Thursday, November 12, 2009

Blast From The Past

Macro Man is back on the desk this morning, safely re-attired in standard-issue hedge fund costume: sport coat, jeans, and collared shirt. He's never been a fan of wearing a suit and tie, but in the current populist backlash against bankers and hedge funds the idea of slipping a knotted length around his neck is distinctly uncomfortable!

Today Macro Man would like to address a couple of old stand-bys and one new development from yesterday. Leading off are his old mates from China, where the market is all aswirl with talk that the authorities will soon countenance an adjustment in the exchange rate. In its recent quarterly report, the PBOC announced that it intends to "improve the exchange rate mechanism is a proactive, controlled, and gradual manner..."

ZZZZZZZZ. Perhaps this is different from the vrap that they've been spewing for the last year, but if so, the changes are marginal. Uncoincidentally, APEC finance ministers had a go overnight, and the Chinese are also confronted with the prospect of finger-wagging Americans and Europeans washing up in Beijing over the next few weeks. The PBOC comments look like a bit of pre-emptive ass-covering, nothing more.

While one year CNY expectations are well off their pre-crisis lows, they are neverthless within a hair's breadth of the their post-crisis lows. Macro Man struggles to see the fascination with playing this. With China, the best course of action is to "watch what I do, not what I say." And right now, they're doing nothin'.
Another blast from the past that has recently caught Macro Man's eye is the underperformance of small cap US equities. Last summer, Macro Man put on a large/cap small cap spread, which squeeeeeeeeeeezed painfully 'til he couldn't take it anymore, then promptly exploded higher after Lehman. Typical!

Anyhow, he's observed that the Russell 2000 has been a notable underperformer recently; in contrast to the SPX, for example, it is some 5% off its recent highs. Perhaps it is simply case of not being "too big to fail", or perhaps there's a more sinister aspect to the underpformance- e.g., strains from lack of access to credit. Regardless, while Macro Man's large cap/small cap proxy indicator (OEX/R2K) has popped recently, it's well off the highs of last year, let alone those from earlier in the decade. Perhaps readers who have focused on this more acutely could share thoughts on positioning in the large cap/small cap spread?
Elsewhere, there was a rather interesting and, frankly, puzzling development in the UK yesterday. In a marked change to the last year, the Bank forecast CPI inflation to be above target in 2 years with unchanged interest rates, and to be above target in three years with current QE and market interest rates. That's quite a change from prior reports, where the Bank had forecast an inflation undershoot over the relevant two year horizon.

From Macro Man's perch, that looked like a relatively hawkish change, on the margin. So naturally, the short sterling strip ripped higher; Dec 2011, for example, is up 20 bps since just before the release. Is Macro Man missing something here, or is the market smoking crack?
In any event, it's worth keeping an eye on the labour market. Macro Man's one-factor BOE model, based on data from the first nine years or so of the MPC's existence, continues to support the case for QE by prescribing sub-zero interest rates. Note, however, that it is turned up slightly....a development that Macro Man plans to watch with interest.
Who knows, maybe in a year or two Macro Man can revisit the relationship in another "blast from the past" moment....


Nemo Incognito said...

Dear Macro Folk,

As a more fundamentals (equities, credit) driven guy I can't help but notice that certain things of a China and consumery nature are really starting to rip (not complaining, but I don't like it when I can't explain away things). Questions:

1) Is some bank out there marketing a basket including Want Want (151.HK)?
2) Are you buying as a corollary of RMB revaluation?
3) Or am I just reading into the tape too much.
3) Or do you think these guys' loan being oversubscribed is really that important? Given this is a growth stock at a high PE, I think not.



jc said...

anyone that thinks the Chinese will change anything to do with the basket are free basing. No freaking chance.

I see it the other way, it's the Europeans and the Japanese that will have to make changes by engineering a fall in their currencies.

This whole thing looks so 1990's in fast motion.

US in recession markets think will be permo... Tick

Strong European currencies vs the buck ..... Tick

Japan in perma frost .... tick

All we need is the US to have a tech type mania.

I thought yesterdays top end real estate showing a 42% sales gain was the most important news for a while.

Tol Bros (TOL) was up 16.5% of the news.

Advice to Americans: buy homes now and don't wait as prices are going up.

Buy BAC or the large bank ETF as it's going higher.

There were even glimmers of hope in Comm Re yesterday.

Go long US stocks and enjoy the recession as it's going much higher.

With Macro man's BOE news that also applies to UK stock too.

Steve said...

MM do you know what's in the base rate model?

Looks like real rates are just too high.

We're turning Japanese...

Steve said...

...if rates "should" negative, could the BOE be trying to manage inflation expectations UP?

abee crombie said...

i too have been watching the SPX - Russell Spread... freaking nuts. Seems to me a lot of year end selling of the junky, risky names and a shift into quality (ala DOW 30) this is what jeremy grantham has been saying all along. Seems more like a sector rotation game to me..easy money has been made on the stocks that dropped 70% last year (mostly smaller cap)and now upgrade to quality dividend paying stocks which have underperformed most of this year

also whats up with June 10 EuroDollar?? isnt there some time value of money that it should trade a discount to the 0.125% implied rate (plus the 12 bps spread for risk).. is it getting fully close to valued??

Anonymous said...


I think the mkt response to BoE was a function of people thinking the curve is too steep -Long L Z0 vs EDZ0 has been a favoured trade over last week - so were looking for an excuse to buy and Merv refusing to rule out further QE was that excuse. Both the growth and inflation fan charts are punchy and whilst they are too optimistic on growth expect we see the reds give some back shortly.

I have nothing on beyond L M0, although the conditional steepeners that went through today look ok am not a fan of selling m/c vol on a 8-month tenor.


Skippy said...

Nemo, the Vampires offer China consumer baskets don't they? I have never looked at what stocks make up their thematic baskets.

On the RMB, I also doubt that they will make any move while export growth remains negative in yoy terms. Contrary to popular belief, China's leadership remain sensitive to external demand weakness.

On small caps, I think it boils down to the fact that the sector is more leveraged to the US domestic cycle, whereas large cap benefit from offshore earnings (weaker dollar), better access to credit and more leverage to the US government fiscal stimulus. Small cap is also probably more cyclical, hence the recent underperformance may be instructive for the performance of other cyclical assets. Small caps also probably have less short-duration cash flow and dividends to support stock prices in cyclical weakness.

Anonymous said...

your observations on russell vs. spx bear out when one looks at the most recent CFTC data on Non-Commercial (Large Prop/HF/etc.) positions. as of current readings, NC accounts show a net/net LONG position of 208k on the e-mini S&P futures contract while those same NC accounts are a net/net SHORT the mini-russell futures to the tune of 75k contracts. i've been scratching my head for plausible explanations for this dichotomy and have come up with only one guess....when the waters are extremely choppy, bigger boats stand a better chance of not getting swamped when the waves crash over the gunwales....

Anonymous said...

Large cap v small cap

Large cap benefit far more on the currency fx from overseas sales plus the rate of global growth vis a vis domestic rate of growth..small cap by definition relate only to what is happening in the domestic economy and the growth for the US and UK are the domestic economies growing faster or more slowly than the global economy ? Nuff said, don't need to make this stuff more complicated than it needs to be.

Macro Man said...

Re: the currency and growth dynamic vis a vis large cap/small cap: those were the very reasons I put that trade on 18 months ago, and as noted in the main text it did nothing but run against me until I couldn't take the pain any more in July of last year. Funny enough, it only worked in times of extreme stress- which, incidentally, saw the dollar scream higher.

I tend to think that the relative performance is, if turds are doing well, market rallies and R2K outperforms. If turds get drilled, so does the R2K. I note that the R^2 between LC/SC and the SPX over the last year is 0.4, so it does tend to be pretty directional...

Jorge said... the current populist backlash against bankers and hedge funds

Can you blame us? ;)

Best trading,


Skippy said...

I guess turds can sometimes fester for a long time before they eventually get flushed...

Anonymous said...

think in a liquidity driven melt up the most melt up is with the biggest crap (i mean short stock positions) and since the biggest shorts are in big names not small spx outperforms small cap--think buying the spread is actually more painful than just selling a bit of spx if you want to fade this move

Anonymous said...


Last year what caused the pain in the spread was the sectoral composition - large-cap financials were hosed whilst small-cap commodity plays went to the moon - it took the turn in oil b4 it started to work. Am not upto date on current sectoral composition. I had the same trade on in Europe but ex-financials and it worked a treat, was a searing reminder to do some sectoral work!

Anonymous said...

Wow, big change from a few weeks ago where everyone was bearish on the whole charade being played out. Now there certainly are a lot of folks looking for more up moves in China, commodities, large caps, etc.

Could it be you all have finally decided to jump aboard, and does that signal something in of itself?

Nemo Incognito said...

True the vampires do offer this basket and Baidu is bid silly today.

Sigh, looks like something else I into early is getting crowded.

Anonymous said...

You mean that Japanese export thing Nemo?

k said...

i just got hurt on a short mid-400 vs long russell-2k trade. international exposure argument? ok. but i'd think less so in the mid-400 as the sp500 or larger caps? (mid400 has more exposure to oil/gas explore and materials reflation?) if you look back at the mid/russell chart it spiked up to these levels at the middle of last may before starting to plummet july-1-08, turned sharply up oct-08 then back down in mar-09. (liquidity / end of world off table for smallest guys) if anyone has insight for divergence starting oct-1-09 beyond 'weak dollar' i'd love to hear. if this is credit related shouldn't i see similar under-performance in HY?

Anonymous said...

MM 12.51
LOL ..have you considered becoming a contrarian indicator ? To within a couple of months you backed the large cap horse right when it ran out of room to jump ..LOL and it will do the same again I'm sure ,but right now the large cap play still benefits from the underlying factors mentioned.Will it still do so in 6 months ? If I could tell you that for sure I'd hardly be posting here would I.

Our Man in NYC said...

Couple of thoughts on the R2K from equity world in the US; the mantra I get from the sell side guys since September has been:
a). Global (read China) = good v US (and USD) = sucks, so be in big caps.
b). A disguised version of; if you want to be long risk assets, you don't have to take liquidity risk as well, just buy some big cap commodity/china/cyclical related stuff.
c). (only used if they fathom you are bearish) it was a short covering rally initially, now's the time for high quality mega-caps leadership. They're big cuddly and safe, and if you change your mind later that's ok as they're liquid too!
d). The final coupe de grace, I just wanted to give you a heads's what the smart guys/larger funds are doing (I work for a very small fund).

CAT and it's projected quadrillions in rev/EPS in 2012 are a prime example of a name that was pushed really hard over the last 3 months and one should have gotten into!

The impression i get is that a lot of the above is true in terms of how/why people have moved their exposure.

leftback said...

The markets are just now coming to the realization that there is an awful lot of oil and products sloshing around in various places in the US, and they might have to sell some crude futures.

That might go some way towards firming up the US dollar, and will in any case be more effective than Tiny Tim's Strong Dollar Policy statements. LB is inclined to the view that $wtic is telling us something that the metals haven't heard yet. Perhaps the RUT is also telling us something that the SPX hasn't caught on to.

Our Man in NYC said...

LB -- the improvements in rail traffic, have shown signs of stalling over the last 3-4 weeks.

Nic said...

WTI could be a pretty good bull flag. I am waiting to see what price does at $73-75

Anonymous said...

Nic I think if crude breaks 75 a lot of people will bail. One big house was passing around a log chart w 200-wk MA at about exactly 75, a few weeks ago. That was also the classic break-up point from consolidation. I am guessing if we take it out gold will reverse too, bit test at 1030.

Anonymous said...

I don't see oil telling us anything new right now.This hasn't been about demand all year and the data today is well within the noise levels of recent weeks.

I don't even think it's just about the dollar anymore either.

When you look at the deficits pumping up in US,UK,Japan and now also even in Germany for god's sake then to me it's about what is out there that protects against currency default in what amounts to about half the worlds paper.
Private sector may have had their blowout ,but we're already looking for the most likely sovereign candidate to blowup next and which fallout shelter do we need to be in.

PJ said...

The buy-commodities-and-gold story is based on the idea that government deficits are "new money" that has its outlet in inflation ... not so ... so far it's just money borrowed from the private sector, and barring future monetization will end up subtracting from private demand ... China is the one true inflater and they've been the source of the lion's share of commodity buying, until speculators recently joined in ... Short-term therefore I expect a correction in commodities as reality intrudes: there isn't as much money sloshing around as people think, it only appears that way when everyone is leveraging up.

leftback said...

Nice rally in the 5y and 7y today, and even the 30y is solid after the not-so-great auction. Change in the weather as we enter the holiday season?

Anon at 5.53, you'll be needing a nice tin-foil hat, sir/madam, for going in that fallout shelter.

Agreed with PJ that leverage is alive and well and playing some interesting tricks with the "optics" of the capital markets.

LB wishes to record yet another day on which the US bond market did not self-destruct, and suspects there will be a lot more such days in the future as we grind through the "recovery".

Anonymous said...

"Nice rally in the 5y and 7y today"

What exactly constitutes a "nice" rally and what would make it a "bad" (or "not nice") rally?

The only people who say "nice rally" are brokers and people who hang out at brokerage office waiting rooms all day

leftback said...

Anon: Nice post, and nice hat.

Tuppence said...

Is Macro Man missing something here, or is the market smoking crack?

He's missing something - change of fiscal policy is imminent, either before or after UK general election. Ergo, inflation forecast is meaningless unless BOE has prior knowledge of new fiscal policy......

getyourselfconnected said...

Its the perfect world: bonds hot, stocks hot, gold hot, beanie babies on ebay hot, dollar gets a bid.

It is economic utopia where everyone makes out, I mean, what could go wrong?