Stress

Two up days in a row!   Way-hey!  If risky assets keep this up, soon punters will be humming "Happy days are here again" on their way to work each morning.  Well, perhaps that depends on the punter.  While equity longs and dip-buyers are no doubt relieved at this week's stabilization, oil's dip below $30/bbl suggests that all is still not quite rosy in paradise.  However, where there is market stress, there is also potential opportunity.  Here are three areas Macro Man's looking at:

* Oil.  It's been discussed ad nauseum here, in the comments, and elsewhere, but it's sort of the elephant in the room these days, so the discussion is merited.  There has been some suggestion that oil is a long-term buy, largely because the number (i.e. price) is low.   Macro Man admits to having some sympathy for this view, and it's always good to be wary when analysts are falling over themselves to downgrade price forecasts.

That being said, and with the caveat that your author makes no pretensions of oil expertise other than that of a generally-informed macro observer, there remain some concerns about the prospects for a bounce.   To be sure, a one- or two-week pop has little to do with fundamentals, so if that's all you're playing for it's easy to disregard them.   That being said, as Macro Man pointed out last month, net supply/demand dynamics stink, and as far as he can make out there's little prospect for near-term improvement.

Macro Man often likes to look at one-year trailing Sharpe ratios for asset prices to get a sense for when trend momentum has reached an extreme.  (You can of course do this with shorter time horizons, though the signals are obviously quite noisy.)  Looking at crude, it's hard to make the argument that the trend momentum is overcooked even with the latest decline; the fall was much more monolithic a year ago.

Looking at a similar chart for the "equity crack" trade mentioned yesterday, we get a somewhat similar story:  momentum remains against energy. of course, but the Sharpe is off of its highs.   That being said, those highs handily outstrip any prior reading in the history of the indicator, which usually makes Macro Man a tad nervous.

One clear winner from the whole oil debacle has been the consumer, who has benefited from the collapse in gasoline prices- the average price per gallon across the country is now below $2.  That being said, the consumption numbers have been somewhat disappointing in light of this; one of the big issues for the first half of this year is whether the beneficent impact of lower energy prices begins to be felt more acutely across the economy.   If so, then there's ample room for positive surprises.  If not....then, to quote Ricky Ricardo, the Fed may have some 'splainin' to do.

* Eurostoxx dividend swaps.   Macro Man has written about these periodically over the years, as they occasionally offer very interesting set-ups, and they are a fascinating product intellectually.   Although they are ostensibly a bet on the level of dividend payouts of the SX5E in a given calendar year, in reality they are much more of a bet on the market's willingness to provide liquidity.   This is because there is one natural seller of this instrument- structured product desks in Europe- and no natural buyers.  As such, the premium demanded by buyers offers an interesting insight into risk appetite- or lack thereof.   What makes the product so interesting is that it settles into the actual dividends paid by the companies in the index; while there is obviously some forecasting that goes into that, over the last several years the payouts have been remarkably stable, particularly given the sovereign crisis and pressure upon various banks (large payers in the index.)

The consensus forecast is for payouts to gradually rise over the next five years, though in fairness five years ago there was a similar forecast profile that failed to materialize.   What is clearly not forecast, however, is payouts declining to levels below those observed in the immediate aftermath of the financial crisis.   And yet that's what priced into the curve these days- the orange line in the chart below.

What's particularly notable is just how much the curve has ratcheted lower over the last 3, 6, and 12 months, despite the improvement in both fundamentals and the degree of ECB policy accommodation.   This is clearly indicative of a market unwilling to furnish liquidity to the structured product guys, either through risk aversion or because specs are already long and wrong.  However, in a world where 5 year German govvies yield -0.11%, being able to generate a CAGR of nearly 6% over the next 5 years (assuming an unchanged index dividend payout) looks pretty decent.   Of course, there are risks to the payout level, even if you own these on a hold-to-maturity basis.....but then again, those risks are two-way.   Indeed, Macro Man would suggest at this juncture that after five years of largely unchanged payouts, they are quite possibly tilted to the upside.

* China.   It still seems kind of crazy to those of us who were playing China a decade ago, when 1 year NDFs would price a deep discount to spot, but China is now officially a carry trade.   Thanks to the heavy intervention and lack of sterilization in money markets, there has been a nasty liquidity squeeze.    On Tuesday, overnight CNH HIBOR fixed up at 65%, with cash rates having traded in triple digits.

FX forwards have unsurprisingly blown out as well, with tenors out to 1 month pricing CNH yields in double digits.  The HKMA did eventually inject some liquidity yesterday; while today's fixes have not been announced at the time of writing, Macro Man would expect a further easing if we assume that the authorities have decided that enough's enough in the short run.  While you can see the decline in the 3 month forward points, there's still way above any previous level other than the ding-dong highs of the August crisis.

For the time being, it's difficult to think of CNH as anything but a low-Sharpe ratio trade.    The carry makes it difficult to be short, as does  the apparent line drawn by the authorities.   That being said, it feels like you're only one lousy day in the equity market to put the boot into CNH, and even the 3 month points only cover you to the apparent line in the sand at 6.69 if you are short dollars.  Sometimes it's best to head for the sidelines and await a bit more clarity; now looks like one of those times.  Although its anathema in many quarters, Macro Man would probably prefer the AUD in some guise to play a China stabilization.   China's trade data today is certainly suggestive that a relief rally would not be amiss.