Disequilibrium

Another day, another equity rally.  The SPX has managed to take its year-to-date loss below 5%, and while most other major indices have fared rather worse by comparison, the feeling that we've stepped away from the brink is palpable.  Spooz are now at a fairly critical level; a sustained break of 1950 would confirm not only another double-bottomed W formation, but also represent a break back above the 50 day moving average.


The feel-good factor isn't confined to equities, however.   Iron ore has quietly put in a 25% rally over the last six weeks or so, and while it is still light-years away from its previous lofty heights, that nevertheless represents the highest price in five months.  Attributing the rally to Chinese demand seems obvious, though as one old friend noted yesterday, determining exactly why the Chinese would snaffle iron ore is a little more problematic.  Embarking on a 2009-style commodity investment orgy would appear to be problematic, both because of the dubious impact it would have on economic output and its apparent contradiction to the regime's long-stated goal of re-balancing the growth model.

In any event, it's another datapoint to suggest that the deflation may not have quite as firm a grip on things as some may have feared (or hoped.)  The irony, of course, is that in stepping away from the brink of deflation, at least in the United States, we draw the Federal Reserve back into play.  And that, with its concomitant implications for financial conditions, is hardly an unalloyed positive for US equities.  It's a reason to expect a broad range to hold in the S&P, as we flit between bad nominal growth/easier money and higher nominal growth/tighter growth regimes, neither of which represents a stable equilibrium for US equities.

After the recent data releases Macro Man ran his US equity model to get an early read on the February output.   Imagine his surprise when he saw the forecast dive quite a bit lower!  There are a couple of reasons for this which astute readers may be able to fathom, but given the success that he's had with the model over the past eight years, he takes any abrupt changes quite seriously.

In an absolute sense, the forecast is still quite high, mind you.  Still, there's been an evident deterioration in the underpinning of the "equities going up forever" religion; one of the factors in Macro Man's scorecard model flipped negative in January and has evidently stayed that way this month.



Neither of these models are suggestive of an immediate requirement to sell equities; indeed, both are consistent with ongoing length, albeit at levels somewhat lower than maximum size.  And that's probably fair, given the competing disequilbria noted above.   Ultimately, 2016 may go down as a stock- or sector-picker's market rather than a notable bull or bear on an index level, at least in the US.  Given that that sounds a lot like 2015, perhaps disequilibrium is the new equilibrium in the US...

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Anonymous
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February 23, 2016 at 10:14 AM ×

It would be helpful to add subsequent 12-month returns to your S&P 500 forecast chart

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Leftback
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February 23, 2016 at 11:17 AM ×

Thanks for the charts and summary, MM.

LB's game plan is to stay moderately long while not much is happening and the echoes of the last little panic continue to ebb. We are also sort of thinking about SPX in terms of a W (having already noted here many parallels between the microstructure of the Aug/Sept and Jan/Feb sell-offs and recoveries), and this means that the bull/bear battle will eventually be joined in earnest up near the 200dma, or somewhere between 1980 and 2000.

Vol selling seems to be back, so Polemic's words are always ringing in our ears, and for the time being this aphorism reigns: "never sell a dull market". In this context, it's interesting how even a firmer yen is apparently no longer disastrous for equities. Does this mean that JPY carry trades were unwound to some extent during the last panic?

LB has been wondering if we might see DGDF re-instituted this year and drive a modest recovery in EMs. Still too early? Probably so. Renewed € and £ weakness probably have some way to go before the Buck finally rolls over. Notwithstanding the effects of rents and health care, we remain quite unconvinced about the return of US inflation. A revival of the Hawks and Hikers club seems premature, although the US may endure a bit of UK-style "Stagflation Lite" during 2016.

Fixed income looks decidedly sickly here. We can expect some of the excesses that led JGB10y to go negative to be worked off, and bunds, gils and Treasury yields all look set to move higher for a while. Stay away. Replay of late Feb to early Mar '15?

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Booger
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February 23, 2016 at 12:03 PM ×

Iron ore: The bounce has slipped my attention until recently as well. ? a short term effect from the Samarco disaster in November last year temporarily reducing global output? With virtually no steel producers in China turning a profit, one wonders when they will have to cut production and the iron ore price heads south again. Long term, the supply-demand dynamics for ore appear worse than oil.

Which has me looking at shorting AUD.USD again. I thought 0.71 was good value and it has now reached 0.725 where I loaded up another half clip. I would be surprised if the rally went beyond 0.735. The spec market has also turned net long AUD.USD for the first time in a year recently.

EUR.USD: really moving in anticipation of Draghi. It will be interesting to see what he delivers in March. The lowhanging fruit may be gone there.

Spoos: 2000 would be a good place to short. The second break might be THE ONE (Or it might not be). Can't see why the things weighing down would not resume (Oil SWF selling, tightening credit conditions particularly HY) dragging on the market. But then again, this is a QE, ZIRP world so things could zip to new highs at any moments notice etc. It's hard to punt much on.

USD.JPY: I wonder why the yen has still been so weak with the Nikkei rallying last 2 weeks, USD.JPY is back to 112. So it must not be just Nikkei liquidation and currency hedging. I wonder where the other side of this equation is.

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washedup
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February 23, 2016 at 12:47 PM ×

MM - very intriguing result indeed - to what do you attribute the steady upwardly sloping channel, or drift in expected returns from equities being produced by your model since say 2002? Steady state valuations haven't really gotten steadily cheaper since then except during crashes for 5 seconds - I would have guessed lowered long term yields but you mentioned once that you don't think structural disinflation is the reason. I know sometimes multi-factor models are hard to interpret that way - would appreciate a hypothesis if you have one.

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Macro Man
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February 23, 2016 at 1:46 PM ×

@ washed it is very clearly the monetary regime put in place. I have periodically disaggregated the model into what I term growth and liquidity factors. The last time was here, and you can clearly see the outsized contribution of liquidity factors (ie super easy monetary policy).

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washedup
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February 23, 2016 at 2:07 PM ×

MM that helps a lot thx - the key question then would be whether to focus on small marginal changes in liquidity (as referenced by M2 or CB balance sheets or LIBOR-OIS), or to focus on the overall level - my hunch would the latter.
Speaking of money supply, I wasn't expecting this for q4 2015 given the carnage in the energy sector:

http://www.tradingeconomics.com/united-states/loans-to-private-sector

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Anonymous
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February 23, 2016 at 2:24 PM ×

Leftback: This observation and confirmation from you makes me quite bullish. Lets see if it is justified or not in a month:) But I have also focused on the breakdown in USDJPY correlation, together with the aggressive vol selling as this possibly being a trend shift in ever higher lows in put to call ratios and USDJPY correlation since january 2014. The fact that I as well as everyone else seems to look for a place to sell though confirms this trend shift possibility.

"Vol selling seems to be back, so Polemic's words are always ringing in our ears, and for the time being this aphorism reigns: "never sell a dull market". In this context, it's interesting how even a firmer yen is apparently no longer disastrous for equities. Does this mean that JPY carry trades were unwound to some extent during the last panic?"

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DownWithTheBeanCounters
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February 23, 2016 at 2:46 PM ×

LB, when you say vol selling is back are you speaking from anecdotal experience or is there some gauge you refer to?

Thanks,
DWTBC

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Anonymous
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February 23, 2016 at 3:40 PM ×

Yen carry SPX correlation:

http://imgur.com/tx40dCf

http://imgur.com/ewnTjut

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Anonymous
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February 23, 2016 at 3:50 PM ×

12/13/15 SPX prediction:

http://imgur.com/3aFxWzD

Status update:

( Top shows what has happened so far...on bottom we are in the midst of the 2nd green arrow )

http://imgur.com/aFAKTya

RED arrow coming..

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Anonymous
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February 23, 2016 at 3:54 PM ×

http://www.telegraph.co.uk/business/2016/02/22/get-ready-to-be-showered-by-helicopter-money/

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CV
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February 23, 2016 at 4:00 PM ×

"Replay of late Feb to early Mar '15?"

Yes LB! I think lazy longs in FI won't like their return sheets in the next couple of months. I think it will be ugly.

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Anonymous
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February 23, 2016 at 5:07 PM ×

"never sell a dull market"- not sure which market u talking about but the year so far - yes including this sweet- could hardly be categorised as dull -esp equities.
for my own - I'm leaning long with a view to get short aroun 2000 spoos- longs are -once again-concentrated in europe

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abee crombie
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February 23, 2016 at 5:10 PM ×

CV - we might need to get some good news for that to happen. Consumer Confidence down, early PMI generally down. El-Erian was out yesterday with a pretty bearish article.

I'd love to be a bull here, with commodities so low and EM FX finally stabilizing. But to really knock the bear case out, you'd wanna see higher rates or at least a steeper curve, which a pro growth signal, IMO. though looking historically I'm not sure if its such a good indicator as the curve flattened big time in 05, and steepened in 07, and you wanted to own stocks in the opposite times, so who knows

Not saying this is even close to 08, but interesting to see how price action has played out so far. In 2008, we had a sharp selloff in Jan (-13% to start the year) , followed by a re-test of the low in March (Bear Sterns) and then a tag of the 200 day in May which was THE place to sell. As well, in both instances, you had the S&P making double tops several months earlier



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Leftback
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February 23, 2016 at 5:52 PM ×

Interesting discussion, with some merit to both sides of the argument.

Vol selling = what happened last week, also collapse in put/call. [Please take a look at what happened to VIX in October].
Dull market - clearly not when one is looking in the rear-view mirror, but when looking forward to Fed on hold and Draghi?
USDJPY/wti/Spoos correlation = what happened today (re-coupling)

Expecting Spoos to tag the 200 day some time in March. A pullback here from 1950 (50 day) was not surprising. Not inclined to do anything at all here but might add a bit if we see the 1870-1895 range again. Wouldn't touch F/I until we see a 2.00% 10y again.

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Anonymous
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February 23, 2016 at 6:05 PM ×

What will Draghi do?

ECB's preferred measure of inflation expectations still dropping. Something spectacular in March needed to stop it.


https://twitter.com/CapEconEurope/status/702159416930521089

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CV
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February 23, 2016 at 6:14 PM ×

Hmm, fair enough Abee. I might be too aggressive. The thing is, I am merely applying the tools that tend to work best when the world is not ending; i.e. stock-to-bond returns for examjavascript:void(0)ple combined with likely mean-reversion in macro surprise indices. Pretty clear message from these now.

I will say one thing about the macro data in the Eurozone,though. They are taking a turn for the worse, indicating cyclical downside. Today's IFO report was dreadful. The crash in the expectations index below 100 is ominous. If it stays there, it signals recession, despite the decent headline GDP data in Q4. In Q4, the survey and economic data swooned as well but Draghi pulled it back from the brink. Can he do it again?

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CV
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February 23, 2016 at 6:14 PM ×

I meant to say:

" In Q4 2014(!), the survey and economic data swooned as well but Draghi pulled it back from the brink. Can he do it again?

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DownWithTheBeanCounters
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February 23, 2016 at 8:13 PM ×

Thank you LB. I figured vol was under performing because everyone was ditching it for long bonds; aka the hedge that pays you.

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Anonymous
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February 23, 2016 at 8:24 PM ×

http://www.forbes.com/sites/jareddillian/2016/02/23/the-gold-bull-market-is-real-and-unbelievably-sinister/#30cb9413201f

The sooner people eliminate these central bank scum the better...

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Anonymous
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February 23, 2016 at 9:29 PM ×

IG CDX holding most of yesterday's gains, & US fins CDS tighter. $18B of new issues yesterday & > $10B today. Credit outperforming stocks today. All is well.

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Nico G
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February 24, 2016 at 2:46 AM ×

'shadow banking' slowly getting out of the shade

Bloomberg covering Ireland's insane level of shadow banking. Watch China next

http://www.bloomberg.com/news/articles/2016-02-24/russian-bank-collapse-shines-light-on-risks-in-irish-shadows

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abee crombie
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February 24, 2016 at 3:48 AM ×

Nico I think the article is touching upon the fact that almost every Russian bond ( at least the ones I've seen ) are issued by an offshore entity and that you don't really have recourse in the Russian company ( not that it would matter much ) . They are organized as loan participation notes with the issuing company usually domiciled in Ireland, Luxembourg etc.

Kinda like how if you own any Chinese adr's you don't really own the Chinese company ( it forbidden) but you own interest in a cayman company who owns the rights to the Chinese company (vie) bc the ceo or founder is Chinese, owns the Chinese company and has pledged that ownership to the cayman company.

Gotta love bankers.

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Anonymous
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February 24, 2016 at 12:38 PM ×

BBG: Tom DeMark
"Now that this S&P 500 trigger has occurred, the benchmark index will decline at least 8.2 percent from Monday’s close (1945) to 1,786, a level last seen in February 2014, according to DeMark. Should the market top correspond with what he referred to as “bad news,” the S&P 500 could see deeper selling down to 1,736, an 11 percent decline. DeMark sees the ongoing market rally as temporary relief as investors exit short positions."

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