A respite from the cesspit

So bonds took a respite from the cesspit yesterday, though the follow though from the strong open was less than impressive.   Still, the best thing for bruised equity longs was a decline in volatility, which Macro Man will confess came a bit earlier than he anticipated (though stocks still sold off on an index level in both the US and Europe.)

How anomalous has this bond market sell-off been thus far?  While it has certainly achieved a goodly amount of attention (and had a knock-on affect on other markets), that seems to be largely a function of the strength of the prior trend and of the apparent contradiction with recent data weakness in the United States.  If we look at a rolling six month information ratio of a US aggregate investment grade index, we see that it is still quite good (1.66), though naturally it is quite a bit lower than the recent peak.  That peak (4.3 in early July) represented the best run for US fixed income in nearly 5 years- just what you'd expect after the onset of the first Fed tightening in a decade, right?


Interestingly, in the post-crisis period this rolling IR has turned negative roughly every two years.   If one believes that the pattern should hold (though really, there's no reason to), that would imply that bonds stabilize fairly soon and only dive properly during the first half of next year.  On the other hand, if you take the view that with an unemployment rate below 5 and inflation slowly crawling its way back to target bonds should put in negative returns over a six month horizon, clearly that would require further weakness.  Given the strength of the peak in recent performance, Macro Man would incline towards the latter view.

What does it mean for stocks?   Well, it's hard to see it as a positive.  If we look at rolling correlations between fixed income and equity returns, we see that they have recently turned positive.  Macro Man has touched on this before, but it is really curious to see how the correlation regime between the two asset classes changed early in the previous decade.  Historically, bond and stock returns have been positively correlated, but for much of the past 12-15 years they have been negatively correlated- the apotheosis of the dreadful risk on/risk off framework.


Given the degree to which accommodative policy conditions have driven expected equity returns since the crisis, it certainly seems reasonable for the longer-term positive correlation to assert itself.   Given the global nature of capital flows, it has perhaps required the belief in other central banks to waver (and for the persistent asset bid from petrodollars to dry up) for this to materialize.



All this being said, while it's tempting to construct a scenario of a return to 1990's style correlations (while dreaming of 90's style volatility and nominal rate levels, etc), the proof of the pudding will be in the eating.  Macro Man wrote the other day that he doesn't think that this is "the big one", so the inclination will be to book profits on further weakness, not to give the market a good kicking (i.e., the "old skool" macro way of trading.)

Still, it's been a nice respite from the cesspit of ultra low vol, and if Macro Man's wrong and it kicks off properly, so much the better- that's a proper trader's environment! 



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Skippy
admin
September 15, 2016 at 7:34 AM ×

Mr Brownstone, with apologies to Guns and Roses

I used to get around seven (%)
Sometimes I got around nine
And I didn't worry about nothin' no
Cause risk was so..., benign

The flow usually starts around seven
We take on risk around nine
Get on the carry at eleven
Sellin' some vol and feelin' fine

We been dancin' with
Mr. Brownstone*
He's been knockin'
Margin finance can't leave it alone

I used ta do a little leverage but a little wouldn't do
So the little got more and more
I just keep tryin' ta get a little better leverage
Said a little better than before
I used ta do a little leverage but a little wouldn't do
So the little got more and more
I just keep tryin' ta get a little better leverage
Said a little better than before

We been dancin' with
Mr. Brownstone*
He's been knockin'
Margin Finance can't leave it alone

Now I take on whatever
I used to manage risk just fine
But the Central Bank he's a real mutha..
Gotta pay the margin on time


*If Mr Brownstone was central bank liquidity

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RI
admin
September 15, 2016 at 2:46 PM ×

very quiet on here today? terrible px action at the long end. Looks like more to go. Seems a stretch to hope for the Japanese to arrest this move.

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johno
admin
September 15, 2016 at 3:03 PM ×

Terrible retail #s and bonds ... sell off. Remember the days when all news was good news for the 30Y bond? It would seem these aren't them. But we'll see whether the new lows hold ...

Meanwhile, MoF reports second consecutive week of net bond selling by Japanese since April. The sell-off in Japanese long rates (and cross-currency basis) affecting Japanese demand for foreign bonds, it would seem.

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12yo HFM
admin
September 15, 2016 at 3:35 PM ×

very quiet on here today?

Everyone is busy selling bonds and fleeing to the safety of Nasdaq 3X ETFs ;)
Am just waiting until the entire world is long APPL, and Janet postpones the next rate hike, so that I can cash in and take another baecation.

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12yo HFM
admin
September 15, 2016 at 3:36 PM ×

or even AAPL...

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CV
admin
September 15, 2016 at 3:46 PM ×

It's a snoozer indeed. U.S. data looking ugly though. September is dead, and December is waltzing close to the cliff here too. Lots of stuff going on in global manufacturing at the moment, though which could be noise.

- VW supply issues
- Hainjin default (this one is ominous, but even if we don't think it heralds anything fundamentally sinister, it likely is curtailing global supply chains and depressing output).

A few more months' data are needed to hit the panic button, but in the EZ I note that the manufacturing numbers have been equally sh't. Although construction has been better which matters for capex too. I doubt that we're falling off a cliff in manufacturing, though, but key sectors such as autos and aerospace do appear to exhibit end-of-cycle dynamics. Of course, basic material commodities prices are turning up this year, and U.S. oil sector capex collapse is fading, so there is that.

Murky waters I think!

As for the market, I think it has to come lower in the short run. I am not biting here. I think the hunting season for vol sellers has only just started.

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Leftback
admin
September 15, 2016 at 4:08 PM ×

Hmm... snoozer into OpEx. Vol selling, dip buying, 12yo Heaven.

Next week, the selling pressure in (bonds/equities) resumes from M-W?
Then comes Dame Janet, singing "Una Paloma Blanca", sending the Spoos to the sky ..... for a day or two?

After that the market gets back to trading stuff other than FOMC - like global rates, and [earnings?]. Nah....

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Mr. T
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September 15, 2016 at 4:29 PM ×

NDX/SPX outperformance off the Friday close pretty remarkable. I get that AAPL (at 11% of NDX!) is in full on beast mode, but the rest of the mega-ndx's are very strong as well. Makes some sense in the "less sensitive to rising rates" (or in the case of the cash rich guys it may be a net positive), but that whole theme seems (rates going higher) seems to be drying up. I think the more generalized, longer term and actionable hypothesis is that these stocks are the spirit-animals of the market and they are very much alive and well and this dip is done. So many of these stocks have hit inflection points in the last year or 2 where all of a sudden they are gushing cash and its plain for everyone to see that all that high-pe-the-growth-is-coming buying was right all along. If those stocks are rallying, they will pull everything else with it.

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12yo HFM
admin
September 15, 2016 at 4:42 PM ×

@Mr T - You've always struck me as a pleasant and intelligent fellow. I concur fully with your thesis.

NDX led on the downside of this 'minor pullback' to 'generational lows'. It is now leading the way back up, having closed the downside gap. As Mr T aptly points out, investors are likely flocking to the safety of Nasdaq stocks, and fleeing the volatility of fixed income. I believe ATH's in US equity indexes await and then a Santa rally. Thoughts as to where I should book my baecation are most welcome.

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Leftback
admin
September 15, 2016 at 6:12 PM ×

Volatility of volatility isn't over, not quite yet. Global bonds are just not bouncing with any vigour at all, and more sellers will join the throng around the exits next week if curve steepening trends in Japan and Germany continue. This macro current is now a stronger influence than the incoherence of the impotent, insipid and increasingly irrelevant Fed.

The charts for US fixed income are still ugly, and bonds will drag the more rate-sensitive issues down with it, so, yes if you must be long, by all means stay with the {cash-rich} AAPLs and GOOGs and beware REITs, energy, commodities. We still like short [TLT, IYR, IWM] as a trading thesis for now, and will re-enter this trade soon once the latest orgy of vol selling ends.

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Chili Boi
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September 15, 2016 at 6:34 PM ×

What's the benchmark for the information ratio? AGG is what's being measured?

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Nico G
admin
September 15, 2016 at 8:40 PM ×

2143 pre-expiry is an optimum short entry for a little sub-2100 scare next week

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Macro Man
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September 15, 2016 at 8:50 PM ×

@ Chili Boi The benchmark is zero. I guess you could call it a Sharpe, but without the T bill yield taken out of the returns.

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Chili Boi
admin
September 15, 2016 at 9:52 PM ×

@Macro Man That's what I suspected and how I would calculate as well. Thanks! Great read.

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Anonymous
admin
September 16, 2016 at 10:25 AM ×

I wish middle aged market participants would stop doing cra@p like this.......you see it constantly. Use an AC/DC and change the lyrics....hillarious

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