Another look at US equities

Macro Man has found relatively little to interest him over the past month or two, which explains the relative paucity of contributions in this space.  To be sure, the abject performance of the US economy in Q1 was notable, but as of yet the uneven bounce-back has rendered him unable to either confirm or deny that the weakness was primarily weather-related.  Europe, meanwhile, remains stuck in the same danse macabre with Greece that has featured regularly for the last several years.   Zzzzzz.  China, of course, appears to be following a Fed-like prescription of keeping the economic balls in the air by encouraging a financial asset bubble rally.  While that's clearly interesting and could ultimately represent the endgame for China's deceleration towards more "normal" levels of economic growth, we may have a ways to go yet before that plays out.

In the absence of inspiration, it is often useful to default to first principles, which in Macro Man's case includes some of the quantitative work he's done in  equities over the years.  Even there, however, the signals are far from unambiguous.  His bread-and-butter regression model, which combines five factors to generate a 12-month return forecast, has been remarkably stable at a remarkably bullish level:


However, this chart illustrates the limits of a regression framework as much as it does the supportive case for equities.  A linear regression is, by definition, linear, thereby assuming a constant proportional change in output for each change in the inputs.   In normal circumstances, this is perfectly fine.   When there are outliers and extremes, however, things can get quite messy when working with factors that are in reality asymptotic rather than truly linear.   Such is the case with this model, where the extremely low readings of headline CPI have perhaps exerted an "overly bullish" influence on the output.

To be sure, when dis-aggregating the model's output into "growth" and "liquidity" dynamics, we can see that the former has actually been quite bearish while the latter has been close to an all-time high.   As this model sees it, low oil prices have provided more financial market accommodation than QE ever did!


Of course, as we know CPI is subject to base effects- and oil prices have already rebounded smartly from their lows of a few months ago, which markets can react to in real time.   The model, however, must wait until the base effect phases out over the next eight months.  By the same token, the growth factor may also have been impacted by oil prices, in this case negatively via energy firms' lower earnings and capex.  That having been said, the tepid contribution from the growth dynamic predates the collapse in oil and could prove worrisome once the liquidity dynamic (as influenced by either oil or Janet Yellen) recedes.

These distortions in the linear model are one of the reasons that Macro Man also combines the factors into a scorecard, with each of the five inputs receiving a score of +1 or -1, depending on whether it exceeds a given threshold.  As noted previously, at the turn of the year the scorecard down-shifted from a max positive reading to a +3, where it has remained ever since.



To be clear, a +3 is still generally conducive to equity gains, but not nearly as much as a +5.  Indeed, when Macro Man runs risk using this model is only 0.5 of a base unit, as opposed to 1.5 units when the scorecard delivers its strongest endorsement.  Macro Man finds it telling and worthy of caution that the scorecard has affirmed its more cautiously bullish stance after years of rampant bullishness in the QE era.

So how are we left?   If one believes that markets are linear and that liquidity trumps all (call it the 'Funny Money' model), then by all means, buy with both hands, particularly on dips.  A more pragmatic (and, dare your author opine, realistic) viewpoint is that while the wheels haven't fallen off, neither is the equity market trucking along with the same momentum (both price and fundamental) that has characterized the last several years.

Much like the case for the US economic rebound, Macro Man at this juncture can neither confirm nor deny that "sell in May" will be a wise call in 2015.  What he does know, however, that any legitimate rebound in economic activity will be met with renewed speculation of Fed tightening, which could push growth and liquidity drivers of equities in ways not observed for a number of years.  It therefore behooves him to continue to assess these factors from a number of different perspectives as he attempts to tease out the trajectory of equities and other asset markets. 


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amplitudeinthehouse
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June 2, 2015 at 3:39 PM ×

You don't have to tease me , MM, I tell ya now, no American shareholder is buying this stock. not now , not ever.

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washedup
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June 2, 2015 at 3:46 PM ×

MM - do you include eurozone and japanese liquidity in the model, or just US?

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Polemic
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June 2, 2015 at 3:49 PM ×

Good question Washed Up.

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amplitudeinthehouse
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June 2, 2015 at 4:02 PM ×

The tax incentives on wall street are shot. Keep your hookers, keep your dividends, keep your keeping up appearances, mother f*8cker..

I'm free as bird, baby.

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amplitudeinthehouse
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June 2, 2015 at 4:22 PM ×

Hey, Macro Man, if your having trouble finding a winner in the markets, why don't you download the lucky screensaver that's doing the rounds. You could do worse.

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Anonymous
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June 2, 2015 at 5:00 PM ×

FT: speaking of non linearity, I recall 1997 and 1998 during the first great yen debasement experiment (as noted in MM's previous post, we just broke out on the upside of a 5 months range, breaking some significant levels in the process)
Back in those days, the eventual pressure on EM asia was too much to bear and in 2 glorious installments the financial world (including but not limited to victor and john) was shaken and stirred.
This time, the pressure is on china and the ever cleaver voldemort has seen it coming and is trying a variation of QE of its own. The problem is that by requesting inclusion in the SDR basket, they can't afford to let the currency go (they just received a satisfecit). At least, not yet.
So, it's rather probable that there will be tremendous pressure on growth on the whole asia ex japan complex.
This, in turn, will trigger some more export of deflation towards the US and Europe (yes, I saw the stat this morning).
I thus expect a bit of market clairvoyance and a rerun of the 97 or 98 variety: a nice equity scare and a subsequent upward explosion fed by a renewed dovish FED.
Disclaimer: no quantitative model involved, just good old fashioned macro

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Mr. T
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June 2, 2015 at 5:05 PM ×

The Achilles heel of CB-driven liquidity is that they can (in theory) take it away leaving it as simply a confidence game. Confidence is certainly not something that tends to move linearly. While it's encouraging that your model identifies the significant contribution of liquidity factors, the trend around here is that more and more of these models are being retired to the dustbin in favor of more qualitative strategies. I see this as another destabilizing factor - we have a confidence driven market with models being discarded in favor of a more behavioral trading style.

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Anonymous
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June 2, 2015 at 6:57 PM ×

“What in the hell is going on out there?
Vince Lombardi

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FunnyMoney
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June 2, 2015 at 8:02 PM ×

".. the Funny Money model... " lol

Can I refer you to the Ben Bernank, who tells us today that "stocks aren't expensive"... (lol)
http://blogs.wsj.com/moneybeat/2015/06/02/janet-who-ben-bernanke-says-stocks-arent-expensive/

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washedup
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June 2, 2015 at 10:20 PM ×

The funny money model is up there with the greats, BS, Merton, HJM and CAPM - note that every model's greatness is measured by the ratio between its profoundness (or is it profundity?) and its simplicity.
To confer instant street cred,I would support a motion to start calling it the FM model.
As for Bernanke's comment - is he then OK with us shorting cash at 2123? he is extrapolating the previous business cycle 'peak' not the previous business cycle 'fair value', isn't he?
Who am I to argue with a princeton whiz, my FM model says BTFD!!

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Macro Man
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June 2, 2015 at 10:59 PM ×

Bernanke also said that US housing could not go down en masse, so he has a bit of form when it comes to dubious assertions on asset valuation. To answer your earlier question washedup, no the model does not explicitly capture liquidity provision in the ROTW; however, insofar as those influence the price of US fixed income securities, they do influence the model. And if they don't influence the price of US fixed income, I don't see how they should be expected to influence the price of US equities.

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Leftback
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June 3, 2015 at 12:23 AM ×

Notes from the hammock, continued..... anyone got meaningful observations on today's EURUSD move, other than "loads of punters were short and then after the EZ inflation data, cor guv'nor, it was bend over and cop this lot of Cold Steel, innit"?

Inclined to remain hammock-bound until something truly cataclysmic happens like, um, VIX > 15... zzzz. The thing about hammock trading is that your reactions do tend to dull a little with time and after a while you forget what the game plan is. To recap, what we at Falling Knife Capital think might occur is somewhat similar to our host and mentor's views, to wit, better US data, mini rate spike and equity dislocation....

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Mr. T
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June 3, 2015 at 4:43 AM ×

The action in bunds today was quite strong, but noone could be bothered to even notice. I'm positioned for a nice Wed/Fri set of Shenzen-style rallies in spoos/dax based on the ever-bullish Greek story and another goldilocks NFP. We already have the fed apologists out pushing back September.

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Nico G
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June 3, 2015 at 7:17 AM ×

party pooper here, 1998, 2000, 2003, 2007, 2009 market turns veteran

the day you acknowledge stupidity by giving it a new name (radio FM), a truck will hit you face. i am saving every bit of such forum where you can see rather intelligent people give in to nonsense, and embrace it. I am saving it for the day when i finally hire a junior and i need to train him on how extreme sentiment/herding savages your soul.

we are full on February 2000. In a couple of years you will feel so dumb because you forgot that investment all boils down to where you sold, it is not about how many months or years you were right to follow the trend. It is the money you got out of it or namely, YOUR ENTRY LEVEL.

i am old school and still think that nothing has changed, that the market will destroy anyone who bought above 1580 (spoo), and probably the one who bought under, because they will feel like, 'no way i am selling at break even after a 30% correction' 'i'll wait another couple of years' and at spoo 1076 after 50% down or so, they will take their loss too.
hing.

i will repeat that thhere's never been a more crucial time to know your investment timeframe, and put effective stops in the machine, before things get funky, to avoid the deer in the headlight thingy. The only thing that worries me is that Roubini just dusted off his bear suit again, the odd of him calling an important top for the second time in a row, knowing how easily he gets distracted by poontang, and how easy 'FM' poontang is in New York those days...

they say never short a dull market and in 2015 spoos are displaying the same dullness only, at a lingering top. good luck

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Polemic
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June 3, 2015 at 8:18 AM ×

My boredom with the mkts has crystalised into concern. So if I have to take a side with the Stalin of the bears ..nico. or the Pol Pot of the bulls.. Funny Money... I'm going with Nico.

http://polemics-pains.blogspot.co.uk/2015/06/a-worry-of-small-things.html

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amplitudeinthehouse
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June 3, 2015 at 9:37 AM ×

NO guys, you missing the point..I need to go one on one with the son of God who invents these talks and discussions and win my freedom back. no idea .

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amplitudeinthehouse
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June 3, 2015 at 9:44 AM ×

How about it son, one on one , you win , you take cash, I win, I'm free.

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amplitudeinthehouse
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June 3, 2015 at 12:10 PM ×

Do me a favor , take my offer up , then everybody can move on.

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amplitudeinthehouse
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June 3, 2015 at 12:14 PM ×

I'm done with you, and I'll do whatever takes move on

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Nico G
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June 3, 2015 at 1:52 PM ×

am not a permabear im only realistic (in EUROPE).

they have broken Greece.

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Anonymous
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June 3, 2015 at 2:43 PM ×

Reviewing all time highs...healthcare providers/pharma cleaning up under Obamacare

https://pinboard.in/u:maoxian/b:1c3190c5e9f0

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Anonymous
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June 3, 2015 at 3:52 PM ×

just remember, nico...opportunity cost costs a lot more than you might think.

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amplitudeinthehouse
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June 3, 2015 at 4:01 PM ×

F$$k off, Nico , I'm going to smash the son of God into next year.

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Anonymous
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June 3, 2015 at 5:59 PM ×

FT: rates up , weak stats....hummmm equities anyone?

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Anonymous
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June 3, 2015 at 6:00 PM ×

FT: unless it's different this time

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Leftback
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June 3, 2015 at 7:55 PM ×

Weakness in US fixed income not complete. USTs selling off alongside bunds, and that's a dynamic that is well worth paying attention to, b/c those rates came down in tandem, and they will rise in tandem. One's thinking brain really fancies a piece of this action, and is ready for standing outside in the downpour with Kevlar gloves, but one's feeling brain is saying no, don't be a complete prat, you'll get struck by lightning you prick, just sit and wait, b/c if they fix Greece over the w/e then you're looking at another 50bps melt-up in 10y easy which would be massively Cold Steel and you'll look a right numpty, and this way after all the wailing and gnashing of teeth you can just wade in and fill yer boots with bonds and rate-sensitive divis, old son, and then you can sit on yer arse all Summer, b/c whatever bollocks is on telly, the US economy is cack. Not back, cack.

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washedup
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June 3, 2015 at 8:33 PM ×

the trend in FI definitely seems strong to the downside and will probably surprise people by how far it could get (more a hunch than anything), so I basically agree with u LB. The weird thing to me today just can't figure out why this market thinks global bonds and commodities should selloff in the face of bad growth data, but the euro must be bought along with US tech stocks - not every puzzle can be solved (I know, flows, leads, lags etc etc) but one of these markets seems horribly wrong. I am beginning to think equities may be a tad expensive for the 'stagflationary' message being telegraphed by these other asset classes, but clearly the FM model output trumps that.

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Bruce in Tennessee
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June 3, 2015 at 10:07 PM ×

I don't believe I've ever looked a right numpty...but then again numpty-looking, I'm rather sure, wasn't common where I grew up..

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June 3, 2015 at 10:47 PM ×

hi guys...
real collapse in Fi with euro as widow maker...
but what rates?? everything post 2 year space, with huge repricing in long tails...
now we have 3m US fwds post 2020 near 4%... are they so expensive???
isn't steepening enough now??
when someone will realize that also to be sat at -0.2% in schatz isn't so bulletproof??
huge divergence between FI/FX vol and equity vol.... also HY US beginning to fell the impact but spoos obviously up...
smelling big VaR stops to be filled...

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FunnyMoney
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June 3, 2015 at 11:53 PM ×

So equities went up again today. For May, equities are up across the board - heavily for JP & some US, modestly for EU. For 2015 to-date, equities have clearly been the way forward. Basically, the 'FM model' has out-performed. Period. (Sorry Nico et al).

My personal strategy in equities was nicely summarised sometime ago by washedup (a short-term, more risk averse approach to BTFD). As you all know, buying dips in a strong trend will work until it doesn't. With tight risk management, one will be long & wrong on the last dip, but there will be no trucks to the face. As outlined before, I have frequently missed portions of each move & left plenty on the table, but nevertheless the approach has worked v nicely.

I also saw this today: 'Gundlach: Fed won't raise rates this year http://cnb.cx/1GksRa9'
Seems he is now also using the FM model on rates :)

Following on from which, FI has been interesting the last couple of days. If we do have a sustained sell-off in bonds (see LB's post above), what other asset class might funds rotate to? Equities perhaps?

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Mr. T
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June 4, 2015 at 12:46 AM ×

If we do have a sustained sell-off in bonds (see LB's post above), what other asset class might funds rotate to? Equities perhaps?

I don't think it works like that. Deleveraging in a fixed income book does not imply there is a pile of money that needs to find a home elsewhere. Especially this direction - its not uncommon to run a substantially higher leverage ratio in FI vs other asset classes.

I still think stocks wiggle higher but its not because of a nice fundamental reason - its just purely momentum. If anything, all these guys who have been saying "stocks are cheap because rates are low" should be getting out there saying "stocks should be incrementally lower because rates are higher" - but I'm not going to hold my breath for that.

Oh and by the way Bullard comments today seemed strange. "We are very close to all our objectives" - "Market is right to push back expectations because we are data dependent and the data stinks". That sounds a lot like their real objectives are "the data", and not the normal objectives of {employment, priceStability}. Or are they confident that there is a good forward-looking relationship between say retail sales and 6-month-out payrolls & inflation? Because I'm pretty sure thats just not the case.

And the answer to "Why is monetary policy still at emergency levels" - "because have have not begun to normalize". Isn't that just dodging the question?

These guys talk too much.

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Anonymous
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June 4, 2015 at 2:00 AM ×

Nico is a sad case

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Anonymous
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June 4, 2015 at 2:58 AM ×

anon @ 2:00 you may be a sadder case if you don't at least consider the possibility that Nico is right, and you are not.

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