Wednesday, July 21, 2010
One of Team Macro Man's favourite pastimes is chuckling at the tin foil hat brigade and their most vocal leaders, the "bullets n Gold" brigade, but when reading this article this morning they couldn't help but wonder if Bloomberg had hired the authors of this site to the editorial staff:
"Deutsche Bank is marketing a tail-risk hedging index that gains in value when investor expectation of stock-market volatility increases, according to material the bank sent to clients. The so-called Equity Long Volatility Investment Strategy, or ELVIS, uses derivatives called variance swaps linked to the S&P500 that bet on the index’s volatility."
But (very poor) jokes aside, TMM is struck by the number of products that have recently appeared allowing suckers investors to "hedge" against tail risks. The news that the CBOE is developing such a product is perhaps the ultimate contrarian signal that the cult of the Black Swan... sorry, err... "propriety portfolio convexity hedge overlay to our alpha strategies" has reached its zenith. Indeed, the usual Wall Street product cycle starts with bank structuring desks creating some utterly useless exotic option structure designed to perform in the conditions of the last crisis period which is far too complex for the purchaser to value, resulting in said bank ripping the poor (or naive?) punter's eyes out. And market veterans will attest, the next crisis is usually caused by an "unknown, unknown", usually resulting in said derivative structure not performing in the way it was expected. In fact one of our maxims is "Correlations work really well.. until you put the trade on". Add to that the fact that the guys that sold it to you are the only ones that will buy it back - and TMM are exceptionally sceptical of any trade ideas with the words "structured" or "exotic" in. But we digress, the Exchanges, in their attempts to keep market share, often try to launch an exchange-traded version of these products, right as focus on them peaks (anyone remember SONIA futures, house price futures & Credit Default Swap Index futures?). You know when the Vampire Squid creates John Paulson an exotic way of getting short China that the credit bubble is about to burst... TMM suspect ELVIS is about to leave the building (sorry, we could not resist that one...)
Speaking of John Paulson, Apple's blow-out earnings are something of a gift to the reflationistas (Paulson, Einhorn et al) as it bails them out, somewhat, against their Gold & BAC holdings, as does the fact that, despite what appeared to be pretty poor earnings numbers, equities staged a remarkable rebound after holding the technically important 1050 level. Perhaps it was just a short squeeze, perhaps it has been misconceptions? TMM was surprised to read that so far, earnings beats are ahead of historical norms, and revenue beats are their highest since 2004. TMM expects punters to begin talking about the potential inverse Head & Shoulders pattern that would target the 1075-ish area.
The other big worry on punters' minds is the European train crash which, since Timmy G advised them to follow the "shut the f*** up" strategy, has surprised on the upside, with the data decelerating a lot more slowly than many expected, the Greek budget & current account data showing reduced insolvency and illiquidity risk (and aiding rebalancing), while EMU bonds appear only to have repriced to a new equilibrium around EONIA+110bps rather than continuing to collapse. The heavily stage-managed leaks of the stress test scenarios and pass/fails almost seems choreographed out of 1500 Pennsylvania Avenue.
But back to China. TMM has been struck, in recent days, by a creeping re-enthusiasm for a reacceleration of Chinese growth (just as the last of the economists had downgraded their forecasts...). Copper and the Aussie Dollar, refused to plumb new lows in the recent equity sell-off, and TMM received reports of sector rotation out of the Financials into Commodity names. Scattered mutterings are also trickling through that steel mills in China have begun raise their ex-factory prices. The chart below shows scrap Iron & Steel prices at Turkish ports, and appears to have bounced since late-June.
The Shanghai Composite (first chart below) also has been showing signs of perkiness as talk (whether real or not) of further stimulus, along with buying from domestic insurers has dragged the index 10% off its lows. But it is not just the locals that have been buying - in the rush to push money East, foreigners have been piling into any exposure they can get, such that some ETFs are trading at large premiums to NAV! (see second chart below):
While none of the above is enough to persuade TMM to abandon their view on "short-term high volatility within summer ranges", a break above 1100 in SPX would be pretty bullish when put in the context of the above. However, if we were to consider the recent moves as just big positions squeezes, then a move higher in risk would fit with a squeeze of the general beliefs we saw in our poll two days ago.