Wednesday, May 18, 2011
Yesterday's bounce in many markets led to surprise in the TMM camp. Not surprise over the bounce occurring (the Soothsayer signals in many USD crosses signaled an end to the run yesterday) but we were more surprised at the amount of pain and woe being expressed by many on the street, as it wasn’t THAT big a bounce. To TMM the corpses of some overexcited new uberbears is good news as it leaves the market more balanced, yet still pretty close to recent lows. This is supportive of our thesis that yesterday's move was just the "R" of our JSTFR play of the past couple of weeks. Hopefully we can get back to the basics now that the panic noise has diminished.
TMM's basics, as expressed here recently, are that both Global and US growth are slowing and still like the idea of JSTFR in Equities while continuing to favour the bull flattener in USTs. But today, we thought they'd take a closer look at the inputs to their ISM model, why it appears to have diverged from the actual numbers over the past year and the outlook moving into the summer. The below chart shows ISM (red line) vs. TMM's ISM model (blue line). Over the past year, this overshot to the downside during last summer's double-dip scare, something TMM believe to be the result of the very large shifts in the global inventory cycle (something we will take a closer look at below), but directionally - if not in actual level terms - the model is clearly pointing to another drop off in industrial production.
The two main variables in TMM's ISM model aim to describe short term inventory cycle-driven factors (see chart below, blue line) and proxy "true" end demand (red line) in terms of raw materials needed for investment in infrastructure. As TMM noted above, the inventory cycle has been very volatile over the past few years, making it very difficult to see the wood for the trees in terms of how the recovery has been progressing, which is why TMM are particularly interested that the end demand variable in their model. And this component has largely settled around sub-trend growth levels, seen either during recessions or mid-cycle slowdowns (c.f. - 1995/96, 2004/5). Now TMM are not anticipating a recession, because a lot of things need to go wrong for such an outturn, but it seems increasingly likely that that growth will slow further over the coming months and that consensus economist expectations for Q2 and Q3 GDP of 3.3% annualised rates have some way to fall...
...which in the context of historic equity performance when the model is these levels (see chart below, SPX YoY% - red line), suggests to TMM that Spooz continue to look vulnerable over the next couple of months, especially given the scarred memories of this time last year for many a trader.
In TMM's experience, growth slowdowns usually morph into growth scares (in recent years morphing further into deflation scares) so we think the curve is likely to continue bull-flattening, with 10yr notes headed to 2.9%. TMM's mates at Nomura rightly point out that given specs are positioned in steepeners and primary dealers are short the belly of the curve that a nasty position squeeze could develop here.
Oh yeah, and Bill is still short.