A bad day to have a bad day

It's just as well that it was a quiet day yesterday, because in Macro Man's little corner of Connecticut it was a stunning 70 degrees F (21C) with brilliant sunshine: not too shabby for November.   Sadly, he had to spend an unhappily large portion of the day in a stuffy dentist's office and running errands; it was a bad day to have a bad day, alas.

Speaking of bad days, the NZD is doing a wonderful job of proving Macro Man's Monday assertion that sporting glory does not necessarily translate into currency success.  While NZD/USD is down a little more than a cent so far this week, the real notable damage has come versus its antipodean neighbour (thus also demonstrating that sporting defeat need not confer financial weakness as well); AUD/NZD is up a full 3% this week at the time of writing.

The reason for the Aussie leg is obvious- the RBA's decision to stand pat- though last night's better-than-expected trade number certainly doesn't hurt.  The raison d'etre for kiwi weakness, meanwhile, is equally obvious to the cognoscenti.  It's all about milk, namely the declining prices that Fonterra is achieving in its milk powder auctions.  That milk can have such a significant impact on the kiwi's fortunes comes as a timely reminder that NZ is, after all, only the size of Melbourne or Kentucky.  Anyone who's traded the NZD for long enough has a story that underscores that fact.   Nevertheless, the recent surge in AUD/NZD gives Macro Man a chance to dust off one of his very favourite long term charts:

The 1.05 "no fly zone" was actually breached earlier this year, but the pair swiftly recovered....only to retest it again very recently.  That the milk market has turned sour and the RBNZ looks poised to cut again could give further impetus to the topside.   Obviously, from a big picture perspective we remain in the midst of a downcycle in this pair, thanks to China and the hard commodity market.  Historically, the bottoming process has typically taken 2-3 years, suggesting that we may only be halfway through.  Nevertheless, it's pretty clear that the long-term equilibrium price is closer to 1.20 than it is to 1.00.   It's probably not a great idea to buy after a sharp 3% gain, but looking to structure longer term upside on any relapse offers solid risk/reward- particularly if and as the monetary divergence continues.

Elsewhere, Stan Druckenmiller made a few headlines (and waves in the comments section) with his comments yesterday, among which were that he believes an equity bear market started in July.  While Macro Man certainly has sympathy for some of Druckenmiller's views- namely his bearish outlook for the euro- he just cannot quite accept that the fundamental drivers of equities as he sees them are consistent with a bear market.

Regular readers will no doubt be familiar with Macro Man's fundamentally-based equity model, which projects SPX returns 12 months forward.  The standard disclaimer applies- the shape of the line is usually more important than absolute levels, and in any case the projection needs to be vol-adjusted to have any meaning.   In any event, the forecast remains incredibly bullish even with a rather tepid outlook for earnings.

The main driver of the forecast is, unsurprisingly, what Macro Man characterizes as "liquidity" factors; "growth factors" have contributed nothing or negatively to the forecast for several years. 

Now obviously, with the Fed potentially perched at the brink of lift-off, it is foolhardy and potentially dangerous to anticipate the liquidity factors to remain as supportive moving forwards.   This is one of the reasons that Macro Man has treated the model forecast with scepticism over the last few months.   Nevertheless, the model gave ample warning of the secular bears that started in 2000 and 2008...as of yet, no such warning exists.   Moreover, the "scorecard" version of the model remains at its maximum positive reading after turning only moderately bullish for the first half of the year.

The fact is, no one can say with certainty how markets will react to lift-off when (or if, cynics might add) it comes.  As noted yesterday, the set-up for a tactical short for Opportunists and Bears alike is excellent...but there's a big difference between a tactical short and a secular bear.  Though distorted (like the market itself) by modern monetary policies, Macro Man's indicators have a demonstrated history both in and out of sample of getting the big bear calls right.   From a process point of view, therefore, every day is a bad day to conflate tactical opportunity with structural turning point.