equities and commodity currencies [aka risk-on], funded by leveraged carry trades in the yen and dollar. Which means that you can be as granular and micro as you like in the meritorious business of analyzing individual stocks, but you will still be carried out on your shield when the ONE TRADE turns around and the arrow points to risk-off.

Anonymous said...

we may use stereotypes to expand our understanding of the markets. please don't take it personally, it was very far from being intended so....to answer your point. i agree that everything is pointing towards risk appetite, i can see that, i'm fortunate to have my sight. i can only resort to buying index puts given the affordability of implied volatility (if difficult lies ahead) and continue with stock analysis and try and hedge out periods of de-risking. PS: i am not alone. you may have noticed the correlation of the VIX and SPX spot reversing towards the end of july i.e going positive. in my humble opinion that could point to inflows into an asset class being immediately hedged with index puts. hence the shallow sell offs and violent index moves as the street is short gamma. in 2 years i have not had as high a % of portfolio allocated to index puts in terms of delta adjusted notional. i am probably not alone.

Rock out with my macro out said...

Could that first time home-buyer subsidy have lifted sales? Gubment handout has been known to prop up sales?

Seems to me like correlations are starting to deteriorate. Stocks up, oil down, bonds up, commodity currencies (CAD, NOK, AUD) down.

Are macro guys always bearish equities? It seems to me like equity guys are always bullish equities.

I for one think macro traders are more comfortable both being long and short because most of us trade futures and forwards - and with those you're just as natural being short as being long. At least I would like to fancy that I am bi-directional that way.

Very interesting point on index puts.

wcw said...

Ugh; my last macro trade, short treasuries, killed me good today, so I am out. Oddly, I saw that as a bullish trade. What are you going to do. Not that I am a real macro player, but I always worry I can get the particulars right and have "the arrow" skewer me nevertheless.

Tomorrow is another day.

Anonymous said...

told you before. don't be a sucker, there won't be any resets in '10.

as per equities, gdps' are down some 2% and stocks were down 60%. normal?
look, spreads are back to normal, so all the big guys are coming slowly back to stocks, where else do you go on zirp? at least this way you have a chance on inflation.
might take a couple of years b4 printing presses shit hits the fan again so it's all good.

ps hempton is a kook. small fish backwater aus, no infrastructure, gets into all these trades where big ($billions) DC knowledge guys think it's worth 2c, yet he thinks the silly default curves mean something.

Nemo Incognito said...

Hempton is pretty kooky (I know the guy) but he's smart and a good financials analyst. I'm not sure you'd describe Platinum as "small fish" in terms of AUM and he was the proverbial big hitter there for some time. And honestly, what have we learnt about guys with great infrastructure now that Citadel and the like have their blood all over the ceiling from last year? I would not be so quick to write him off.

Nemo Incognito said...

The comments about macro vs equity guys are true but I will make one observation about directional macro guys: when they don't understand whats going on and stuff stops going their way they cut, and do so quickly. Equity guys seldom have a great deal of trading discipline, credit guys even more so.

If this does crap out, the average guy on this blogs comments will have lost a few hundred bps max but will be out and able to chase down when it goes very much unlike equity people who will be screaming why everyone else is wrong and they are right. I know this because I worked at a fund, left in Feb 08, and watched them drop 50%+ in 2008 due to nothing more than poor discipline and arrogance in the belief that their DCF held all the world's answers.

Anonymous said...

illuminati set up the cia/fed audit
setting up for a global power to be the "savior"... ugh
they'll pull the plug again, so well go begging back to a bigger trough which they get to run

run delta neutral and layer in puts

Crisis Management said...

wcw @ 9:44 PM,

Fighting Anglo central bankers on the long end is like bringing a knife to a gun fight.

They really do tell you which direction various markets will trend towards, rarely wrong.

wcw said...

that was Anon, not I. blogger's comment attribution formatting is very misleading, I agree.