Monday, July 11, 2011

Macro Ain't Easy

If you’ve been befuddled by some of TMM’s missteps and confusion at the world well, apparently we are not alone per the WSJ. It has not been a particularly easy year for the industry thus far and looks to be getting no better. Some of this is no doubt due to there being way too much money in this space chasing far few trades but some of it invariably comes down to the set of opportunities available at the moment. Most investors require some kind of dispersion to make money or generate “alpha” in order to get paid. “Dispersion” is pretty broad but ultimately it comes down to how much of a spread there is between the stuff you trade. If things are all moving together all the time, there is only the business of when to be long and in what size rather than what to be long and short and in what size. Picking winners and doing research is irrelevant in a directional punters market and really, it is hard to have any distinctive edge.

Dispersion operates at a few levels: the typical macro stuff like different equity indices, FX, and rates but also within indices (sectors, subsectors, etc) as well as dispersion within those sectors. Different mandates and strategies require different types of dispersion to make money: market neutral guys can do great in range bound markets if there is a lot of change in the profitability within indices, opportunistic or thematic guys can do well out of long term industrial or technology trends and macro guys need to see some separation of indices and broader more liquid rates. A chart is below:

That sadly is what appears to be the case in big picture asset allocation land and most major indices. Dispersion is relatively short lived and there isn’t an awful lot that is consistently trending. As a result researching something that is durable and lasting is tricky. There are things, however, that do seem to work but they are increasingly looking like they are all the same trade – look at Eurobanks and EURCHF below.

The implication of which is that your positions are highly correlated, therefore you cannot be as leveraged and make less money on the trend.

This is not happening so much within sectors or themes. Take two examples close to TMM’s heart: the inevitability of Chinese clothing and footwear manufacturers getting squeezed as they cannot move up the quality chain to displace the likes of Nike and the wage pressure they get from a workforce with little slack left. TMM can say this has worked out pretty well and has been nice and low(-ish) volatility. Price performance of the basket:

Historical Vol:

And Bollinger bands to show how well it has trended:

Similar names would include a basket of large lithium producers / battery separator producers (PPO US, SQM US, FMC US, ROC US) or a basket of Chinese banks or Aussie banks, names associated with cloud computing… you get the drift. The baskets tend to be lower vol and as performance is pretty similar amongst the names, you get a better sharpe. If your mandate allows you to trade sectors and themes without having to slavishly stay market neutral then the pickings have been pretty rich this year though as always you have to go out and pick them.

With that in mind, what do TMM think is going to “work” in equities against what is regarded as a relatively tough longer term macro backdrop of rising input prices and higher funding costs if not in EM then generally? A few things seem to work to TMM:

  1. Stuff with an inflation linked top line but relatively consistent unit costs. Railroads are one example, gas producers aren’t far off. These are often slow moving changes in margins but they tend to last. Pretty basket friendly, for the most part.
  2. Picking the winner of a tournament where the winner gets monopoly rents. Who is the next Google / Microsoft? Facebook? Limit long – the incredible performance of Netflix and the fact that Google trades pretty rich despite being close to ex-growth says a lot about what people are willing to pay up for a “big moat”. Consumer brands in EM that establish supply chains and channels quickly would also fit in this bucket. The downside hurts if you lose a tournament though (ask Myspace) so this is definitely a situation where buying a basket of 10 gives you one 10 bagger and lots of disasters. This is single name territory.
  3. Eat Somebody Else’s Lunch: Find an industry which is going to more or less inevitably replace something else because you can wait. The lithium names’ pricing relative to other mining names reflects this now but is indicative of what the market is willing to pay up for now. This is very basket friendly.

Aside from that, there is plenty to short so long as the data looks this awful. TMM look to earnings season with bated breath.


abee crombie said...

great post. I hadnt heard of PPO. Interesting company.

Re: Cloud computing, data center etc. At what point do valuations play (if not now). CRM is great, and probably a takeover candidate, but at 15x revenue? For me I think we missed it

Also are you saying netflix has a big moat?? Its only a matter of time b4 the studios / appl use the same tech

Last one, who are some name in the chinese footwear man basket.

I'm waiting for a market sell off to load up on RIMM

Ambo said...

Isn't trading in one shape or form mirroring the below.

50% macro 30% sector 20% alpha ( stock-fx etc)

Ambo said...

I forgot Polemic, So what ya think about the real thing the other day, you poms won't even acknowledge now its from Australia, now its out how real it is, you all say the Irish horse this , the Irish horse that.Don't worry about the big guy,I'll give him a riding lesson he'll never forget.

Anonymous said...

'confused from cheltenham' thinks this post was very good and a return to form as of late he wondered if macro was being sucked into market noise to a greater degree than any macro should be.

Nemo Incognito said...

Abee - yeah frankly i think this stuff is really fully priced. Gordon growth models are toolish but..... lets face it, the last big growth cycle collapsed with a wrenching rate rise. Don't see that soon but I think the sanity check for tech is some sense of market saturation..... when you have 500mm users like Facebook and the addressable market is x and you are supposedly competitor free.... you get where I am going here.

Ambo, I'd say almost anything breaks down into components and risk/style/asset class factors the point was more that depending on whether you do micro or macro, the opportunity set can be a feast or famine.

Nemo Incognito said...

Oh and viz NFLX, yeah not here. I sold at $180 (oops). Point is, people like the idea of a big moat - whether it exists or not. That being said go back to MSFT in the 90s - traded at 50x PE for a long time so long as revs were growing 30% pa. For some businesses like Baidu you can model revenue growth almost as a diffusion equation so long as GOOG is still on Zhongnanhai's shitlist.

Leftback said...

Off topic and reverting to last week's Eurobolleaux™, The Italian government are asking for short positions to be disclosed and are apparently offering to send men carrying violin cases to pay a visit.

LB doubts that a sudden liquidity shortage would reveal risk management problems, excessive leverage and corruption in the pristine Italian banking system, but hey, you never know....

abee crombie said...

i love the idea of a moat in a business that is only 5-10 years old!

railroads have a moat.. fb, while I think it may be the next msft, needs to constantly adapt. I think zuckerberg and the team there are genius .. but you never know

which company will be around in 20 years, RIMM or NFLX? It doest matter, just trade!

Leftback said...

Spanish 10y over 6.0%, Italian banks cliff-diving. It's all going pear-shaped over there today.

This week might see remarkable firmness in the USD, as US data can hardly be more dismal than last week, and the way European banks are trading, a short-term disorderly unwind of dollar carry trades is not entirely out of the question.

Leftback said...

Tin foil hats on, chaps. Ambrose weighs in on the gloom and doom....

AEP on Italy and Spain

Just when we declared Macro dead, it rears its ugly head and threatens to rain all over the beginning of Q2 earnings season.

WellRed said...

I agree with Abee that RIMM with a forward earnings yield of 20-25% seems like a good time for a punt.

WellRed said...

Interesting Guardina article. Strikes me that Ambrose missed the real kicker: Germany doesn't have room on its balance sheet to guarantee the entire stock of Spanish and/or Italian debt. If these refi levels are sustained, it seems like it's checkmate for the Euro, as surreal a statement as that is to make (I had been operating under the assumption that the firewall between PIG and IS would remain intact).

Thoughts anyone?

Anonymous said...

Ok, help those who don't visit often: Step 1) long bonds short equities thru Greek tragedy only to be destroyed in relief short covering rally
Step 2) totally lost, hold the above losing positions wait 36 hours
Step 3) Follow the squids, switch to long equities on grounds of US "decoupling" - US economy is strong after a ridiculous ISM which was inventory stuffing and the experts at TMM did not bother to look inside for details
Step 4): Follow the frenchies of Socgen: declare PIIGS can fly as for Italy to burn, "all must go wrong for TMM to be in Nero's grave so don't worry, trust us, "PIIGS can really fly"
Step 5) Stage of acceptance - be proud like all fund managers, we were wrong but so were everyone else, so we are still about average. Oh, and draw those consultants' 2 by 2 matrix to befuddle more readers
Step 6) Recommend what Buffeet and the Venture Capitalists do - ie dry your luck at lottery and pick the next 10 bagger
Arhg, you folks are just super,
Step 7) cannot wait ... :)

Marshall Jung said...

Anon 12:49

You know I used to type the same stuff back when I didn't take responsibility for my own trades. Take TMM's advice or don't. At least they write pretty damn well and are willing to put it on the line every day (or two, depending). But whatever. I think the bestudded youths on the corner would call you a "hater".

P.S. - Point me in the direction of your daily blog. I am in need of some can't lose trading ideas.

Nemo Incognito said...

Anon, another problem is that this is collective effort of people who don't work at the same place or even trade the same products so the apparent ADHD is more due to the fact that there is a couple of different books being discussed here (you may have guessed that I am equities and corporates punter for the most part - you would be right).